IOWA STUDENT LOAN LIQUIDITY CORPORATION. Financial Statements. June 30, 2011 and (With Independent Auditors Reports Thereon)

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1 Financial Statements (With Independent Auditors Reports Thereon)

2 Table of Contents Page(s) Independent Auditors Report 1 Management s Discussion and Analysis 3 9 Financial Statements: Statements of Net Assets 10 Statements of Revenues, Expenses, and Changes in Net Assets 11 Statements of Cash Flows Report on Internal Control over Financial Reporting and on Compliance and Other Matters Based on an Audit of Financial Statements Performed in Accordance with Government Auditing Standards 48 49

3 KPMG LLP 2500 Ruan Center 666 Grand Avenue Des Moines, IA Independent Auditors Report The Board of Directors Iowa Student Loan Liquidity Corporation Des Moines, Iowa: We have audited the accompanying statements of net assets of Iowa Student Loan Liquidity Corporation (the Corporation) as of, and the related statements of revenue, expenses, and changes in net assets and cash flows for the years then ended. These financial statements are the responsibility of the Corporation s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America and the standards applicable to financial audits contained in Government Auditing Standards, issued by the Comptroller General of the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Corporation s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Iowa Student Loan Liquidity Corporation as of, and the changes in its net assets and its cash flows for the years then ended, in conformity with U.S. generally accepted accounting principles. In accordance with Government Auditing Standards, we have also issued a report dated October 25, 2011 on our consideration of the Corporation s internal control over financial reporting and on our tests of its compliance with certain provisions of laws, regulations, contracts, and grant agreements and other matters. The purpose of that report is to describe the scope of our testing of internal control over financial reporting and compliance and the results of that testing, and not to provide an opinion on the internal control over financial reporting or on compliance. That report is an integral part of an audit performed in accordance with Government Auditing Standards and should be considered in assessing the results of our audit. KPMG LLP is a Delaware limited liability partnership, the U.S. member firm of KPMG International Cooperative ( KPMG International ), a Swiss entity.

4 The management s discussion and analysis on pages 3 through 9 is not a required part of the basic financial statements but is supplementary information required by U.S. generally accepted accounting principles. We have applied certain limited procedures, which consisted principally of inquiries of management regarding the methods of measurement and presentation of the management discussion and analysis information. However, we did not audit the information and express no opinion on it. Des Moines, Iowa October 25,

5 Management s Discussion and Analysis This section of the Iowa Student Loan Liquidity Corporation s (the Corporation) annual financial statements presents management s discussion and analysis of the financial position and results of operations for the fiscal years ended June 30, 2011 (FY11) and 2010 (FY10). This information is being presented to provide additional information regarding the activities of the Corporation, pursuant to the requirements of Governmental Accounting Standards Board Statement No. 34, Basic Financial Statements and Management s Discussion and Analysis for State and Local Governments; Statement No. 37, Basic Financial Statements and Management s Discussion and Analysis for State and Local Governments: Omnibus; and Statement No. 38, Certain Financial Statement Note Disclosures. This discussion and analysis should be read in conjunction with the independent auditors report of KPMG LLP, the financial statements, and the accompanying notes. Financial Highlights The Corporation purchased or originated over $29 million in student loans under both its own and serviced portfolios. Retired or redeemed over $344 million in bonds and notes payable resulting in a net gain of $11 million. Sold over $149 million in student loans to the U.S. Department of Education through the Ensuring Continued Access to Student Loan Act (ECASLA) programs. Overview of the Financial Statements The financial statements consist of management s discussion and analysis (this section) and the basic financial statements. The basic financial statements include statements of net assets; statements of revenues, expenses, and changes in net assets; statements of cash flows; and notes to financial statements section. Each of the basic financial statements describes information for the following major funds: General Fund Student Loan Purchase Program Fund While the various funds of the Corporation are grouped together for convenience, the combined assets are available only in accordance with the applicable bond resolutions, federal and Iowa laws, and other outstanding agreements. The statements of net assets present information on all of the Corporation s assets and liabilities with the difference between the two reported as net assets. Over time, increases or decreases in net assets may serve as a useful indicator of whether the financial position of the Corporation is improving or deteriorating. The statements of revenues, expenses, and changes in net assets present information showing how the Corporation s net assets changed during FY11 and FY10. The statements of cash flows report the cash receipts, cash payments, and net changes in cash resulting from operations, capital and noncapital financing activities, and investing activities. 3 (Continued)

6 Management s Discussion and Analysis Condensed Financial Information The following tables present condensed financial information for FY11, FY10, and FY09 for the Corporation as a whole. The financial information includes net assets and revenues, expenses, and changes in net assets. Net Assets June 30, 2011, 2010, and 2009 (In millions of dollars) Assets: Cash $ Investments Student loans receivable, net 2, , ,624.2 Accrued interest receivable Other receivables Prepaid and deferred expenses Capital assets, net Total assets $ 3, , ,046.5 Liabilities: Accounts payable and accrued expenses $ Deferred origination fees Accrued interest payable Arbitrage rebate liability Notes payable Bonds payable 2, , ,576.0 Total liabilities 3, , ,833.8 Net assets: Invested in capital assets Restricted, student loan purchase program Unrestricted, board designated Total net assets Total liabilities and net assets $ 3, , , (Continued)

