**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

** **

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**FORM 10-Q**

** **

**(MARKONE)**
| **x**                                                                                                                                                                                                                      | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|-------------------------------------------------------------------------------------------------------------|
| ** **                                                                                                                                                                                                                 | ** **                                                                                                  | ** ** |
| **For the  quarterly period ended March 31, 2006**                                                                                                                                                                         |
| ** **                                                                                                                                                                                                                 | ** **                                                                                                  | ** ** |
| **OR**                                                                                                                                                                                                                     |
| ** **                                                                                                                                                                                                                 | ** **                                                                                                  | ** ** |
| **o**                                                                                                                                                                                                                      | **TRANSITION REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**     |
| ** **                                                                                                                                                                                                                 | ** **                                                                                                  |
| **For the  transition period  from               to               ** |
|                                                                                                                                                                                                                            |                                                                                                             |  |  |

 

**Commission File Number001-31825**

** **

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**TheFirst Marblehead Corporation**

(ExactName of Registrant as Specified in Its Charter)

 

| **Delaware**                              | ** ** | **04-3295311**      |
|-------------------------------------------|------------|---------------------|
| (State or Other  Jurisdiction of          |       | (I.R.S. Employer    |
| Incorporation or  Organization)           |       | Identification No.) |
|                                      |       |                |
| **The  Prudential Tower**                 | ** ** | ** **          |
| **800  Boylston Street, 34th Floor**      | ** ** | ** **          |
| **Boston,  Massachusetts**                | ** ** | **02199-8157**      |
| (Address of Principal  Executive Offices) |       | (Zip Code)          |

 

Registrant’stelephone number, including area code: **(617) 638-2000**

 

Indicateby check mark whether the registrant: (1) has filed all reports requiredto be filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject tosuch filing requirements for the past 90 days.   Yes  ý   No  o

 

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Indicateby check mark whether the registrant is a large accelerated filer, an acceleratedfiler, or a non-accelerated filer. See definition of “accelerated filer andlarge accelerated filer” in Rule 12b-2 of the Exchange Act.  (Checkone):

 
| Large  accelerated filer ý |   | Accelerated  Filer o |   | Non-accelerated  filer o |
|--------------------------------------|--------|---------------------------|--------|-------------------------------|

 

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

 

Asof April 30, 2006, the registrant had 62,899,260 shares of Common Stock, $0.01par value per share, outstanding.

 

 

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**THEFIRST MARBLEHEAD CORPORATION AND SUBSIDIARIES**

** **

**Tableof Contents**

 
| ** **                          | ** **                                                                                                                | ** ** | **Page** |
|-------------------------------------|---------------------------------------------------------------------------------------------------------------------------|------------|----------|
| Part I.  Financial Information |                                                                                                                      |       |
| Item 1—                        | Financial Statements                                                                                                      |       |     |
|                                | Condensed Consolidated  Balance Sheets as of March 31, 2006 and June 30, 2005                                   | 3          |
|                                | Condensed Consolidated  Statements of Operations for the three months and nine months ended  March 31, 2006 and 2005 | 4          |
|                                | Condensed Consolidated  Statement of Changes in Stockholders’ Equity for the nine months ended  March 31, 2006  | 5          |
|                                | Condensed Consolidated  Statements of Cash Flows for the nine months ended March 31, 2006 and  2005                  | 6          |
|                                | Notes to Unaudited  Condensed Consolidated Financial Statements                                                           | 7          |
| Item 2—                        | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                               |       | 16       |
| Item 3—                        | Quantitative and  Qualitative Disclosures About Market Risk                                                               |       | 37       |
| Item 4—                        | Controls and  Procedures                                                                                                  |       | 37       |
| Part II.  Other Information    |                                                                                                                      |       |
| Item 1A—                       | Risk  Factors                                                                                                             |       | 37       |
| Item 2—                        | Unregistered  Sales of Equity Securities and Use of Proceeds                                                              |       | 49       |
| Item 6—                        | Exhibits                                                                                                                  |       | 49       |
| SIGNATURES                          |                                                                                                                      |       | 50       |
| EXHIBIT INDEX                  |                                                                                                                      | 51         |
|                                     |                                                                                                                           |            |          |  |

