UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

 

 

Form 10-K

 

 

Commission file numbers 001-13251

 

 

 

 

SLM Corporation

(Exact Name of Registrant as Specified in Its Charter)

 

 

(703) 810-3000

(Registrant’s Telephone Number, Including Area Code)

 

Securities registered pursuant to Section 12(b) of the Act

Common Stock, par value $.20 per share.

Name of Exchange on which Listed:

New York Stock Exchange

6.97% Cumulative Redeemable Preferred Stock, Series A, par value $.20 per share

Floating Rate Non-Cumulative Preferred Stock, Series B, par value $.20 per share

Name of Exchange on which Listed:

New York Stock Exchange

Medium Term Notes, Series A, CPI-Linked Notes due 2017

Medium Term Notes, Series A, CPI-Linked Notes due 2018

6% Senior Notes due December 15, 2043

Name of Exchange on which Listed:

New York Stock Exchange

Securities registered pursuant to Section 12(g) of the Act:

None.

 

 

 

 

Indicate by check mark whether the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes þ     No o

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act.  Yes o     No þ

 

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 þ     No o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes þ     No o

 

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.  þ

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o     No þ

 

The aggregate market value of voting stock held by non-affiliates of the registrant as of June 30, 2010 was $5.0 billion (based on closing sale price of $10.39 per share as reported for the New York Stock Exchange — Composite Transactions).

 

As of January 31, 2011, there were 526,909,601 shares of voting common stock outstanding.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Portions of the Proxy Statement relating to the registrant’s Annual Meeting of Shareholders scheduled to be held May 19, 2011 are incorporated by reference into Part III of this Report.

 

 

FORWARD-LOOKING AND CAUTIONARY STATEMENTS

 

This report contains forward-looking statements and information based on management’s current expectations as of the date of this document. Statements that are not historical facts, including statements about our beliefs or expectations and statements that assume or are dependent upon future events, are forward-looking statements. Forward-looking statements are subject to risks, uncertainties, assumptions and other factors that may cause actual results to be materially different from those reflected in such forward-looking statements. These factors include, among others, the risks and uncertainties set forth in Item 1A “Risk Factors” and elsewhere in this Annual Report on Form 10-K; increases in financing costs; limits on liquidity; increases in costs associated with compliance with laws and regulations; any adverse outcomes in any significant litigation to which we are a party; credit risk associated with our exposure to third parties, including counterparties to our derivative transactions; and changes in the terms of student loans and the educational credit marketplace (including changes resulting from new laws and the implementation of existing laws). We could also be affected by, among other things: changes in our funding costs and availability; reductions to our credit ratings; failures of our operating systems or infrastructure, including those of third-party vendors; damage to our reputation; failures to successfully implement cost-cutting and restructuring initiatives and adverse effects of such initiatives on our business; changes in the demand for educational financing or in financing preferences of lenders, educational institutions, students and their families; changes in law and regulations with respect to the student lending business and financial institutions generally; increased competition from banks and other consumer lenders; the creditworthiness of our customers; changes in the general interest rate environment, including the rate relationships among relevant money-market instruments and those of our earning assets versus our funding arrangements; changes in general economic conditions; and changes in the demand for debt management services. The preparation of our consolidated financial statements also requires management to make certain estimates and assumptions including estimates and assumptions about future events. These estimates or assumptions may prove to be incorrect. All forward-looking statements contained in this report are qualified by these cautionary statements and are made only as of the date of this document. We do not undertake any obligation to update or revise these forward-looking statements to conform the statement to actual results or changes in our expectations.

 

Definitions for capitalized terms used in this document can be found in the “Glossary” at the end of this document.

 

AVAILABLE INFORMATION

 

The Securities and Exchange Commission (“SEC”) maintains an Internet site (http://www. sec.gov) that contains periodic and other reports such as annual, quarterly and current reports on Forms 10-K, 10-Q and 8-K, respectively, as well as proxy and information statements regarding SLM Corporation and other companies that file electronically with the SEC. Copies of our annual reports on Form 10-K, quarterly reports on Form 10-Q and other periodic reports are available on our website as soon as reasonably practicable after we electronically file such reports with the SEC. Investors and other interested parties can also access these reports at www.salliemae.com/about/investors.

 

Our Code of Business Conduct, which applies to Board members and all employees, including our Chief Executive Officer and Chief Financial Officer, is also available, free of charge, on our website at www.salliemae.com/about/business_code. htm. We intend to disclose any amendments to or waivers from our Code of Business Conduct (to the extent applicable to our Chief Executive Officer or Chief Financial Officer) by posting such information on our website.

 

In 2010, we submitted the annual certification of our Chief Executive Officer regarding our compliance with the NYSE’s corporate governance listing standards, pursuant to Section 303A.12 (a) of the NYSE Listed Company Manual.

 

In addition, we filed as exhibits to our annual reports on Form 10-K for the years ended December 31, 2008 and 2009 and to this Annual Report on Form 10-K, the certifications required under Section 302 of the Sarbanes-Oxley Act of 2002.

PART I.

 

 

SLM Corporation, more commonly known as Sallie Mae, is the nation’s leading saving, planning and paying for education company. SLM Corporation is a holding company that operates through a number of subsidiaries. References in this Annual Report to “we,” “us,” “our” and “the Company,” refer to SLM Corporation and its subsidiaries, except as otherwise indicated or unless the context otherwise requires. The Company was formed in 1972 as the Student Loan Marketing Association, a federally chartered government sponsored enterprise (“GSE”), with the goal of furthering access to higher education by providing liquidity to the student loan marketplace. On December 29, 2004, we completed the privatization process that began in 1997 and resulted in the dissolution of the GSE.

 

Our primary business is to originate, service and collect loans made to students and/or their parents to finance the cost of their education. We provide funding, delivery and servicing support for education loans in the United States, through our non-federally guaranteed Private Education Loan programs and as a servicer and collector of loans for the Department of Education (“ED”). In addition we are the largest holder, servicer and collector of loans made under the Federal Family Education Loan Program (“FFELP”), a program that was recently discontinued.

 

We have used internal growth and strategic acquisitions to attain our leadership position in the education finance market. The core of our marketing strategy is to generate student loan originations by promoting our products on campus through the financial aid office and through direct marketing to students and their parents. These sales and marketing efforts are supported by the largest and most diversified servicing capabilities in the industry.

 

We also earn fee income by providing student loan-related services including student loan servicing, loan default aversion and defaulted loan collections, processing capabilities and information technology to educational institutions, and 529 college-savings plan program management services and a consumer savings network.

 

At December 31, 2010, we had approximately 7,600 employees.

 

We are in the process of relocating our headquarters from Reston, Virginia to Newark, Delaware, and expect to complete the move by March 31, 2011.

 

Recent Developments and Expected Future Trends

 

On March 30, 2010, President Obama signed into law H.R. 4872, the Health Care and Education Reconciliation Act of 2010 (“HCERA”) which included the SAFRA Act. Effective July 1, 2010, all federal loans to students are now made through the Direct Student Loan Program (“DSLP”). The FFELP, through which we historically generated the majority of our net income, was eliminated. However, HCERA does not alter or affect the terms and conditions of existing FFELP Loans. The $1.37 billion net interest income we earned on our FFELP Loan portfolio in 2010 will decline as the portfolio amortizes.

 

In addition, SAFRA eliminates the Guarantor function and the services we provide to Guarantors. We earned an origination fee when we processed a loan guarantee for a Guarantor client and a maintenance fee for the life of the loan for servicing the Guarantor’s portfolio of loans. Since FFELP Loans are no longer originated, we will no longer earn the origination fee paid by the Guarantor. The portfolio that generates the maintenance fee is now in run off, and the maintenance fees we earn will decline as the portfolio amortizes. In 2010, we earned Guarantor origination fees of $34 million and maintenance fees of $56 million.

 

Our student loan contingent collection business is also affected by HCERA. We currently have 13 Guarantors and ED as clients. We earn revenue from Guarantors for collecting defaulted loans as well as for managing their portfolios of defaulted loans. In 2010, contingency collection revenue from Guarantor clients totaled $245 million. We anticipate that revenue from Guarantors will be relatively stable through 2012 and then begin to steadily decline as the portfolio of defaulted loans we manage is resolved and amortizes.

We have been collecting defaulted student loans on behalf of ED since 1997. The contract is merit based and accounts are awarded on collection performance. We have consistently ranked number one or two among the ED collectors. In anticipation of a surge in volume as more loans switch to DSLP, ED added five new collection companies bringing the total to 22. This led to a decline in account placements, which we believe is temporary. We expect that as the DSLP grows, increased revenue under the ED contract will partially offset the decline in revenue from our Guarantor clients.

 

As a result of HCERA, our FFELP Loans segment is now a runoff business. Our Consumer Lending and components of Business Services segments are ongoing businesses with growth opportunities. We are currently restructuring our operations to reflect the impact of the legislation which has resulted in significant restructuring expenses. In 2010 most of our $85 million of restructuring expenses related to HCERA.

 

Student Lending Market

 

Students and their families use multiple sources of funding to pay for their college education, including savings, current income, grants, scholarships, and federally guaranteed and private education loans. Due to an increase in federal loan limits that took effect in 2007 and 2008, we have seen a substantial increase in borrowing from federal loan programs in recent years. In the Academic Year (“AY”) that ended on June 30, 2010, according to the College Board, borrowing from federal loan programs increased 14 percent from the prior year to $96.8 billion and has a five-year compound annual growth rate of 9.9 percent. Borrowing from Private Education Loan programs decreased 24 percent to $7.7 billion and is down significantly from the peak of $21.8 billion in the AY 2007-2008. The College Board also reported that federal grants increased 64 percent to $41.2 billion from $25.2 billion in the most recent year. We believe the drop in borrowing from private loan programs was caused by an increase in federal loans and consumer deleveraging.