7 Management s Discussion and Analysis Revenues, Expenses, and Changes in Net Assets Years ended June 30, 2011, 2010, and 2009 (In millions of dollars) Operating revenues: Investment income $ Net decrease in fair market value of investments (22.7) Student loan interest income Other student loan revenue Other income Gain on extinguishment of debt Total operating revenues Operating expenses (income): Interest on bonds and notes payable Amortization of gain on refunding of bonds (24.3) (20.3) Debt-related expenses General and administrative Provision for loan losses Total operating expenses Operating income (loss) (4.9) Net assets at beginning of year Net assets at end of year $ Financial Analysis 2011 Total Assets Total assets ended in FY11 at $3.4 billion, a decrease of 9.35% ($350.5 million) as compared to the FY10 amount of $3.7 billion. Cash and investments increased 33.53% ($93.9 million) compared to FY10. Most of this increase is due to the accumulation of student loan principal and interest receipts in excess of the use of cash for operating expenses, debt services, and loan funding. This increase was partially offset from the use of cash towards the early redemption of outstanding debt. Total net student loans receivable decreased 12.57% ($425.4 million) as compared to FY10. The Corporation purchased or originated $18.6 million in student loans under its own portfolio during FY11, a decrease of 88.92% ($149.2 million) from FY10. Total Liabilities Total liabilities decreased 10.41% ($362.7 million) as compared to FY10. This change is predominantly due to a decrease in overall debt outstanding through early redemption and maturities. The Corporation redeemed debt totaling $65.3 million and bond and note maturities totaled $278.8 million. U.S. Department of Education notes totaling $152.2 million were paid off. Deferred unamortized gain on refunding of bonds decreased 27.91% ($24.3 million) due to amortization. Deferred revenue (related to private 5 (Continued)

8 Management s Discussion and Analysis loans) decreased 17.18% ($4.4 million) compared to FY10 primarily due to fee amortization. Unamortized prepaid cost of issuance expenses decreased 11.34% ($1.5 million). Net Assets Net assets of the Corporation increased 4.63% ($12.2 million) during FY11 to $275.9 million from an ending FY10 balance of $263.7 million. Positive net interest margins, improved debt related costs, lower operating expenses, and realized gains on early redemptions of debt all contributed. Total Operating Revenues The Corporation earned $109.2 million in total operating revenues during FY11, a decrease of 8.73% ($10.5 million) from FY10, excluding gain on extinguishment of debt of $10.8 million. Investment interest income was down compared to FY10 due to continued stress in the capital markets and a related decline in investment yields. Student loan interest income decreased 8.43% ($9.0 million) compared to FY10. The Corporation s owned student loan portfolio fell by 11.38% ($394.1 million) in FY11. The single largest transaction having the biggest impact was an ECASLA Participation PUT to the Department of Education. Less APO Liability was recorded against student loan interest income in FY 11 compared to FY 10. Total Operating Expenses The Corporation s total operating expenses for FY11 decreased 13.99% ($17.6 million) from FY10. Total interest expense on bonds and notes during FY11 decreased 1.35% ($0.6 million) from FY10. The Corporation s overall outstanding debt decreased by 10.25% ($344.2 million) when compared to FY10. The FY11 amortization of the gain of refunding of bonds recorded in FY11 was $24.3 million. The provision for loan losses (related primarily to private loans) decreased in FY11 by 18.74% ($6.1 million) when compared to FY10. This decrease is mainly due to a more seasoned repayment portfolio and holding overall delinquencies at historical levels. Total Operating Income The Corporation s change in net assets decreased during FY11 by $38.8 million below FY10. 6 (Continued)