 

Federal Family Education Loan Program (“FFELP”)

 

Prior to its elimination on July 1, 2010 by HCERA, the FFELP was the source of the vast majority of federal loans to students. (For a full description of FFELP, see Appendix A “Federal Family Education Loan Program.”) As of September 30, 2010, there were $759 billion in federal student loans outstanding, $529 billion of which were originated under the FFELP. Private entities held $390 billion of FFELP Loans as of September 30, 2010, with the remaining amount held by ED. We were the largest originator of loans under the FFELP and had $148.6 billion of loans outstanding at December 31, 2010. See Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Segment Earnings Summary — ‘Core Earnings’ Basis — FFELP Loans Segment” for a full discussion of our FFELP business and related loan portfolio.

 

The Higher Education Act (the “HEA”) regulates every aspect of the FFELP, including communications with borrowers and default aversion requirements. Failure to service a FFELP Loan properly jeopardizes the guarantee on the loan. This guarantee generally covers 98 or 97 percent of the student loan’s principal and accrued interest for loans disbursed before and after July 1, 2006, respectively. In the case of death, disability or bankruptcy of the borrower, the guarantee covers 100 percent of the loan’s principal and accrued interest. The guarantees on our existing loans were not affected by HCERA.

 

FFELP Loans are guaranteed by state agencies or not-for-profit companies designated as Guarantors, with ED providing reinsurance to the Guarantors. Guarantors are responsible for performing certain functions necessary to ensure the program’s soundness and accountability. Generally, the Guarantor is responsible for ensuring that loans are serviced in compliance with the requirements of the HEA. When a borrower defaults, we submit a claim to the Guarantor who provides reimbursements of principal and accrued interest subject to Risk Sharing. (See Appendix A “Federal Family Education Loan Program” for a description of the role of Guarantors.)

 

Private Education Loan Products

 

We offer Private Education Loan products to bridge the gap between family resources, federal loans, grants, student aid, scholarships, and the cost of a college education. Historically, the majority of our Private Education Loans were made in conjunction with a FFELP Stafford Loan and were marketed to schools

through the same marketing channels and by the same sales force as FFELP Loans. We also originated Private Education Loans at DSLP schools. While we continue to actively maintain our presence in school marketing channels, changes in the student loan industry, school practices and the marketing of consumer lending products in general require us to continue to develop and evolve our marketing efforts through various other direct and indirect marketing channels, such as direct mailings, internet channels and marketing alliances with various banks and financial institutions. As a result of the credit market dislocation of 2008 and 2009, a large number of lenders have exited the Private Education Loan business and only a few of the country’s largest banks and specialty finance companies continue to originate the product in any significant volumes.

 

Growth in the Student Loan Industry

 

Growth in our “Core Earnings” basis student loan portfolio and our servicing and collections businesses is driven by the growth in the overall market for student loans, as well as by market share gains. Rising enrollment and college costs and increases in borrowing limits have caused the federal student loan market to grow at a 10-year annual growth rate of 8.6 percent.

 

According to the College Board, tuition and fees at four-year public institutions and four-year private institutions have increased at a compound annual growth rate of 11.4 percent and 7.1 percent, respectively, since AY 2000-2001, well in excess of the 2.3 percent compound annual growth rate of the consumer price index. The first federal loan limit increases since 1992 were implemented July 1, 2007. In response to the credit crisis, Congress significantly increased loan limits again on July 1, 2008. Borrowers using DSLP are expected to increase 4 percent per year over the next three years. If the cost of education continues to increase at a pace that exceeds income and savings growth, we expect more students to borrow from private loan programs.

 

The National Center for Education Statistics predicts that college-enrollment will increase 14 percent from 2010 to 2019. Demand for education credit is expected to increase with enrollment over the next decade.

 

Federal Direct Student Loan Programs

 

Students and their families can borrow money directly from the federal government to pay for a college education under the DSLP. The loans can be used to cover the cost of tuition, room and board. A dependent undergraduate student can borrow up to $5,500 as a freshman and $7,500 as a senior. An independent undergraduate student can borrow $9,500 as a freshman and up to $12,500 as a senior. A graduate student can borrow up to the full cost of attendance. Students apply directly to the federal government for a Direct Loan and the funds are dispersed directly to the school he or she is attending. The DSLP is serviced by four private sector institutions, including Sallie Mae. Defaulted Direct Loans are collected by 22 private sector companies, including Sallie Mae.

The following charts show the historical and projected enrollment and average tuition and fee growth for four-year public and private colleges and universities.

 

Historical and Projected Enrollment
(in millions)

 

 

Source: National Center for Education Statistics

 

Note:  Total enrollment in all degree-granting institutions; middle alternative projections for 2009 onward.

 

Cost of Attendance⁽¹⁾
Cumulative % Increase from AY 2000-2001

 

 

Source: The College Board

 

 

Business Segments

 

We have three primary business segments — the FFELP Loans segment, Consumer Lending segment and the Business Services segment. A fourth segment — Other, primarily consists of the financial results related to the repurchase of debt, the corporate liquidity portfolio and all overhead. We also include results from smaller wind-down and discontinued operations within this segment.

 

FFELP Loans Segment

 

Our FFELP Loans business segment consists of our FFELP Loan portfolio and the underlying debt and capital funding the loans. These FFELP Loans are financed through various types of secured non-recourse

financing vehicles and unsecured debt. At December 31, 2010, we held $148.6 billion of FFELP Loans, of which 77 percent were funded to term by securitization trusts, 16 percent were funded through the ED Conduit Program which terminates on January 19, 2014, and 5 percent were funded in our multi-year asset-backed commercial paper (“ABCP”) facility and Federal Home Loan Bank in Des Moines facility (“FHLB-DM”). The remainder was funded with unsecured debt. As a result of the long-term funding used in the FFELP Loan portfolio and the government guarantees provided on the loans, the net interest margin recorded in the FFELP Loans segment tends to be relatively stable. In addition to the net interest margin, we earn other fee income which is primarily generated by late fees on the loans in the portfolio. For a more detailed description of these various funding facilities, see Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources.”

 

FFELP Loans segment operating expenses primarily represent an intercompany charge from the Business Services segment which performs the servicing of these loans. Servicing is charged at rates paid by the trusts which own the loans. These servicing rates exceed the actual cost of servicing the loans.

 

Our FFELP Loan portfolio will amortize over approximately 25 years. Our goal is to maximize the cash flow generated by the portfolio. We will seek to acquire third-party FFELP Loan portfolios to add spread income and servicing revenue as portfolios are converted onto our platforms to generate incremental earnings and cash flow. We expect owners of runoff portfolios to sell them in the future.

 

Consumer Lending Segment

 

In this segment, we originate, acquire, finance and service Private Education Loans. Private Education Loans consist of two general types: (1) those that are designed to bridge the gap between the cost of higher education and the amount financed through either federal loans or the borrowers’ resources, and (2) those that are used to meet the needs of students in alternative learning programs such as career training, distance learning and lifelong learning programs. Private Education Loans bear the full credit risk of the borrower. We manage this risk by underwriting and pricing according to credit risk based upon customized credit scoring criteria and the addition of qualified cosigners.

 

In 2010 we originated $2.3 billion of Private Education Loans. As of December 31, 2010 and 2009, we had $35.7 billion and $35.1 billion of total “Core Earnings” basis Private Education Loans outstanding, respectively. For a more detailed description of these amounts, see Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Segment Earnings Summary — ‘Core Earnings’ Basis — Consumer Lending Segment.” At December 31, 2010, 68 percent of our Private Education Loans were funded to term in securitization trusts and the remainder was funded with term unsecured debt and bank deposits.

 

In this segment, we earn net interest income on the loan portfolio (after provision for loan losses) as well as account fees, primarily late payment and forbearance fees. Operating expenses for this segment include costs incurred to acquire and to service our loans.

 

In early 2011, we will launch a pilot Sallie Mae credit card that is tailored to meet the financial needs of the college-educated consumer. We will market this card to college students and their parents and to customers who have completed their education. We will focus on customers who have a strong credit profile. We have a customer base of more than 20 million. Successfully cross-selling the Sallie Mae credit card could lead to an expanded product mix on a stand-alone and partnership basis.

 

Sallie Mae Bank (“the Bank”), a Utah industrial bank subsidiary, plays an integral role in this segment. We received our Utah State charter approval order effective October 12, 2005 and approval for our insurance from the Federal Deposit Insurance Corporation (“FDIC”) on October 26, 2005. Since the beginning of 2006, nearly all Private Education Loans have been originated and initially funded by the Bank. At December 31, 2010, the Bank had total assets of $7.6 billion including $4.4 billion in Private Education Loans and total deposits of $5.9 billion. Historically, the Bank focused on raising brokered deposits with an average life in excess of two years. In 2010 we began to gather retail deposits targeting our core customer base. We raised more than $1 billion in retail deposits. We are now fully developing our banking products and services to offer

education finance products to colleges. As a result of recent changes in the student loan marketplace, we have broadened our marketing activities to include Direct to Consumer initiatives and referral lending relationships. We also intend to create loan volume through our “Planning, Paying and Saving” for college activities.

 

We face competition for Private Education Loans from a group of the nation’s larger banks and specialty finance companies. However, in recent years this sector has seen a significant departure of market participants as a result of the nation’s financial challenges as well as the recent significant changes in the FFELP.

 

Business Services Segment

 

The Business Services segment generates its revenue from servicing our FFELP Loan portfolio as well as servicing FFELP and other loans for other financial institutions, Guarantors and ED. The segment also performs default aversion work and contingency collections on behalf of Guarantors and ED, Campus Payment Solutions, account asset servicing and transaction processing activities. We are the largest servicer of student loans, the largest collector of defaulted student loans, the largest administrator of 529 college-savings plans and saving for college loyalty programs, and we have a growing Campus Payment Solutions platform.

 

The segment generates revenue from servicing FFELP Loans owned and managed by us. These revenues are intercompany charges to the FFELP Loans segment and are primarily charged at rates paid by the trusts where the loans reside. The fees are contractually designated as the first payment from the trust cash flows. These fees are high quality in terms of both their priority and predictability and exceed the actual cost of servicing the loans. Revenue is also generated by servicing third-party loans for other financial institutions and ED.

 

We generate revenue by servicing FFELP Loans for Guarantors. We earn an account maintenance fee on a portfolio of $99 billion of FFELP Loans for nine Guarantors. We provide a full complement of default aversion and default collection services on a contingency or pay for performance basis to 13 Guarantors, campus-based programs and ED. We have performed default collections work for over ten years and have consistently been a top performer.

 

Through Upromise we generate revenue by providing program management services for 529 college-savings plans with assets of $34.5 billion in 32 college-savings plans in 16 states. We also generate revenue in the form of transaction fees generated by our consumer savings network, through which members have earned $600 million in rewards by purchasing products at hundreds of online retailers, booking travel, purchasing a home, dining out, buying gas and groceries, using the Upromise World Master Card and completing qualified transactions. We earn a fee for the marketing and administrative services we provide to companies that participate in Upromise savings network.

 

Finally, our Campus Payment Solutions business offers a suite of solutions designed to help campus business offices increase their services to students and families. The product suite includes electronic billing, collection, payment and refund services plus full tuition payment plan administration. In 2010, we generated servicing revenue from over 1,100 schools.

 

Operating expenses for this segment include the cost incurred to perform the services described above.

 

We expect that FFELP-related servicing and Guarantor servicing and contingency revenue will decline over time as the FFELP Loan portfolios amortize. We expect that revenues under the ED collections contract will increase as the Direct Lending program expands. Between 2004 and 2008, less than 25 percent of student loans were originated under the Direct Lending program. Effective July 1, 2010, all government guaranteed student loans are originated through the Direct Lending program. This growth will create revenue opportunity under the ED collections contract as the volume of defaults of Direct Loans surges in the coming years. We expect revenue to increase under our ED Direct Loan servicing contract, as discussed below, as that program grows. We also expect growth in our 529 college-savings plan programs and Campus Payment Solutions businesses.

The Bank is also a key component of our Campus Payment Solutions and college savings products. We utilize the Bank to warehouse funds from our Campus Payment Solutions and refund services business. In addition, the Upromise rewards earned by members are held at the Bank.

 

FFELP and Guarantor servicing is a runoff business and therefore we face very little competition. In the second quarter of 2009, ED named Sallie Mae as one of four servicers awarded a servicing contract (the “ED Servicing Contract”) to service all federal loans owned by ED. The contract will span five years with one, five-year renewal at the option of ED. We compete for Direct Loan servicing volume from ED with the three other servicing companies with whom we share the contract. The contract has four years remaining. Account allocations are awarded annually based on each company’s performance on five different metrics: defaulted borrower count, defaulted borrower dollar amount, a survey of borrowers, a survey of schools and a survey of federal personnel. We are focused on improving our performance as measured by these metrics to increase our market share and allocation of accounts under the ED Servicing Contract.

 

The private sector collections industry is highly fragmented with a few large companies and a large number of small scale companies. The businesses that provide third-party collections services for ED, FFELP Guarantors and other federal holders of defaulted debt are highly competitive. In addition to competing with other collection enterprises, we also compete with credit grantors who each have unique mixes of internal collections, outsourced collections and debt sales.

 

The account asset servicing and transaction processing businesses are also highly competitive. We compete for Campus Payment Solutions business and 529 college-savings plan and transaction services business with banks, financial services and other processing companies.

 

The scale, diversification and performance of our Business Services segment have been, and we expect them to remain, a competitive advantage for us.

 

Other Segment

 

The Other segment primarily consists of the financial results related to the repurchase of debt, the corporate liquidity portfolio and all overhead. We also include results from smaller wind-down and discontinued operations within this segment. These are the Purchased Paper businesses and mortgage and other loan businesses. The Other segment includes our remaining businesses that do not pertain directly to the primary segments identified above. Overhead expenses include costs related to executive management, the board of directors, accounting, finance, legal, human resources, stock option expense and certain information technology costs related to infrastructure and operations.

 

Recent Legislation

 

The passage of H.R. 4872, including SAFRA, and its impact on our business has previously been discussed in Item 1 “Business — Recent Developments and Expected Future Trends.”

 

Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010).

 

On July 21, 2010, President Obama signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act” or “the Act”), legislation to reform and strengthen supervision of the U.S. financial services industry. The Dodd-Frank Act represents a comprehensive change to banking laws, imposing significant new regulation on almost every aspect of the U.S. financial services industry.

 

The Dodd-Frank Act will result in significant new regulation in key areas of our business and the markets in which we operate. The Act mandates changes in regulation and compliance of financial institutions and systemically important nonbank financial companies, securities regulation, executive compensation, regulation of derivatives, corporate governance, transactions with affiliates, deposit insurance assessments and consumer protection. Pursuant to the Act, we and many of our subsidiaries, including the Bank, will be subject to regulations promulgated by a new consumer protection bureau housed within the Federal Reserve System, known as the Bureau of Consumer Financial Protection (the “Bureau”). The Bureau will have substantial

power to define the rights of consumers and responsibilities of lending institutions, including our Private Education lending and retail banking businesses. The Bureau will not examine the Bank, and the Bank’s primary regulators will remain the FDIC and the Utah Department of Financial Institutions. The U.S. Treasury Department has designated July 21, 2011 as the date upon which the Bureau will begin to exercise its authority.

 

The Act also supplements the Federal Trade Commission Act’s prohibitions against practices that are unfair or deceptive by also prohibiting practices that are “abusive.” After this term is defined by implementing regulations, we will evaluate our consumer financial products and services to confirm they are in compliance with this provision.

 

More specific to our core business the Dodd-Frank Act provides for the designation of a private education loan ombudsman within the Bureau, whose functions will include the informal resolution of complaints from private education loan borrowers, a process similar to and to be coordinated with the ombudsman structure currently in place for federally guaranteed student loans. The Act also requires the Bureau’s director and the Secretary of Education to submit a report to Congress on the second anniversary of enactment on private education loans and private education lenders. In addition, the act mandates the U.S. Secretary of Education to examine the private education loan market in the U.S. and provide a report to Congress by July 20, 2012.

 

The Act also provides that the newly established Financial Services Oversight Council (the “FSOC”) may designate that certain nonbank financial companies must be supervised by the Board of Governors of the Federal Reserve System (the “Federal Reserve Board”) and be subject to enhanced prudential supervision and regulatory standards to be developed by the Federal Reserve Board. The FSOC may designate a nonbank financial company as systemically important if they find that material financial distress at the company — or its nature, scope, size, scale, concentration, interconnectedness, or mix of activities — could pose a threat to the financial stability of the United States. Such enhanced standards will include among other things, risk-based capital and liquidity requirements, special regulatory and insolvency regimes, production of a resolution plan to cover potential insolvencies and may include such additional requirements on matters such as credit exposure concentrations.

 

Finally, the Dodd-Frank Act creates a comprehensive new regulatory framework for oversight of derivatives transactions by the Commodity Futures Trading Commission (the “CFTC”) and the SEC. This new framework, among other things, subjects certain swap participants to new capital and margin requirements, recordkeeping and business conduct standards and imposes registration and regulation of swap dealers and major swap participants. The scope of potential exemptions remains to be further defined through agency rulemakings. Moreover, while we may or may not qualify for exemptions, many of our derivatives counterparties are likely to be subject to the new capital, margin and business conduct requirements.

 

Most of the component parts of the Dodd-Frank Act will be subject to intensive rulemaking and public comment over the coming months and we cannot predict the ultimate effect the Act or required examinations of the private education loan market could have on our operations or those of our subsidiaries, such as the Bank, at this time. It is likely, however, that operational expenses will increase if new or additional compliance requirements are imposed on our operations and our competitiveness could be significantly affected if we are subjected to supervision and regulatory standards not otherwise applicable to our competitors.

 

Other Significant Sources of Regulation

 

Many aspects of our businesses are subject to regulation by federal and state regulation and administrative oversight. The most significant of these are described below.

 

We are subject to the HEA and, from time to time, our student loan operations are reviewed by ED and guarantee agencies. As a servicer of federal student loans, we are subject to certain ED regulations regarding financial responsibility and administrative capability that govern all third-party servicers of insured student loans. In connection with our Guarantor servicing operations, we must comply with, on behalf of our Guarantor clients, certain ED regulations that govern Guarantor activities as well as agreements for

reimbursement between ED and our Guarantor clients. As a third-party service provider to financial institutions, we are also subject to examination by the Federal Financial Institutions Examination Council (“FFIEC”).

 

Our originating or servicing of federal and Private Education Loans also subjects us to federal and state consumer protection, privacy and related laws and regulations. Some of the more significant federal laws and regulations that are applicable to our business include:

 

 

Our Business Services segment’s debt collection and receivables management activities are subject to federal and state consumer protection, privacy and related laws and regulations. Some of the more significant federal statutes are the Fair Debt Collection Practices Act and additional provisions of the acts listed above, as well as the HEA and under the various laws and regulations that govern government contractors.

 

These activities are also subject to state laws and regulations similar to the federal laws and regulations listed above.

 

The Bank is subject to Utah banking regulations as well as regulations issued by the FDIC, and undergoes periodic regulatory examinations by the FDIC and the Utah Department of Financial Institutions.

 

Our Upromise activities are subject to regulation by the Municipal Securities Rulemaking Board, the Financial Industry Regulatory Authority (formerly the National Association of Securities Dealers, Inc.) and the SEC, as well as various state regulatory authorities.

 

Our business activities involve a variety of risks. Below we describe the significant risk factors affecting our business. The risks described below are not the only risks facing us — other risks also could impact our business.

 

Funding and Liquidity.

 

Our business is affected by funding constraints in the capital markets and the interest rate characteristics of our earning assets do not always match the interest rate characteristics of our funding arrangements. These factors may increase the price of or decrease our ability to obtain liquidity as well expose us to basis and repricing risk.

 

The capital markets have experienced and continue to experience a prolonged period of volatility. This volatility has had varying degrees of impact on most financial organizations, including us. These conditions have affected our access to and cost of capital necessary to manage and effectively operate our business. Additional factors that could make financing difficult, more expensive or unavailable on any terms include, but are not limited to, our financial results and losses, changes within our organization, events that have an adverse impact on our reputation, changes in the activities of our business partners, events that have an adverse impact on the financial services industry, counterparty availability, changes affecting our assets, corporate and regulatory actions, absolute and comparative interest rate changes, ratings agencies’ actions, general economic conditions and the legal, regulatory, accounting and tax environments governing our funding transactions. If financing becomes more difficult, expensive or unavailable, our business, financial condition and results of operations could be materially and adversely affected.