9 Management s Discussion and Analysis Major Financing and Long-Term Debt Activity The following list details the major financing activity of the Corporation during FY11: Date Amount Type of activity Various $ 4,016,732 Net borrowing under the U.S. Department of Education s FFELP loan participation program. 7/26/2010 5,468,587 Principal payment on notes outstanding. 7/28/2010 2,800,000 Early redemption of principal on bonds outstanding. 7/29/ ,575,000 Early redemption of principal on bonds outstanding. 8/25/2010 4,598,367 Principal payment on notes outstanding. 9/27/ ,236,390 Principal payment on bonds outstanding. 9/27/2010 6,469,601 Principal payment on notes outstanding. 9/30/ ,000 Early redemption of principal on bonds outstanding. 10/15/ ,204,198 Principal payment on participation interests outstanding under U.S. Department of Education s FFELP loan participation program. 10/18/ ,000 Early redemption of principal on bonds outstanding. 10/25/2010 6,266,265 Principal payment on notes outstanding. 10/29/ ,300,000 Early redemption of principal on bonds outstanding. 11/26/2010 5,628,943 Principal payment on notes outstanding. 12/1/2010 5,000,000 Principal payment on bonds outstanding. 12/21/2010 3,000,000 Early redemption of principal on bonds outstanding. 12/27/ ,595,494 Principal payment on bonds outstanding. 12/27/2010 5,453,527 Principal payment on notes outstanding. 1/25/2011 4,857,117 Principal payment on notes outstanding. 2/25/2011 5,852,145 Principal payment on notes outstanding. 3/22/2011 2,550,000 Early redemption of principal on bonds outstanding. 3/25/ ,073,097 Principal payment on bonds outstanding. 3/25/2011 7,679,891 Principal payment on notes outstanding. 4/5/2011 2,700,000 Early redemption of principal on bonds outstanding. 4/25/2011 7,079,024 Principal payment on notes outstanding. 5/25/2011 7,500,551 Principal payment on notes outstanding. 6/27/ ,912,940 Principal payment on bonds outstanding. 6/27/2011 5,922,522 Principal payment on notes outstanding. Financial Analysis 2010 Total Assets Total assets ended in FY10 at $3.7 billion, a decrease of 7.37% ($298.2 million) as compared to the FY09 amount of $4.0 billion. Cash and investments decreased 12.70% ($40.8 million) compared to FY09. Throughout the year, the Corporation experienced an accumulation of cash student loan principal and interest receipts and loan servicing revenue in excess of normal expenditures for operating expenses, debt service, and loan funding. An offset to this increase was the use of cash towards the early redemption of outstanding debt. Total net student loans receivable decreased 6.62% ($239.9 million) as compared to FY09. The Corporation purchased or originated $167.8 million in student loans under its own portfolio during FY10, a decrease of 8.31% ($15.2 million) under FY09. 7 (Continued)

10 Management s Discussion and Analysis Total Liabilities Total liabilities decreased 9.11% ($349.2 million) as compared to FY09. This change is predominantly due to a decrease in overall debt outstanding through early redemption and maturities. The Corporation redeemed debt totaling $1.1 billion resulting in a deferred gain on refunding of $87.2 million. Bond and note maturities totaled $195.2 million. U.S. Department of Education notes totaling $137.6 million were paid off. The Corporation utilized additional ECASLA facilities (Conduit and Participation) that added new debt totaling a net $709.9 million. Additional bonds were issued during FY10 totaling $230.2 million. Deferred revenue (related to private loans) decreased 15.89% ($4.8 million) compared to FY09 primarily due to fee amortization. Unamortized prepaid cost of issuance expenses decreased 15.02% ($2.4 million). Net Assets Net assets of the Corporation increased 23.98% ($51.0 million) during FY10 to $263.7 million from an ending FY09 balance of $212.7 million. Positive net interest margins and improved debt related costs contributed positively to net assets FY10. The Corporation realized gains on early redemptions of debt. Total Operating Revenues The Corporation earned $119.7 million in total operating revenues during FY10, a decrease of 26.65% ($43.5 million) from FY09 excluding gain on extinguishment of debt of $56.7 million. Investment interest income was down compared to FY09 due to continued stress in the capital markets and a related decline in investment yields. Student loan interest income decreased 38.56% ($67.1 million) compared to FY09 due to an overall decline in student loan interest rates experienced during FY10. In addition, the Corporation s owned student loan portfolio fell by 5.52% ($202.4 million) in FY10. Student loan interest income decreased during FY10 due to the impact of additional APO liability expense. Additional fee revenue from the Department of Education Participation Put transaction was realized in FY10. Total Operating Expenses The Corporation s total operating expenses for FY10 decreased 25.41% ($42.6 million) from FY09. Total interest expense on bonds and notes during FY10 decreased 36.96% ($25.6 million) from FY09. A more favorable interest rate environment has contributed to the positive outcome. In addition, the Corporation s overall outstanding debt decreased by 11.71% ($445.3 million) when compared to FY09. The FY10 amortization of the gain of refunding of bonds recorded in FY10 was $20.3 million. Debt-related expenses increased 82.90% ($2.9 million) in FY10. This is the result of expense credits recorded in FY09 that were not repeated in FY10. Total Operating Income The Corporation s change in net assets increased during FY10 by $55.9 million above FY09. 8 (Continued)

11 Management s Discussion and Analysis Major Financing and Long-Term Debt Activity The following list details the major financing activity of the Corporation during FY10: Date Amount Type of activity Various $ 152,155,516 Net borrowing under the U.S. Department of Education s FFELP loan participation program. Various 561,755,505 Net borrowing under the U.S. Department of Education s Conduit Program 8/5/ ,000,000 Early redemption of principal on bonds outstanding. 9/1/ ,000,000 Early redemption of principal on bonds outstanding. 9/8/ ,000,000 Early redemption of principal on bonds outstanding. 9/25/ ,584,999 Principal payment on bonds outstanding. 9/30/ ,890,000 Principal payment on notes outstanding. 10/14/ ,571,960 Principal payment on participation interests outstanding under U.S. Department of Education s FFELP loan participation program. 11/18/ ,170,000 New issue tax-exempt student loan revenue bonds 12/18/ ,925,000 Early redemption of principal on bonds outstanding. 12/28/ ,680,295 Principal payment on bonds outstanding. 2/1/ ,650,000 Early redemption of principal on bonds outstanding. 3/25/ ,686,467 Principal payment on bonds outstanding. 3/31/2010 1,500,000 New issue promissory note used to fund private loans. Payment of principal and interest backed by school guarantee. 4/30/ ,350,000 Early redemption of principal on bonds outstanding. 5/21/2010 3,600,000 Early redemption of principal on bonds outstanding. 6/1/ ,100,000 Principal payment on bonds outstanding. 6/25/ ,640,390 Principal payment on bonds outstanding. 9

12 Statements of Net Assets Assets Current assets: Cash (note 2) $ 7,428,437 8,946,958 Assets held by trustee (substantially restricted) (note 3): Investments (note 2) 354,676, ,851,295 Student loans receivable, net (note 3) 144,524, ,669,436 Student loans held-for-sale 147,964,747 Accrued interest receivable 9,292,387 13,777,365 Other receivables 6,634,013 5,279,745 Prepaid and deferred expenses 6,178,419 7,314,466 Total current assets 528,733, ,804,012 Noncurrent assets: Assets held by trustee (substantially restricted) (note 3): Investments (note 2) 11,967,531 17,336,187 Student loans receivable, net (note 3) 2,814,530,930 3,029,787,499 Accrued interest receivable 21,746,260 32,608,420 Prepaid and deferred expenses 14,924,121 19,412,960 Capital assets, net of accumulated depreciation and amortization 5,837,245 5,336,473 Total noncurrent assets 2,869,006,087 3,104,481,539 Total assets $ 3,397,739,774 3,748,285,551 Liabilities and Net Assets Current liabilities: Other accounts payable and accrued expenses $ 6,001,001 6,926,443 Deferred origination fees 3,785,474 4,047,214 Accrued interest payable 1,671,175 1,912,790 Notes payable, net (note 4) 83,599, ,228,659 Bonds payable, net (note 4) 52,827,506 78,240,950 Total current liabilities 147,884, ,356,056 Noncurrent liabilities: Deferred origination fees 17,221,860 21,318,499 Arbitrage rebate liability (note 6) 23,547,900 18,562,600 Notes payable, net (note 4) 470,573, ,719,849 Bonds payable, net (note 4) 2,462,570,274 2,555,588,123 Total noncurrent liabilities 2,973,913,377 3,221,189,071 Total liabilities 3,121,797,879 3,484,545,127 Commitments and contingencies (notes 5, 6, and 7) Net assets (note 9): Invested in capital assets 5,837,245 5,336,473 Restricted, student loan purchase program 151,466, ,720,996 Unrestricted, board designated 118,638, ,682,955 Total net assets 275,941, ,740,424 Total liabilities and net assets $ 3,397,739,774 3,748,285,551 See accompanying notes to financial statements. 10

13 Statements of Revenues, Expenses, and Changes in Net Assets Years ended Operating revenues: Investment income $ 90, ,360 Student loan interest income 97,892, ,907,959 Other student loan revenue 7,308,861 7,578,796 Other income 3,925,219 4,619,383 Gain on extinguishment of debt 10,787,673 56,745,262 Total operating revenues 120,004, ,412,760 Operating expenses (income): Interest on bonds and notes payable 43,091,762 43,681,281 Amortization of gain on refunding of bonds (24,339,453) (20,282,878) Debt-related expenses 3,495,273 6,260,643 General and administrative 58,780,414 62,725,696 Provision for loan losses (note 3) 26,774,695 32,949,992 Total operating expenses 107,802, ,334,734 Operating income 12,201,471 51,078,026 Net assets, beginning of year 263,740, ,662,398 Net assets, end of year $ 275,941, ,740,424 See accompanying notes to financial statements. 11