 

In recent years, the ongoing volatility and illiquidity of the capital markets has caused the U.S. Federal government to intervene and provide various forms of financial assistance and liquidity programs to numerous industries, including the student loan industry. Our participation in these programs provided significant liquidity for us at times when capital market alternatives were of limited availability or borrowing costs were otherwise excessive. Given current Federal budgetary constraints and recent congressional actions that have affected the student loan industry, there can be no assurance that these types of financial assistance and liquidity programs will again be made available if volatility and illiquidity of the capital markets were to increase or continue for a prolonged period of time.

 

During 2010, we funded Private Education Loan originations primarily through term brokered and retail deposits raised by the Bank. Assets funded in this manner result in re-financing risk because the average term of the deposits is shorter than the expected term of some of the same assets. There is no assurance that this or other sources of funding, such as the term asset-backed securities market, will be available at a level and a cost that makes new Private Education Loan originations possible or profitable, nor is there any assurance that the loans can be re-financed at profitable margins. For additional discussion on regulatory and compliance risks relating to the Bank, see below at Item 1A “Risk Factors — Regulatory and Compliance.” If we were unable to obtain funds from which to make new Private Education Loans our business, financial condition and results of operations would be materially and adversely affected.

 

The interest rate characteristics of our earning assets do not always match the interest rate characteristics of our funding arrangements. This mismatch exposes us to risk in the form of basis risk and repricing risk. While most of such basis risks are hedged using interest rate swap contracts, such hedges are not always perfect matches and, therefore, may result in losses. Moreover, it may not always be possible to hedge all of our exposure to such basis risks. While the asset and hedge indices are short-term with rate movements that are typically highly correlated, there can be no assurance that the historically high correlation will not be disrupted by capital market dislocations or other factors not within our control. In such circumstances, our earnings could be adversely affected, possibly to a material extent. For instance, as a result of the turmoil in the capital markets, the historically tight spread between CP (the index used for many of our assets) and LIBOR (the index used for much of our debt) began to widen dramatically in the fourth quarter of 2008 resulting in substantial increases in our cost of funds. The spread subsequently returned to historical levels beginning in the third quarter of 2009 and has been stable since then.

Our credit ratings are important to our liquidity. A reduction in our credit ratings could adversely affect our liquidity, increase our borrowing costs, limit our access to the markets or trigger obligations under certain provisions in collateralized arrangements. Under these provisions, counterparties may require us to segregate collateral or terminate certain contracts.

 

Further deterioration in the economy could result in a decrease in demand for consumer credit and credit quality could adversely be affected. Higher credit-related losses and weaker credit quality could negatively affect our business, financial condition and results of operations and limit funding options, including capital markets activity, which could also adversely impact our liquidity position.

 

Operations.

 

A failure of our operating systems or infrastructure, or those of our third-party vendors, could disrupt our business, result in disclosure of confidential customer information, damage our reputation and cause losses.

 

A failure of our operating systems or infrastructure, or those of our third-party vendors, could disrupt our business. Our business is dependent on our ability to process and monitor large numbers of daily transactions in compliance with legal and regulatory standards and our product specifications, which we change to reflect our business needs. As processing demands change and our loan portfolios grow in both volume and differing terms and conditions, developing and maintaining our operating systems and infrastructure becomes increasingly challenging and there is no assurance that we can adequately or efficiently develop and maintain such systems.

 

Our loan originations and conversions and the servicing, financial, accounting, data processing or other operating systems and facilities that support them may fail to operate properly or become disabled as a result of events that are beyond our control, adversely affecting our ability to process these transactions. Any such failure could adversely affect our ability to service our clients, result in financial loss or liability to our clients, disrupt our business, result in regulatory action or cause reputational damage. Despite the plans and facilities we have in place, our ability to conduct business may be adversely affected by a disruption in the infrastructure that supports our businesses. This may include a disruption involving electrical, communications, internet, transportation or other services used by us or third parties with which we conduct business. Notwithstanding our efforts to maintain business continuity, a disruptive event impacting our processing locations could adversely affect our business, financial condition and results of operations.

 

Our operations rely on the secure processing, storage and transmission of personal, confidential and other information in our computer systems and networks. Although we take protective measures, our computer systems, software and networks may be vulnerable to unauthorized access, computer viruses, malicious attacks and other events that could have a security impact beyond our control. If one or more of such events occur, personal, confidential and other information processed and stored in, and transmitted through, our computer systems and networks, could be jeopardized or otherwise interruptions or malfunctions in our operations could result in significant losses or reputational damage. We also routinely transmit and receive personal, confidential and proprietary information, some through third parties. We have put in place secure transmission capability, and work to ensure third parties follow similar procedures. An interception, misuse or mishandling of personal, confidential or proprietary information being sent to or received from a customer or third party could result in legal liability, regulatory action and reputational harm. In the event personal, confidential or other information is jeopardized, intercepted, misused or mishandled, we may be required to expend significant additional resources to modify our protective measures or to investigate and remediate vulnerabilities or other exposures, and we may be subject to fines, penalties, litigation costs and settlements and financial losses that are either not insured against or not fully covered through any insurance maintained by us. If one or more of such events occur, our business, financial condition or results of operations could be significantly and adversely affected.

We continue to undertake numerous cost-cutting initiatives to realign and restructure our business in light of significant legislative changes in the past several years. Our business, results of operations and financial condition could be adversely affected if we do not effectively align our cost structure with our current business operations and future business prospects.

 

In response to significant legislative changes in the past several years, we have undertaken and continue to undertake cost-cutting initiatives, including workforce reductions, servicing center closures, restructuring and transfers of business functions to new locations, enhancements to our web-based customer services, adoption of new procurement strategies and investments in operational efficiencies. Our business and financial condition could be adversely affected by these cost-cutting initiatives if cost reductions taken are so dramatic as to cause disruptions in our business or reductions in the quality of the services we provide. We may be unable to successfully execute on certain growth and other business strategies or achieve certain business goals or objectives if cost reductions are too dramatic. Alternatively, we may not be able to achieve our desired cost savings, and if that is the case our results of operations could be adversely affected.

 

Incorrect estimates and assumptions by management in connection with the preparation of our consolidated financial statements could adversely affect the reported assets, liabilities, income and expenses.

 

Incorrect estimates and assumptions by management in connection with the preparation of our consolidated financial statements could adversely affect the reported amounts of assets and liabilities and the reported amounts of income and expenses. The preparation of our consolidated financial statements requires management to make certain critical accounting estimates and assumptions that could affect the reported amounts of assets and liabilities and the reported amounts of income and expense during the reporting periods. A description of our critical accounting estimates and assumptions may be found in Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Critical Accounting Policies and Estimates” and in “Note 2 — Significant Accounting Policies.” If we make incorrect assumptions or estimates, we may under- or overstate reported financial results, which could materially and adversely affect our business, financial condition and results of operations.

 

Political and Reputational.

 

The scope and profitability of our lending businesses remain subject to risks arising from legislative and administrative actions.

 

Through the HCERA, the U.S. Congress mandated that all future federally guaranteed student loans be made through the DSLP, eliminating the FFELP. Further legislative action by Congress could adversely affect our business, financial condition and results of operations. For instance, the President’s Fiscal 2012 Budget includes a provision that would, for a limited period of time, incent borrowers that have loans with the FFELP and DSLP to move their FFELP Loans to ED. While such consolidations have been permitted for some time, incentives such as these, if such a proposal were to be approved, could incrementally increase the rate at which borrowers might otherwise have moved certain FFELP Loans to ED and our future estimated cash flows and profitability from our FFELP Loan portfolios could be detrimentally affected. Likewise, additional restrictions or requirements imposed on private student lending could increase our costs, affect our ability to recover loans and materially and adversely impact our business, financial condition and results of operations.

 

Changes in laws and regulations that affect the financial services industries generally have the potential to negatively impact our business and results of operations.

 

As a non-bank financial institution we are often subject to laws and regulations related to the broader financial services industry. For instance, the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 has the potential to significantly increase our costs of doing business or affect our relative competitiveness within our industry. For a more detailed description of the implications of this act, see below at Item 1A

“Risk Factors — Regulatory and Compliance.” In 2010, we were anticipating the introduction of the Troubled Asset Relief Program (“TARP”) tax, which had the potential to significantly reduce our net income. The President’s Fiscal 2012 Budget resubmits such a tax for Congress’ consideration. The passage of sweeping changes to the legal and regulatory environments in which we operate, including increases in taxation or fees charged on our business, have the potential to materially and adversely impact our business, financial condition and results of operations.

 

Our ability to continue to grow our businesses related to contracting with state and federal governments is partly reliant on our ability to remain compliant with the laws and regulations applicable to those contracts.

 

We are subject to a variety of laws and regulations related to our government contracting businesses, including our contracts with ED. In addition, these government contracts are subject to termination rights, audits and investigations. If we were found in noncompliance with the contract provisions or applicable laws or regulations, or the government exercised its termination or other rights for that or other reasons, our reputation could be negatively affected, and our ability to compete for new contracts could be diminished. If this were to occur, the future prospects, revenues and results of operations of this portion of our business could be negatively affected.

 

Competition.

 

We operate in a competitive environment, and our product offerings are primarily concentrated in loan and savings products for higher education.

 

We compete in the private credit lending business with banks and other consumer lending institutions, many with strong consumer brand name recognition. We compete based on our products, origination capability and customer service. To the extent our competitors compete aggressively or more effectively, we could lose market share to them or subject our existing loans to refinancing risk. In addition, there is a risk that any new education or loan products that we introduce will not be accepted in the marketplace. Our product offerings may not prove to be profitable and may fail to offset the loss of business in the education credit market.