14 Statements of Cash Flows Years ended Cash flows from operating activities: Principal receipts on student loans $ 307,149, ,126,660 Interest receipts on student loans 71,182,174 70,640,948 Purchases of student loans (18,596,162) (167,785,716) Cash receipts (refunds) for fees, net (37,416) 46,171 Payments to employees (15,494,937) (14,588,762) Payments to vendors (30,230,129) (36,601,523) Other 7,307,180 10,661,957 Net cash provided by operating activities 321,280, ,499,735 Cash flows from capital and related financing activities: Acquisition of capital assets (2,776,161) (1,799,894) Proceeds from issuance of bonds 230,170,000 Repayment of bonds (108,071,921) (1,009,178,896) Interest paid on bonds (43,490,179) (41,611,225) Proceeds from issuance of notes 5,197, ,308,180 Repayment of notes (75,855,181) (130,104,075) Payments for debt service costs (2,584,980) (3,527,179) Payments for bond issuance costs 164,360 (4,026,239) Net cash used in capital and related financing activities (227,416,526) (192,769,328) Cash flows from investing activities: Interest received on investments 73,741 98,716 Arbitrage payments (1,599,010) Maturities of investments 5,368,656 5,353,563 Net cash provided by investing activities 5,442,397 3,853,269 Net increase (decrease) in cash and cash equivalents 99,306,465 (35,416,324) Cash and cash equivalents, beginning of year 262,798, ,214,577 Cash and cash equivalents, end of year $ 362,104, ,798,253 Reconciliation of operating income to cash provided by operating activities: Operating income $ 12,201,471 51,078,026 Adjustments to reconcile operating income to net cash provided by operating activities: Depreciation and amortization on capital assets 2,238,438 2,140,613 Amortization of prepaid origination fees 5,062,155 5,406,014 Interest income from investments (90,317) (561,360) Amortization of gain on refunding of bonds (24,339,453) (20,282,878) Gain on extinguishment of debt (10,787,673) (56,745,262) Interest expense on bonds and notes payable 43,091,762 43,681,281 Debt-related expenses 3,495,273 6,260,643 Decrease in student loans receivable 276,211, ,485,566 Decrease in student loan interest receivable 15,341,714 10,205,034 (Increase) decrease in other receivables (1,354,270) 1,009,267 Disposal of capital assets 1, ,600 Increase in employee and vendor-related prepaid and deferred expense 510,278 60,790 Decrease in other accounts payable and accrued expenses (950,251) (801,955) Decrease in deferred origination fees (4,358,377) (4,886,024) Increase in arbitrage rebate liability 5,007,300 12,267,380 Net cash provided by operating activities $ 321,280, ,499,735 Supplemental disclosure of non-cash activity: Decrease in student loans receivable due to ECASLA put 149,155, ,410,920 Decrease in notes payable due to ECASLA put 149,155, ,410,920 See accompanying notes to financial statements. 12

15 (1) Organization and Summary of Significant Accounting Policies (a) Reporting Entity The Iowa Student Loan Liquidity Corporation (the Corporation) was incorporated in 1979 as a private nonprofit corporation for the purpose of providing funds for the acquisition of student loan notes incurred under the United States Higher Education Act of 1965, as amended, and to provide procedures for servicing such notes. ISL Service Corp. (SC), a wholly owned subsidiary of the Corporation, was incorporated in 2001 to provide services not related to the Corporation s nonprofit purpose. SC has developed systems and procedures for loan origination and disbursement related processes including supporting the functions of electronic data transmissions management, Web reporting, loan information delivery, and centralized loan disbursement services. SC also provides on-going portfolio servicing for student loan portfolios not owned by the Corporation. The Corporation s board of directors is appointed by the Governor of the State of Iowa. The State of Iowa s accountability does not extend beyond the appointment of the board of directors, and therefore, the Corporation is not a component unit of the State of Iowa. Pursuant to Section 7C.4A(3) of the Code of Iowa, the Corporation has the ability to directly issue debt that pays interest, which is exempt from federal taxation. Pursuant to the action of the Legislature of the State of Iowa, the Corporation is also empowered to finance and originate alternative education loans in addition to those permitted under the United States Higher Education Act of The Corporation has no taxing authority. Bonds and notes issued do not constitute a debt, liability of, obligation of, or a pledge of the faith and credit of the State of Iowa or any agency or political subdivision thereof. There are no other organizations or agencies whose financial statements should be combined and presented with those of the Corporation. (b) (c) Basis of Presentation The accompanying financial statements of the Corporation have been prepared in conformity with U.S. generally accepted accounting principles (GAAP). Basis of Accounting and Accounting Estimates The accounting and financial reporting treatment applied is the economic resources measurement focus and the accrual basis of accounting. Under this method, revenues are reported when earned and expenses are reported at the time liabilities are incurred, regardless of when the related cash flows take place. The Corporation has elected to apply all applicable Governmental Accounting Standards Board (GASB) pronouncements, as well as Financial Accounting Standards Board (FASB) pronouncements, including those issued on or before November 30, 1989, unless those pronouncements conflict or contradict GASB pronouncements. In preparing the accompanying financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date 13 (Continued)

16 of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. (d) (e) (f) Cash Equivalents For purposes of the statements of cash flows, all highly liquid investments with maturity of three months or less when purchased are considered to be cash equivalents. This includes United States government and agency obligations, corporate notes and bonds, and various money market funds. Investments The Corporation carries its investments at fair value based on available market prices. Changes in fair value are recorded in the statements of revenues, expenses, and changes in net assets. Interest on investments is accrued and credited to interest income. Student Loans Receivable Student loans consist of federally insured student loans and alternative (nonfederally insured) student loans. If the Corporation has the ability and intent to hold loans for the foreseeable future, such loans are held for investment and carried at amortized cost. Amortized cost includes the unamortized premiums and capitalized origination costs and fees, all of which are amortized to interest income. Loans which are held-for-investment also have an allowance for loan loss as needed. Any loans the Corporation has the ability and intent to sell are classified as held for sale and are carried at the lower of cost or fair value. Loans which are held-for-sale do not have the associated premium and origination costs and fees amortized into interest income. In 2010, the Corporation elected to sell FFELP loans financed under the Department of Education s Participation Program. In August 2008, the Department implemented the Purchase Program and the Participation Program pursuant to the Ensuring Continued Access to Student Loans Act of 2008 (ECASLA). Under the Participation Program, the Department provided interim short-term liquidity to FFELP lenders by purchasing participation interests in pools of FFELP loans. Loans funded under the Participation Program for the academic year were required to be either refinanced by the lender or sold to the Department pursuant to the Purchase Program prior to September 30, As of June 30, 2010, the Corporation had approximately $147,964,747 of FFELP loans funded using the Participation Program. Because the Corporation maintained control of the loans, they remained on the balance sheet at June 30, 2010, and the Corporation recognized a liability equal to the amount of cash received for the participating interest. These loans were sold to the Department under its Purchase Program in October The loans were sold at par plus accrued interest, and accordingly no gain or loss was recognized on sale. (g) Allowance for Losses on Loans and Uncollected Interest The allowance for loan losses represents management s estimate of probable losses on student loans. This evaluation process is subject to numerous estimates and judgments. The Corporation evaluates the adequacy of the allowance for loan losses on its federally insured loan portfolio separately from its nonfederally insured loan portfolio. 14 (Continued)

17 The allowance for the federally insured loan portfolio is based on periodic evaluations of the Corporation s loan portfolios considering past experience, trends in student loan claims rejected for payment by guarantors, changes to federal student loan programs, current economic conditions, and other relevant factors. The federal government currently guarantees 97% of the principal of and the interest on federally insured student loans disbursed on and after July 1, 2006 (and 98% for those loans disbursed prior to July 1, 2006), which limits the Company s loss exposure on the outstanding balance of the Corporation s federally insured portfolio. Student loans disbursed prior to October 1, 1993 are fully insured. In determining the adequacy of the allowance for loan losses on the alternative loans, the Corporation considers several factors including: loans in repayment versus those in a nonpaying status, delinquency status, type of program, and trends in defaults in the portfolio based on Corporation and industry data. The Corporation places an alternative loan on nonaccrual status when the terms of a loan are restructured, and the Corporation does not resume accrual of interest. Cash receipts on nonaccrual loans are first applied to any accrued and unpaid interest before being applied to principal. Student loans are charged off in the event of a borrower s death, permanent disability, or amounts representing the unguaranteed portion of FFEL loans. At, loans totaling $39,376,237 and $42,022,592 were greater than 90 days past due and accruing interest. The Corporation assesses accrued and unpaid student loan interest for collectability, and reverses student loan interest income in the period in which it is determined that collection is doubtful. The evaluation of the allowance for loan losses is inherently subjective, as it requires material estimates that may be subject to significant changes. The provision for loan losses reflects the activity for the applicable period and provides an allowance at a level that the Corporation s management believes is adequate to cover probable losses inherent in the loan portfolio. (h) Revenue Recognition Loan interest is paid by the Department or the borrower, depending on the status of the loan at the time of the accrual. In addition, the Department makes quarterly interest subsidy payments on certain qualified FFELP loans until the student is required under the provisions of the Higher Education Act to begin repayment. The Department provides a special allowance to lenders participating in the FFEL Program. The special allowance is accrued based upon the fiscal quarter average rate of 13-week Treasury Bill auctions (for loans originated prior to January 1, 2000) or the fiscal quarter average rate of daily H15 financial commercial paper rates (for loans originated on and after January 1, 2000) relative to the yield of the student loan. The Corporation recognizes student loan income as earned, net of amortization of loan premiums and deferred origination costs. Loan income is recognized based upon the expected yield of the loan after giving effect to borrower utilization of incentives such as timely payments (borrower benefits) and other yield adjustments. Loan premiums, deferred origination costs, and borrower benefits are amortized over the estimated life of the loan. 15 (Continued)

18 (i) (j) Loan Origination Costs Loan origination costs and premiums paid are deferred if material, and the net cost or premium is recognized as an adjustment to interest income over life of the loans, using the effective-interest method. Prepaid Origination Fees The U.S. Department of Education requires all lenders to withhold from the loan proceeds a federal loan origination fee on the principal amount of the loan. As a borrower benefit, the Corporation pays these fees on behalf of the student borrower. This fee is capitalized and amortized over the estimated life of the loan. Unamortized loan origination fees are included with prepaid and deferred expenses within the statements of net assets. If these fees had been directly expensed in the period paid, the Corporation s net assets would have been reduced by an equal amount. A summary of loan origination fee activity for the years ended is as follows: Accumulated fees paid $ 54,726,898 54,733,846 Less accumulated amortization (37,630,444) (32,568,316) Unamortized balance, end of year $ 17,096,454 22,165,530 Amortization expense for the years ended was approximately $5,062,128 and $5,406,014, respectively. (k) Capital Assets Furniture, equipment, and leasehold improvements are stated at cost. Depreciation on furniture and equipment is calculated on the straight-line method over the estimated useful lives of three to ten years. Leasehold improvements are amortized on the straight-line method over the shorter of the lease term or estimated useful life of the asset. Capital assets had the following activity during the years ended : June 30, June 30, 2010 Additions Retirements 2011 Furniture, equipment, and leasehold improvements $ 23,249,917 2,741, ,710 25,517,523 Less accumulated depreciation 17,913,444 2,239, ,343 19,680,278 Furniture, equipment, and leasehold improvements, net $ 5,336, ,139 1,367 5,837, (Continued)