 

We are a leading provider of saving- and paying-for-college products and programs. This concentration gives us a competitive advantage in the marketplace. This concentration also creates risks in our business, particularly in light of our concentration as a private credit lender and servicer for the FFELP and DSLP. If population demographics result in a decrease in college-age individuals, if demand for higher education decreases, if the cost of attendance of higher education decreases, if public resistance to higher education costs increases, or if the demand for higher education loans decreases, our private credit lending business could be negatively affected. In addition, the federal government, through the DSLP, poses significant competition to our private credit loan products. If loan limits under the DSLP increase, as they did in late 2007 and 2008, DSLP loans could be more widely available to students and parents and DSLP loan limits could increase, resulting in a decrease in the size of the private credit education loan market and lessened demand for our private credit education loan products.

 

Credit and Counterparty.

 

Unexpected and sharp changes in the overall economic environment may negatively impact the performance of our loan and credit portfolios.

 

Unexpected changes in the overall economic environment may result in the credit performance of our loan portfolio being materially different from what we expect. Our earnings are critically dependent on the evolving creditworthiness of our student loan customers. We maintain a reserve for credit losses based on expected future charge-offs which considers many factors, including levels of past due loans and forbearances and expected economic conditions. However, management’s determination of the appropriate reserve level may under- or over-estimate future losses. If the credit quality of our customer base materially decreases, if a market risk changes significantly, or if our reserves for credit losses are not adequate, our business, financial condition and results of operations could suffer.

In addition to the credit risk associated with our education loan customers, we are also subject to the creditworthiness of other third parties, including counterparties to our derivative transactions. For example, we have exposure to the financial condition of various lending, investment and derivative counterparties. If any of our counterparties is unable to perform its obligations, we could, depending on the type of counterparty arrangement, experience a loss of liquidity or an economic loss. In addition, we might not be able to cost effectively replace the derivative position depending on the type of derivative and the current economic environment, and thus be exposed to a greater level of interest rate and/or foreign currency exchange rate risk which could lead to additional losses. Our counterparty exposure is more fully discussed in Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources — Counterparty Exposure.” If our counterparties are unable to perform their obligations, our business, financial condition and results of operations could suffer.

 

Regulatory and Compliance.

 

Our businesses are regulated by various state and federal laws and regulations, and our failure to comply with these laws and regulations may result in significant costs, sanctions, litigation or the loss of federal guarantees on affected FFELP Loans.

 

Our businesses are subject to numerous state and federal laws and regulations and our failure to comply with these laws and regulations may result in significant costs, including litigation costs, and/or business sanctions. In addition, changes to such laws and regulations could adversely impact our business and results of operations if we are not able to adequately mitigate the impact of such changes.

 

Our private credit lending and debt collection businesses are subject to regulation and oversight by various state and federal agencies, particularly in the area of consumer protection. Some state attorneys general have been active in this area of consumer protection regulation. We are subject, and may be subject in the future, to inquiries and audits from state and federal regulators as well as frequent litigation from private plaintiffs.

 

The Bank is subject to state and FDIC regulation, oversight and regular examination. The FDIC and state regulators have the authority to impose fines, penalties or other limitations on the Bank’s operations should they conclude that its operations are not compliant with applicable laws and regulations. At the time of this filing, the Bank was the subject of a cease and desist order for weaknesses in its compliance function. While the issues addressed in the order have largely been remediated, the order has not yet been lifted. Our failure to comply with various laws and regulations or with the terms of the cease and desist order or to have issues raised during an examination could result in litigation expenses, fines, business sanctions, and limitations on our ability to fund our Private Education Loans, which are currently funded by deposits raised by the Bank, or restrictions on the operations of the Bank. The imposition of fines, penalties or other limitations on the Bank’s business could negatively impact our business, financial condition and results of operations.

 

Loans serviced under the FFELP are subject to the HEA and related regulations. Our servicing operations are designed and monitored to comply with the HEA, related regulations and program guidance; however ED could determine that we are not in compliance for a variety of reasons, including that we misinterpreted ED guidance or incorrectly applied the HEA and its related regulations or policies. Failure to comply could result in fines, the loss of the federal guarantees on affected FFELP Loans, expenses required to cure servicing deficiencies, suspension or termination of our right to participate as a servicer, negative publicity and potential legal claims. A summary of the FFELP, which indicates its complexity and frequent changes, may be found in Appendix A “Federal Family Education Loan Program.” The imposition of significant fines, the loss of federal guarantees on a material number of FFELP Loans, the incurrence of additional expenses and/or the loss of our ability to participate as a FFELP servicer could individually or in the aggregate have a material, negative impact on our business, financial condition or results of operations.

 

Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010

 

On July 21, 2010, President Obama signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act” or the “Act”), legislation to reform and strengthen supervision of the

U.S. financial services industry. The Dodd-Frank Act represents a comprehensive change to banking laws, imposing significant new regulation on almost every aspect of the U.S. financial services industry.

 

The Dodd-Frank Act will result in significant new regulation in key areas of our business and the markets in which we operate. Pursuant to the Act, we and many of our subsidiaries, including the Bank, will be subject to regulations promulgated by a new consumer protection bureau housed within the Federal Reserve System, known as the Bureau of Consumer Financial Protection (the “Bureau”). The Bureau will have substantial power to define the rights of consumers and responsibilities of lending institutions, including our Private Education lending and retail banking businesses. The Bureau will not examine the Bank, and the Bank’s primary regulator will remain the FDIC and the Utah Department of Financial Institutions. The U.S. Treasury Department has designated July 21, 2011 as the date upon which the Bureau will begin to exercise its authority. In addition, the act mandates the U.S. Secretary of Education to examine the private education loan market in the U.S. and provide a report to Congress by July 20, 2012.

 

The Dodd-Frank Act also provides that the newly established Financial Services Oversight Council (the “FSOC”) may designate that certain nonbank financial companies must be supervised by the Board of Governors of the Federal Reserve System (the “Federal Reserve Board”) and be subject to enhanced prudential supervision and regulatory standards to be developed by the Federal Reserve Board. The FSOC may designate a nonbank financial company as systemically important if they find that material financial distress at the company — or its nature, scope, size, scale, concentration, interconnectedness, or mix of activities — could pose a threat to the financial stability of the United States. Such enhanced standards will include, among other things, risk-based capital and liquidity requirements, special regulatory and insolvency regimes, production of a resolution plan to cover potential insolvencies and may include such additional requirements on matters such as credit exposure concentrations.

 

Most of the component parts of the Dodd-Frank Act will be subject to intensive rulemaking and public comment over the coming months and we cannot predict the ultimate effect the Act or required examinations of the private education loan market could have on our operations or those of our subsidiaries, such as the Bank, at this time. It is likely, however, that operational expenses will increase if new or additional compliance requirements are imposed on our operations and our competitiveness could be significantly affected if we are subjected to supervision and regulatory standards not otherwise applicable to our competitors.

 

 

None.

 

 

The following table lists the principal facilities owned by us as of December 31, 2010:

 

 

 

 

The following table lists the principal facilities leased by us as of December 31, 2010:

 

 

 

 

None of the facilities that we own is encumbered by a mortgage. We believe that our headquarters, loan servicing centers, data center, back-up facility and data management and collections centers are generally adequate to meet our long-term student loan and business goals. Our headquarters are currently in leased space at 12061 Bluemont Way, Reston, Virginia, 20190. We are relocating our headquarters to Newark, Delaware from Reston, Virginia by March 31, 2011.

 

Investor Litigation

 

On January 31, 2008, a putative class action lawsuit was filed against us and certain officers in the United States District Court for the Southern District of New York. This case and other actions arising out of the same circumstances and alleged acts have been consolidated and are now identified as In Re SLM Corporation Securities Litigation. The case purports to be brought on behalf of those who acquired our common stock between January 18, 2007 and January 23, 2008 (the “Securities Class Period”). The complaint alleges that the Company and certain officers violated federal securities laws by issuing a series of materially false and misleading statements and that the statements had the effect of artificially inflating the market price for our securities. The complaint alleges that Defendants caused our results for year-end 2006 and for the first quarter of 2007 to be materially misstated because we failed to adequately provide for loan losses, which overstated our net income, and that we failed to adequately disclose allegedly known trends and uncertainties with respect to our non-traditional loan portfolio. On September 24, 2010, the court denied our motion to dismiss Mr. Albert Lord and the Company, but dismissed Mr. C.E. Andrews as a defendant in the action. The matter is now in the discovery phase. Lead Plaintiff seeks unspecified compensatory damages, attorneys’ fees, costs, and equitable and injunctive relief.

 

A similar case is pending against the Company, certain officers, retirement plan fiduciaries, and the Board of Directors, In Re SLM Corporation ERISA Litigation, formerly in the U.S. District Court for the Southern District of New York and now before the United States Court of Appeals for the Second Circuit. The case was originally filed on May 8, 2008 and the purported class consists of participants in or beneficiaries of the Sallie Mae 401(K) Retirement Savings Plan and Sallie Mae 401(k) Savings Plan (“401K Plans”) between January 18, 2007 and “the present” whose accounts included investments in our common stock (“401K Class Period”). The complaint alleges breaches of fiduciary duties and prohibited transactions in violation of the Employee Retirement Income Security Act arising out of alleged false and misleading public statements regarding our business made during the 401K Class Period and investments in our common stock by participants in the 401K Plans. On September 24, 2010, this case was dismissed; however, the Plaintiffs appealed. The appeal is pending. The Plaintiffs/Appellants seek unspecified damages, attorneys’ fees, costs, and equitable and injunctive relief.

 

Lending and Collection Litigation and Investigations

 

On July 15, 2009, the United States District Court for the District of Columbia unsealed the qui tam False Claims Act complaint of relator Sheldon Batiste, a former employee of SLM Financial Corporation (U.S. ex rel. Batiste v. SLM Corporation, et al.). The First Amended Complaint alleges that we violated the False Claims Act by our “systemic failure to service loans and abide by forbearance regulations” and our “receipt of U.S. subsidies to which it was not entitled” through the federally guaranteed student loan program, FFELP. No amount in controversy is specified, but the relator seeks treble actual damages, as well as civil monetary penalties on each of its claims. The U.S. Department of Justice declined intervention. Defendants filed their Motion to Dismiss on September 21, 2009. On September 24, 2010, the United States District Court for the District of Columbia granted our Motion to Dismiss in its entirety. On October 25, 2010, Plaintiff/Relator filed a Notice of Appeal with the United States Court of Appeals for the District of Columbia Circuit. The appeal is pending.