19 June 30, June 30, 2009 Additions Retirements 2010 Furniture, equipment, and leasehold improvements $ 21,770,856 1,827, ,210 23,249,917 Less accumulated depreciation 15,938,440 2,140, ,609 17,913,444 Furniture, equipment, and leasehold improvements, net $ 5,832,416 (313,342) 182,601 5,336,473 (l) (m) (n) (o) Deferred Revenue Origination fees are received by the Corporation at the time of origination of loans under the Iowa Partnership Loan Program. These fees are amortized over the life of the loan using the sum-of-the-years-digits method, which approximates the interest method. Debt Refunding and Extinguishment During the year ended June 30, 2011, the Corporation extinguished bonds outstanding with a par amount $65.3 million for cash proceeds of $54.3 million. This resulted in a gain of $10.8 million recognized as a gain on extinguishment of debt in the statement of revenues, expenses, and changes in net assets. During the year ended June 30, 2011, $24.3 million was amortized and recognized in the statement of revenues, expenses, and changes in net assets from a previous year s deferred gain. Bond and Note Issuance Costs and Discounts/Premiums Bond and note issuance costs, discounts, and premiums are deferred and amortized using the bonds-outstanding method. Deferred issuance costs, discounts, and premiums at June 30, 2011 and 2010 were $10,873,238 and $11,961,565, respectively, and are reflected in bonds payable on the statements of net assets. Derivative Products On July 1, 2009, the Corporation adopted the provisions of GASB 53, Accounting and Financial Reporting for Derivative Instruments, which addresses the recognition, measurement, and disclosure of information regarding derivative instruments. The Corporation has entered into an interest rate swap agreement to hedge the variable interest rate on certain debt. The Corporation is receiving payments based on the three-month LIBOR rate which matches the rate paid on the debt. The Corporation is making payments to the counterparty based on the 91-day Treasury bill rate which matches the rate received from the collateral securitizing the debt. This agreement has a current notional amount of $39,100,000 that amortizes to zero on the final termination date of December 25, The value of the interest rate swap is recorded in the statement of net assets, with any related changes in value recorded in the statement of changes in net assets. As of, the value of the swap was estimated to be $(639,900) and 17 (Continued)

20 $(367,900), respectively, and is reflected in other accounts payable and accrued expenses. The fair value adjustment on this swap during the years ended is $272,000 and $376,075, respectively. The Corporation has recognized the fair value adjustment in interest on bonds and notes payable on the statements of revenues, expenses, and changes in net assets and has not evaluated for hedge effectiveness. At which time the valuation of the swap becomes material, a test of effectiveness will be performed. The fair values of the interest rate swaps were estimated using the zero-coupon method. This method calculates the future net settlement payments required by the swap, assuming that the current forward rates implied by the yield curve correctly anticipate future spot interest rates. These payments are then discounted using the spot rates implied by the current yield curve for hypothetical zero-coupon bonds due on the date of each future net settlement on the swaps. Credit risk The Corporation is not exposed to credit risk on its interest rate swap because it is in a negative fair value or liability position. However, if interest rates change and the fair value become positive, the Corporation would have exposure to credit risk in the amount of the derivative s positive fair value. Termination risk Upon the occurrence of any default or termination event the swap agreement terminates and a termination payment may be required to be made by either the Corporation or the counterparty to the other party. The termination payment is based on market quotations and loss amounts netted against any unpaid amounts. All or a portion of the swap agreement may be terminated by the Corporation on any quarterly distribution date on or after December 25, 2013 and neither party will be required to make a termination payment. Interest Rate and Basis risk The Corporation has limited exposure to interest rate and basis risk on the interest rate swap because the variable interest rate payments received by the Corporation are based on the same index as those paid on the debt and cash flows received from the collateral securitizing the debt are based on the same rate as payments made to the counterparty. Rollover risk The Corporation is hedging the interest rate basis risk because the interest rate received on the collateralized assets is mismatched with the interest rate paid on the debt. The Corporation is not exposed to rollover risk, because the maturity date of the swap agreement closely matches the amortization period of the collateralized assets. (p) (q) Income Taxes The Corporation is a tax-exempt organization as described in Section 501(c)(3) of the Internal Revenue Code, and accordingly, no provision for income taxes has been made in the accompanying financial statements. As such, the Corporation is subject to federal and state income taxes only on any net unrelated business income under the provisions of Section 511 of the Internal Revenue Code. Fair Value of Financial Instruments On July 1, 2008, the Corporation adopted the provisions of Statement of Financial Accounting Standards (SFAS) No. 157, Fair Value Measurements, included in ASC Topic 820, which defines 18 (Continued)