 

On February 2, 2010, a putative class action suit was filed by a borrower in U.S. District Court for the Western District of Washington (Mark A. Arthur et al. v. SLM Corporation). The suit complains that we allegedly contacted “tens of thousands” of consumers on their cellular telephones via autodialer without their prior express consent in violation of the Telephone Consumer Protection Act, 47 U.S.C. § 227 et seq. (“TCPA”). Each violation under the TCPA provides for $500 in statutory damages ($1,500 if a willful violation is shown). Plaintiffs seek statutory damages, damages for willful violations, attorneys’ fees, costs, and injunctive relief. On April 5, 2010, Plaintiffs filed a First Amended Class Action Complaint changing the defendant from SLM Corporation to Sallie Mae, Inc. The parties in this matter have reached a tentative settlement which is subject to court approval and other conditions. On September 14, 2010, the United States District Court for the Western District of Washington agreed to Plaintiff’s Motion for Preliminary Approval of Settlement Agreement. We have vigorously denied all claims asserted against us, but agreed to the settlement to avoid the burden and expense of

continued litigation. If the settlement receives final approval from the Court, settlement awards will be made to eligible class members on a claims-made basis from a settlement fund of $19.5 million, and class members may opt out of certain calls to their cellular telephones. On January 21, 2011, and February 7, 2011, the Company filed submissions with the Court to advise that approximately 1.76 million individuals had been omitted from the original notice list for a total of approximately 6.6 million class members. In response, Class Counsel asked the Company to contribute additional unspecified amounts to the settlement fund. On February 10, 2011, the Court granted a Consented Motion to Stay Implementation of Settlement and Certain Deadlines. The Court ordered Class Counsel to file a status report on March 18, 2011. On February 10, 2011, Judith Harper filed a Motion to Intervene as Party Plaintiff, which the Court terminated on February 11, 2011 based upon the Court’s February 10, 2011 Stay. On February 9, 2011, Ms. Harper filed a similar Class Action Complaint regarding the TCPA against Arrow Financial Services, LLC, in the U.S. District Court for the Northern District of Illinois (the “Harper case”). On February 22, 2011, Arrow Financial Services, LLC filed a Motion to Stay Proceedings in the Harper case. That Motion is pending.

 

On December 17, 2007, plaintiffs filed a complaint against us in Rodriguez v. SLM Corporation et al., in the U.S. District Court for the District of Connecticut alleging that we engaged in underwriting practices which, among other things, resulted in certain applicants for student loans being directed into substandard and expensive loans on the basis of race. The complaint does not identify the relief plaintiffs seek. The court denied our Motion for Summary Judgment without prejudice on June 24, 2009. The Court granted Defendants’ partial Motion to Dismiss the Truth in Lending Act counts on November 10, 2009. The matter is now in the discovery phase.

 

ED’s Office of the Inspector General (“OIG”) commenced an audit regarding Special Allowance Payments on September 10, 2007. On August 3, 2009, we received the final audit report of the OIG related to our billing practices for Special Allowance Payments. Among other things, the OIG recommended that ED instruct us to return approximately $22 million in alleged special allowance overpayments. We continue to believe that our practices were consistent with longstanding ED guidance and all applicable rules and regulations and intend to continue disputing these findings. We provided our response to the Secretary on October 2, 2009 and we provided additional information to ED in 2010.

 

The Company and its subsidiaries and affiliates also are subject to various claims, lawsuits and other actions that arise in the normal course of business. Most of these matters are claims by borrowers disputing the manner in which their loans have been processed or the accuracy of our reports to credit bureaus. In addition, our collections subsidiaries are routinely named in individual plaintiff or class action lawsuits in which the plaintiffs allege that those subsidiaries have violated a federal or state law in the process of collecting their accounts. We believe that these claims, lawsuits and other actions will not have a material adverse effect on our business, financial condition or results of operations. Finally, from time to time, the Company receives information and document requests from state attorneys general and Congressional committees concerning certain business practices. Our practice has been and continues to be to cooperate with the state attorneys general and Congressional committees and to be responsive to any such requests.

 

 

We did not submit any matters to a vote of security holders during the three months ended December 31, 2010.

 

PART II.

 

 

Our common stock is listed and traded on the New York Stock Exchange under the symbol SLM. The number of holders of record of our common stock as of January 31, 2011 was 494. Because many shares of our common stock are held by brokers and other institutions on behalf of shareholders, we are unable to estimate the total number of beneficial owners represented by these record holders. The following table sets forth the high and low sales prices for our common stock for each full quarterly period within the two most recent fiscal years.

 

Common Stock Prices

 

 

There were no dividends paid in 2008, 2009 or 2010.

 

Issuer Purchases of Equity Securities

 

The following table summarizes our common share repurchases during 2010. The only repurchases conducted by us during the period were in connection with the exercise of stock options and vesting of restricted stock to satisfy minimum statutory tax withholding obligations and shares tendered by employees to satisfy option exercise costs (which combined totaled approximately 1.1 million shares for 2010) and not in connection with any authorized buyback program. See “Note 11 — Stockholders’ Equity.”

 

Stock Performance

 

The following graph compares the yearly percentage change in our cumulative total shareholder return on our common stock to that of Standard & Poor’s 500 Stock Index and Standard & Poor’s Financials Index. The graph assumes a base investment of $100 at December 31, 2005 and reinvestment of dividends through December 31, 2010.

 

Five Year Cumulative Total Shareholder Return

 

 

 

 

Source: Bloomberg Total Return Analysis

 

Selected Financial Data 2006-2010
(Dollars in millions, except per share amounts)

 

The following table sets forth our selected financial and other operating information prepared in accordance with GAAP. The selected financial data in the table is derived from our consolidated financial statements. The data should be read in conjunction with the consolidated financial statements, related notes, and 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 our Consolidated Financial Statements and related Notes included elsewhere in this Annual Report on Form 10-K. This discussion and analysis also contains forward-looking statements and should also be read in conjunction with the disclosures and information contained in “Forward-Looking and Cautionary Statements” and Item 1A “Risk Factors” in this Annual Report on Form 10-K.

 

Through this discussion and analysis, we intend to provide the reader with some narrative context for how our management views our consolidated financial statements, additional context within which to assess our operating results, and information on the quality and variability of our earnings, liquidity and cash flows.

 

Overview

 

We provide Private Education Loans that help students and their families bridge the gap between family resources, federal loans, grants, student aid, scholarships, and the cost of a college education. We also provide savings products to help save for a college education. In addition we provide servicing and collection services on federal loans. We also offer servicing, collection and transaction support directly to colleges and universities in addition to the saving for college industry. Finally, we are the largest private owner of FFELP Loans.

 

Effective July 1, 2010, HCERA legislation eliminated the authority to originate new loans under FFELP. Consequently, we no longer originate FFELP Loans. As a result, in the fourth quarter of 2010 we changed the way we regularly monitor and assess our ongoing operations and results by realigning our business segments into four reportable segments: (1) FFELP Loans, (2) Consumer Lending, (3) Business Services and (4) Other. Management now views our business as consisting of three primary segments comprised of one runoff business (FFELP Loans) and two continuing growth businesses (Consumer Lending and Business Services).

 

FFELP Loans Segment

 

Our FFELP Loans segment consists of our $148.6 billion FFELP Loan portfolio and underlying debt and capital funding these loans. This includes the acquisition of loans from the Student Loan Corporation on December 31, 2010 (see “Segment Earnings Summary — ‘Core-Earnings’ Basis — FFELP Loans Segment” of this Item 7 for further discussion). Because we no longer originate FFELP Loans the portfolio is in runoff and is expected to amortize over approximately the next 25 years with a weighted average remaining life of 7.7 years. We actively seek to acquire FFELP Loan portfolios to leverage our servicing scale and expertise to generate incremental earnings and cash flow to create additional shareholder value. Of our total FFELP Loan portfolio, 77 percent was funded to term through securitization trusts, 16 percent was funded through the ED Conduit Program which terminates on January 19, 2014, 5 percent was funded in our multi-year ABCP facility and FHLB-DM facility, and the remainder was funded with unsecured debt. It is expected to generate a stable net interest margin and significant amounts of cash as the portfolio amortizes.

 

Consumer Lending Segment

 

In our Consumer Lending segment we originate, acquire, finance and service Private Education Loans. As of December 31, 2010 we had $35.7 billion of Private Education Loans outstanding. In 2010 we originated $2.3 billion of Private Education Loans, down from $3.2 billion in the prior year. We provide Private Education Loans to students and their families to help them pay for a college education. We provide loans through the financial aid office, direct-to-consumer and through referral and partner lenders. We also provide savings products, primarily in the form of retail deposits, to help customers save for a college education (we refer to this as our Direct Banking business line).

 

Business Services Segment

 

In our Business Services segment we provide loan servicing to our FFELP Loans segment, ED and other third parties. We provide default aversion work and contingency collections on behalf of Guarantors, colleges and ED. We also perform Campus Payment Solutions, account asset servicing and transaction processing activities.

 

Other

 

Our Other segment primarily consists of the financial results related to the repurchase of debt, the corporate liquidity portfolio and all overhead. We also include results from smaller wind-down and discontinued operations within this segment.

The following table shows how we realigned our old reportable segments existing prior to the fourth quarter of 2010 into our new business lines as part of the change in business segments discussed above.

 

 

Key Financial Measures

 

Our operating results are primarily driven by net interest income from our student loan portfolios, provision for loan losses, financing costs, costs necessary to generate new assets, the revenues and expenses generated by our service businesses and gains and losses on loan sales, debt repurchases and derivatives. We manage and assess the performance of each business segment separately as each is focused on different customer bases and derive their revenue from different activities and services. A brief summary of our key financial measures are listed below.

 

Net Interest Income

 

The most significant portion of our earnings are generated by the spread earned between the interest revenue we receive on assets in our student loan portfolios and the interest cost of funding these loans. We report these earnings as net interest income. Net interest income in our FFELP Loans and Consumer Lending segments are driven by significantly different factors.

 

FFELP Loans Segment

 

Net interest income will be the primary source of cash flow generated by this segment as the portfolio runs off and we will no longer generate revenues from new originations. We may continue to acquire existing portfolios of FFELP Loans from third parties. We would expect any acquisitions to be accretive. The FFELP Loans segment’s net interest margin was 93 basis points in 2010 compared with 67 basis points in 2009. The major sources of variability in net interest margin are expected to be the CP/LIBOR spread and Floor Income.

 

 

Additional cash flow should be generated within this segment as many of our secured financing vehicles are over-collateralized, creating the potential for additional cash flow to be distributed to us over time as the loans amortize.

 

Consumer Lending Segment

 

We expect to grow our Private Education Loan portfolio primarily through our school and direct-to-consumer channels. Net interest income in this segment is determined by the Private Education Loan asset yields, which are determined by interest rates established by us based upon the credit of the borrower and any co-borrower, the level of price competition in the Private Education Loan market and our cost of funds. Our cost of funds can be influenced by a number of factors including the quality of the loans in our portfolio, our corporate credit rating, general economic conditions, investor demand for ABS and corporate unsecured debt and competition in the deposit market. Loans are priced to anticipate our cost of funds and expected charge-off rate over the life of the loans. Our Private Education Loans earn variable rate interest and are funded primarily with variable rate liabilities. The Consumer Lending segment’s net interest margin was 3.85 percent in 2010 and 2009.

 

Provision For Loan Losses

 

Management estimates and maintains an allowance for loan losses equal to charge-offs expected over the next two years. The provision is an income statement item that reduces segment revenues. Generally the allowance rises when charge-offs are expected to increase and falls when charge-offs are expected to decline. Our loss exposure and resulting provision for losses is smaller for FFELP Loans than for Private Education Loans because we bear a maximum of 3 percent loss exposure on FFELP Loans. Our provision for losses in our FFELP Loans segment was $98 million in 2010 compared with $119 million in 2009. Our loss exposure and resulting provision in our Consumer Lending segment is much greater than our FFELP Loans segment. Losses in our Consumer Lending segment are primarily driven by risk characteristics such as loan program type, school type, loan status (in-school, grace, forbearance, repayment and delinquency), seasoning (number of months in active repayment for which a scheduled payment was due), underwriting criteria (e.g., credit scores), existence or absence of a cosigner and the current economic environment. Our provision for loan losses in our Consumer Lending segment was $1.298 billion in 2010 compared with $1.399 billion in 2009.

 

Charge-Offs and Delinquencies

 

When we conclude a loan is uncollectable (from the borrower or Guarantor), the unrecoverable portion of the loan is charged against the allowance for loan losses in the relevant lending segment. Information regarding charge-offs provides relevant information over time with respect to the actual performance of our loan portfolios as compared against the provisions for loan losses on those portfolios. The Consumer Lending segment’s charge off-rate was 5 percent of loans in 2010 compared with 6 percent in 2009. Delinquencies are a very important indicator of the potential future credit performance. Management focuses on the overall level of delinquencies as well as the progression of loans from early to late stage delinquency. “Core Earnings” basis Private Education Loan delinquencies as a percentage of Private Education Loans in repayment decreased from 12.1 percent at December 31, 2009 to 10.6 percent at December 31, 2010.

 

Servicing and Contingency Revenues

 

We earn servicing revenues from servicing student loans, Campus Payment Solutions, and from account asset servicing related to 529 college-savings plans. We earn contingency revenue related to default aversion and contingency collections work we do primarily on federal loans. The fees we recognize are primarily driven by our success in collecting or rehabilitating defaulted loans, the number of transactions processed and the underlying volume of loans we are servicing on behalf of others.

Other Income/(Loss)

 

In managing our loan portfolios and funding sources we periodically engage in sales of loans and the repurchase of our outstanding debt. In each case, depending on market conditions, we may incur gains or losses from these transactions that affect our results from operations. We also recognize gains and losses in accordance with GAAP on our derivative and hedging activities from the changes in the fair value of derivatives that do not qualify for hedge accounting treatment and ineffectiveness on derivatives that do qualify for hedge accounting.

 

Operating Expenses

 

The operating expenses reported for our Consumer Lending and Business Services segments are those that are directly attributable to the generation of revenues by those segments. The operating expenses for the FFELP Loans segment primarily represent an intercompany servicing charge from the Business Services segment and do not reflect our actual underlying costs incurred to service the loans. We have included corporate overhead expenses and certain information technology costs (together referred to as “Overhead”) in our Other segment rather than allocate those expenses by segment. These overhead expenses include costs related to executive management, the board of directors, accounting, finance, legal, human resources, stock option expense and certain information technology costs related to infrastructure and operations.

 

Core Earnings

 

Management uses “Core Earnings” as the primary financial performance measure to evaluate performance and to allocate resources. “Core Earnings” is the basis in which we prepare our segment disclosures as required by GAAP under ASC 280 “Segment Reporting” (see “Note 19—Segment Reporting”). For a full explanation of the contents and limitations of “Core Earnings” see ‘‘‘Core Earnings’—Definition and Limitations” of this Item 7.

 

2010 Summary

 

We overcame considerable challenges and achieved significant accomplishments in 2010. We continue to operate in an extremely challenging macroeconomic environment marked by high unemployment and periods of extreme illiquidity in the capital markets.

 

Effective July 1, 2010, HCERA eliminated FFELP Loan originations, a major source of our net income. As a result, we will no longer have revenue related to FFELP Loan originations and will have declining net income related to our portfolio of FFELP Loans and related FFELP Loan servicing and collections activities. HCERA does not alter or affect the terms and conditions of our existing FFELP Loans. Net interest income we earn on our FFELP Loan portfolio will decline over time as the portfolio amortizes. We will no longer earn any origination fees for originating FFELP Loans (which was $34 million in 2010) and the Guarantor maintenance fees (which was $56 million in 2010) will decline as the portfolio pays down. In addition, we earned $245 million in FFELP contingency revenue in 2010, which we expect to remain relatively stable through 2012 and then steadily decline as the portfolio of defaulted FFELP Loans we manage is resolved and amortizes.

 

In response to these legislative and economic challenges we explored splitting the Company into two publicly traded companies, representing our runoff and growth businesses. We also explored selling our residual interests in our securitized FFELP Loans to effectively remove the securitized loans from our balance sheet. After evaluating both strategies we determined that neither strategy currently provides better economic returns to investors than our current operating structure.

 

On December 31, 2010, we closed on our agreement to purchase the $26.1 billion of securitized federal loans and related assets from the Student Loan Corporation. This transaction will be accretive to 2011 earnings and beyond. We continue to seek to acquire FFELP Loan portfolios.

 

Despite the economic environment, we saw significant improvements in the quality of our lending business segments.

 

In our Business Services segment, we saw increased revenue in our third-party servicing, contingency collections and account asset servicing lines of business. We decided to discontinue our Purchased Paper collection business at the end of 2010.

 

In response to the elimination of FFELP, in 2010 we expanded an ongoing operating expense reduction initiative, including closing our Florida and Texas servicing centers and relocating our headquarters to Newark, Delaware by March 31, 2011.

 

“Core Earnings” improved significantly to $1 billion from $807 million in the prior year. This was due to a number of factors including lower provision for loan losses, and a higher net interest margin. In 2010 we issued $1.5 billion of 10-year unsecured debt and repurchased $4.9 billion of unsecured debt. Combined with our asset-backed securitization transactions, these actions significantly improved the overall maturity profile of our outstanding debt.

 

2011 Outlook

 

We do not expect the economic environment to improve significantly in 2011. A high unemployment rate is expected to result in a challenging environment for financial services companies such as ours. We expect our “Core Earnings” business results to improve principally due to the significant improvement in the quality of our Private Education Loan portfolio. Increases in the cost of attaining a higher education and enrollments should drive increased volume in our consumer lending, servicing and collection businesses. “Core Earnings” are expected to be lower in 2011 than in 2010; however, this is principally due to a sharp decline in gains on debt repurchases and the absence of revenue generated from the sale of FFELP Loans to ED.

 

In 2008 we significantly tightened our underwriting criteria and exited certain lending segments. In addition, each successive repayment cohort, i.e., a group of loans that enter their initial repayment status in the same calendar year upon exiting their grace period following graduation/separation from school, has been of higher quality. In 2009 we began to offer Smart Option Student Loans, which require students to make interest payments while they are in school, a departure from past practices where all required payments were deferred until the student graduated. In 2010, we began offering the Fixed Pay repayment option, which requires a payment during school that is less than a full interest payment. The loans that entered repayment in the fourth quarter of 2010 will influence delinquency trends in the first half of 2011 and charge-offs in the second half. This cohort of loans is significantly smaller and of higher quality than previous repay cohorts, it has a higher average credit score and is comprised of significantly smaller amounts of higher risk non-traditional and non-cosigned loans on a percentage basis and in total volume.

 

On January 11, 2011 we issued $2 billion, five-year 6.25 percent fixed rate unsecured notes. The rate on the notes was swapped from a fixed rate to a floating rate equal to an all-in cost of one month LIBOR plus 4.46 percent. Investor demand was the highest ever for a Sallie Mae issue, which we believe reflects investors’ views that our financial condition has strengthened. In 2011, we expect to access the unsecured debt market

and the term asset-backed securities market to re-finance both FFELP and Private Education Loans. We believe that conditions in these markets have improved as compared to last year and are conducive to funding at more favorable spreads and advance rates. Retail Bank deposits are also expected to continue to be a source of funding at favorable rates. We currently expect our net interest margins in the coming year to be stable in both our FFELP Loans and Consumer Lending segments.

 

2011 Management Objectives

 

In 2011 we have set out five major goals to create shareholder value. They are: (1) Reduce our operating expenses; (2) Maximize cash flows from FFELP Loans; (3) Prudently grow Consumer Lending segment assets and revenue; (4) Increase Business Services segment revenue; and (5) Reinstate dividends and/or share repurchases. Here is how we plan to achieve these objectives.