21 fair value, establishes a framework for measuring fair value, and expands the disclosures about fair value measurement. The Corporation holds certain assets that are required to be measured at fair value on a recurring basis. These include the Corporation s investment in state and municipal obligations included in marketable securities owned. The fair values of these assets are determined based on inputs that are readily available in public markets or can be derived from information available in publicly quoted markets. The Corporation is required to group its assets and liabilities at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value. These levels are: Level 1 Valuation is based upon quoted prices for identical instruments traded in active markets. Level 2 Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market. Level 3 Valuation is generated from model-based techniques that use significant assumptions not observable in the market. These unobservable assumptions reflect our own estimates of assumptions that market participants would use in pricing the asset or liability. Valuation techniques include use of option pricing models, discounted cash flow models and similar techniques. The Corporation s investments in money market mutual funds are valued using quoted market prices for identical instruments traded in active markets, and are therefore Level 1 in the ASC Topic 820 (Statement 157), Fair Value, hierarchy. Corporate notes and bonds are valued using quoted prices for identical instruments in markets that are not active, and are therefore Level 2. The Company s interest rate swap, included in other accounts payable and accrued expenses, is valued using widely accepted valuation techniques based on observable market-based inputs, is therefore in Level 2. The Corporation had no nonfinancial assets or liabilities that were recognized or disclosed in the financial statements on a nonrecurring basis. The methods and assumptions used by the Corporation to estimate the fair value of its financial instruments not recorded in the financial statements at fair value are set forth below: Student Loans Receivable The fair value was estimated by modeling loan cash flows using existing loan terms and assumptions to determine loan yields, average term, and present value. The discount rate is estimated using currently offered investment yields of similar remaining maturities. Student Loans Held-for Sale The carrying amount for student loans held-for-sale approximates fair value, based on the agreement to sell to the U.S. Department of Education. Accrued Interest Receivable The carrying amount for accrued interest receivable approximates its fair value. 19 (Continued)

22 Bonds Payable The fair value of bonds payable is calculated by discounting scheduled cash flows through maturity using estimated market discount rates. The discount rate is estimated using the rates currently offered for debt of similar remaining maturities. Notes Payable The carrying amount for notes payable approximates fair value due to variable interest rates. Accounts Payable and Accrued Expenses The carrying amount for accounts payable and accrued expenses approximates its fair value. Arbitrage Rebate Liability The carrying amount for arbitrage rebate liability approximates its fair value. Deferred Revenue The carrying amount for deferred revenue approximates its fair value. Accrued Interest Payable The carrying amount for accrued interest payable approximates its fair value. Limitations Fair value estimates are made at a specific point in time, based on relevant market information and information about the financial instrument. Because no market exists for a significant portion of the Corporation s financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and, therefore, cannot be determined with precision. Changes in assumptions could significantly affect the estimates. (r) Reclassifications Certain 2010 amounts in the statement of cash flows have been reclassified to conform with the current year presentation. (2) Deposits and Investments (a) Cash Deposits and Cash Equivalents At, the Corporation s cash deposits of $7,428,437 and $8,946,958, respectively, were covered by federal depository insurance or collateralized trust accounts. Cash equivalents of $354,676,281 and $253,851,295, respectively, were included in investments in the statement of net assets. 20 (Continued)

23 (b) Investments The following table displays the types of investments, amounts, and the average maturity of the investment: Average Average Face amount Fair value maturity Face amount Fair value maturity Corporate notes and bonds $ 58,254,431 11,967, years $ 63,623,087 17,336, years Money market mutual funds investing in United States government and agency obligations 354,676, ,676,281 Less than 1 year 253,851, ,851,295 Less than 1 year $ 412,930, ,643,812 $ 317,474, ,187,482 (c) Investment Policy Investment portfolio management is the responsibility of the Corporation s management and staff. The Corporation s board of directors has established a general investment policy and specific bond indentures direct investment policy for assets restricted under those bond indentures. Qualified investments under the general investment policy include investments in U.S. Treasury, agency, and instrumentality obligations; interest-bearing time or demand deposits, certificates of deposits, and repurchase agreements and reverse repurchase agreements with any financial institution provided that such funds are fully insured by an agency of the federal government or collateralized at 100% with securities unconditionally and fully guaranteed by the U.S. government or collateralized with 102% of nongovernmental securities in this policy. Commercial paper rated, at the time of purchase, at least P1 by Moody s, A1 by S & P, and F-1+ by Fitch. Money market funds and corporate notes rated, at the time of purchase, at least in the top two tiers of one of the nationally recognized rating agencies. Investment agreements or guarantee investment contracts, secured by collateral securities that may be entered into with any bank, bank holding company, corporation, or any other financial institution whose outstanding: (i) commercial paper is rated, at the time of purchase, at least the same as commercial paper above for agreements 12 months or less, (ii) unsecured long-term debt is rated, at time of purchase, in the top two rating categories of one of the nationally recognized rating agencies, and commercial paper rated the same as above for agreements greater than 12 months, or (iii) in each case, by an insurance company whose claims paying ability is rated as provided in (ii) above. All investment purchase orders must be authorized by a Corporate Officer, the Board Chairman, or the Board Vice Chairman. Concentration Limits With the exception of treasury and agency securities, no more than 5% of the overall investment portfolio, or 5% of the investment portfolio of any trust estate, may be invested in one asset category. 21 (Continued)