 

Reduce Operating Expenses

 

The elimination of FFELP by HCERA greatly reduced the scope of our historical revenue generating capabilities. In 2010 we originated $14 billion of loans, 84 percent of them FFELP Loans; in 2011 we expect to originate $2.5 billion of new loans, all of them Private Education Loans. Our FFELP related revenues will decline over the coming years. As a result, we must effectively match our cost structure to our ongoing business. Operating expenses will be reduced company wide. We have set a goal of getting to an annualized operating expense quarterly run rate of $250 million by the fourth quarter of 2011.

 

Maximize Cash Flows from FFELP Loans

 

We have a $148.6 billion portfolio of FFELP Loans that is expected to generate significant amounts of cash flow and earnings in the coming years. We plan to reduce related costs, minimize income volatility and opportunistically purchase other FFELP Loan portfolios like we did with SLC.

 

Grow Consumer Lending Segment Assets and Revenue

 

Successfully growing Private Education Loan lending is the key component of our long-term plan to grow shareholder value. We must originate increasing numbers of high quality Private Education Loans, increase net interest margins and further reduce charge-offs and provision for loan losses. To manage our borrowing costs, we must achieve more attractive term asset-backed securities market access and prices in the coming year.

 

Increase Business Services Segment Revenue

 

Our Business Services segment is comprised of several businesses with customers related to FFELP that will experience revenue declines and several businesses with customers that provide growth opportunities. Our growth businesses are ED servicing, ED collections, other school-based asset type servicing and collections, Campus Payment Solutions, transaction processing and 529 college-savings plan account asset servicing. We currently have a 22 percent market share of the ED Servicing Contract. This volume will grow organically as more loans are originated under DL. Our goal is to further expand our market share and broaden the services we provide to ED and other third party servicing clients. The ED collection contract will also grow organically as more loans are originated under DL. We also seek to increase our market share through improved performance. Campus Payment Solutions is a business line that we expect to grow by expanding our product offerings and leveraging our deep relationships with colleges and universities. Assets under management in 529 college-savings plans total $34.5 billion and have been growing at a rate of 21 percent over the last three years. Our goal is to service additional 529 plans.

 

Reinstate Dividends and/or Share Repurchases

 

We suspended our dividend and share repurchase programs in April 2007 and have not since reinstated these programs. We now believe that our cash flow and capital positions have strengthened sufficiently that by

the second half of 2011, we will be able to recommend to our board of directors that we either reinstate a dividend, begin to repurchase shares or do a combination of both.

 

Results of Operations

 

We present the results of operations first on a consolidated basis in accordance with GAAP. As discussed earlier, we have four business segments, FFELP Loans, Consumer Lending, Business Services and Other segments. Since these segments operate in distinct business environments, the discussion following the Consolidated Earnings Summary is presented on a segment basis and is shown on a “Core Earnings” basis. See Item 1 “Business — Business Segments” for further discussion on the components of each segment.

GAAP Statements of Income

 

Consolidated Earnings Summary — GAAP-basis

 

Year Ended December 31, 2010 Compared with Year Ended December 31, 2009

 

For the years ended December 31, 2010 and 2009, net income was $530 million, or $.94 diluted earnings per common share, and $324 million, or $.38 diluted earnings per common share, respectively. For the year ended December 31, 2010 and 2009, net income from continuing operations was $597 million, or $1.08 diluted earnings per common share, and $544 million, or $.85 diluted earnings per common share, respectively. For the year ended December 31, 2010 and 2009, net loss from discontinued operations was $67 million, or $.14 diluted loss per common share, and $220 million, or $.47 diluted loss per common share from discontinued operations per common share, respectively.

 

Income from Continuing Operations before Income Tax Expense

 

Income from continuing operations before income tax expenses increased for the year ended December 31, 2010, by $282 million as compared with the prior year primarily due to a $1.5 billion increase in net interest income after provisions for loan losses and a $243 million decrease in net losses on derivative and hedging activities. These improvements were partially offset by a $660 million goodwill and intangible asset impairment charge, a $165 million increase in operating expenses, a $219 million decrease in gains on debt repurchases and a decrease in securitization servicing and Residual Interest revenue of $295 million.

 

The primary contributors to each of the identified drivers of changes in income from continuing operations before income tax expense for the year-over-year period are as follows:

 

 

 

 

 

Net Loss from Discontinued Operations.

 

Net loss from discontinued operations in the year ended December 31, 2010 was $67 million compared with a net loss from discontinued operations of $220 million for the year ended December 31, 2009. In the fourth quarter of 2009, we sold our Purchased Paper — Mortgage/Properties business for $280 million which resulted in an after-tax loss of $95 million. As a result of this sale, the results of operations of this business were presented in discontinued operations in the fourth quarter of 2009. In the fourth quarter of 2010, we began actively marketing our Purchased Paper — Non Mortgage business for sale and have concluded it is probable this business will be sold within one year at which time we would exit the business. As a result, the results of operations of this business were also required to be presented in discontinued operations beginning in the fourth quarter of 2010. In connection with this presentation, we are required to carry this business at the lower of fair value or historical cost basis. As a result, we recorded an after-tax loss of $52 million from discontinued operations in the fourth quarter of 2010, primarily due to adjusting the value of this business to its estimated fair value. Our Purchased Paper businesses are presented in discontinued operations for the current and prior periods. The additional losses for both years that are more than the losses discussed above relate to ongoing impairment recorded as a result of the weakened economy’s effect on our ability to collect the receivables.

 

Year Ended December 31, 2009 Compared with Year Ended December 31, 2008

 

For the years ended December 31, 2009 and 2008, net income was $324 million, or $.38 diluted earnings per common share, and a net loss of $213 million, or $.69 diluted loss per common share, respectively. For the years ended December 31, 2009 and 2008, net income from continuing operations was $544 million, or $.85 diluted earnings per common share, and $2 million, or $.23 diluted loss per common share, respectively. For the years ended December 31, 2009 and 2008, net loss from discontinued operations was $220 million, or $.47 diluted loss per common share, and $215 million, or $.46 diluted loss from discontinued operations per common share, respectively.

 

Income from Continuing Operations before Income Tax Expense.

 

Income from continuing operations before income tax expense for the year ended December 31, 2009 increased $842 million from the prior year. The $842 million increase was primarily due to an increase in gains on debt repurchases of $472 million and an increase in gains on sales of loans and securities of $470 million offset by an increase of $159 million in net losses on derivative and hedging activities.

 

The primary contributors to each of the identified drivers of changes in income from continuing operations before income tax expense for the year-over-year period are as follows:

 

 

 

Net Loss from Discontinued Operations.

 

Net loss from discontinued operations in the year ended December 31, 2009 increased $5 million from the prior year. Our Purchased Paper businesses are presented in discontinued operations for the current and prior years.

 

Preferred Stock Dividend Expense

 

During 2009, we converted $339 million of our Series C Preferred Stock to common stock. As part of this conversion, we delivered to the holders of the preferred stock: (1) approximately 17 million shares (the number of common shares they would most likely receive if the preferred stock they held mandatorily converted to common shares in the fourth quarter of 2010) plus (2) a discounted amount of the preferred stock dividends the holders of the preferred stock would have received if they held the preferred stock through the mandatory conversion date. The accounting treatment for this conversion resulted in additional expense recorded as a part of preferred stock dividends for the period of approximately $53 million.

 

“Core Earnings” — Definition and Limitations

 

We prepare financial statements in accordance with GAAP. However, we also evaluate our business segments on a basis that differs from GAAP. We refer to this different basis of presentation as “Core Earnings”. We provide this “Core Earnings” basis of presentation on a consolidated basis for each business segment because this is what we internally review when making management decisions regarding our performance and how we allocate resources. We also refer to this information in our presentations with credit rating agencies, lenders and investors. Because our “Core Earnings” basis of presentation corresponds to our segment financial presentations, we are required by GAAP to provide “Core Earnings” disclosure in the notes to our consolidated financial statements for our business segments. For additional information, see “Note 19 — Segment Reporting.”

 

“Core Earnings” are not a substitute for reported results under GAAP. We use “Core Earnings” to manage each business segment because “Core Earnings” reflect adjustments to GAAP financial results for three items, discussed below, that create significant volatility mostly due to timing factors generally beyond the control of management. Accordingly, we believe that “Core Earnings” provide management with a useful basis from which to better evaluate results from ongoing operations against the business plan or against results from prior periods. Consequently, we disclose this information as we believe it provides investors with additional information regarding the operational and performance indicators that are most closely assessed by management. The three items adjusted for in our “Core Earnings” presentations are (1) the off-balance sheet treatment of certain securitization transactions, (2) our use of derivatives instruments to hedge our economic risks that do not qualify for hedge accounting treatment or do qualify for hedge accounting treatment but result in ineffectiveness and (3) the accounting for goodwill and acquired intangible assets.

 

While GAAP provides a uniform, comprehensive basis of accounting, for the reasons described above, our “Core Earnings” basis of presentation does not. “Core Earnings” are subject to certain general and specific limitations that investors should carefully consider. For example, there is no comprehensive, authoritative guidance for management reporting. Our “Core Earnings” are not defined terms within GAAP and may not be comparable to similarly titled measures reported by other companies. Accordingly, our “Core Earnings” presentation does not represent a comprehensive basis of accounting. Investors, therefore, may not be able to compare our performance with that of other financial services companies based upon “Core Earnings.” “Core Earnings” results are only meant to supplement GAAP results by providing additional information regarding the operational and performance indicators that are most closely used by management, our board of directors, rating agencies, lenders and investors to assess performance.

 

Specific adjustments that management makes to GAAP results to derive our “Core Earnings” basis of presentation are described in detail in the section entitled “‘Core Earnings’ — Definition and Limitations — Differences between ‘Core Earnings’ and GAAP” of this Item 7.

The following tables show “Core Earnings” for each business segment and our business as a whole along with the adjustments made to the income/expense items to reconcile the amounts to our reported GAAP results as required by GAAP and reported in “Note 19 — Segment Reporting.”