 

2

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**Part I.   FinancialInformation**

 

**Item1—Financial Statements**

 

**THEFIRST MARBLEHEAD CORPORATION AND SUBSIDIARIES**

 

**CONDENSEDCONSOLIDATED BALANCE SHEETS(unaudited)(in thousands, except per share amounts)**

 
| ** **                                                                                                                                                                                                                                                                                                          | ** ** | **March 31,   2006** | ** ** | **June 30,   2005** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------|------------|-------------------------------|------------|
| **ASSETS**                                                                                                                                                                                                                                                                                                          |       |                           |       |                          |       |
| Cash and cash  equivalents                                                                                                                                                                                                                                                                                          |       | $                              | 142,568    |                          | $          | 193,796 |   |
| Service  receivables:                                                                                                                                                                                                                                                                                               |       |                           |       |                          |       |
| Structural  advisory fees                                                                                                                                                                                                                                                                                           |       | 78,316                         |       | 53,371                        |       |
| Residuals                                                                                                                                                                                                                                                                                                           |       | 398,519                        |       | 247,275                       |       |
| Processing fees  from The Education Resources Institute (TERI)                                                                                                                                                                                                                                                      |       | 8,943                          |       | 8,944                         |       |
|                                                                                                                                                                                                                                                                                                                |       | 485,778                        |       | 309,590                       |       |
| Property and  equipment                                                                                                                                                                                                                                                                                             |       | 57,897                         |       | 49,269                        |       |
| Less accumulated  depreciation and amortization                                                                                                                                                                                                                                                                     |       | (19,566                        | )          | (10,174                       | )          |
| Property and  equipment, net                                                                                                                                                                                                                                                                                        |       | 38,331                         |       | 39,095                        |       |
| Goodwill                                                                                                                                                                                                                                                                                                            |       | 3,176                          |       | 3,176                         |       |
| Intangible  assets, net                                                                                                                                                                                                                                                                                             |       | 2,092                          |       | 2,620                         |       |
| Prepaid income  taxes                                                                                                                                                                                                                                                                                               |       | —                         |       | 2,594                         |       |
| Other prepaid expenses                                                                                                                                                                                                                                                                                              |       | 6,247                          |       | 4,163                         |       |
| Other assets                                                                                                                                                                                                                                                                                                        |       | 3,983                          |       | 3,159                         |       |
| Total assets                                                                                                                                                                                                                                                                                                        |       | $                              | 682,175    |                          | $          | 558,193 |   |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                                                                                                                                                                                                      |       |                           |       |                          |       |
| Liabilities:                                                                                                                                                                                                                                                                                                        |       |                           |       |                          |       |
| Accounts payable  and accrued expenses                                                                                                                                                                                                                                                                              |       | $                              | 28,579     |                          | $          | 33,318 |   |
| Income taxes  payable                                                                                                                                                                                                                                                                                               |       | 1,823                          |       | —                        |       |
| Net deferred  income tax liability                                                                                                                                                                                                                                                                                  |       | 127,700                        |       | 84,208                        |       |
| Capital lease  obligations                                                                                                                                                                                                                                                                                          |       | 9,729                          |       | 12,118                        |       |
| Notes payable to  TERI                                                                                                                                                                                                                                                                                              |       | 4,730                          |       | 5,292                         |       |
| Other liabilities                                                                                                                                                                                                                                                                                                   |       | 3,547                          |       | 1,691                         |       |
| Total  liabilities                                                                                                                                                                                                                                                                                                  |       | 176,108                        |       | 136,627                       |       |
| Commitments and  contingencies                                                                                                                                                                                                                                                                                      |       |                           |       |                          |       |
| Stockholders’  equity:                                                                                                                                                                                                                                                                                         |       |                           |       |                          |       |
| Preferred stock,  par value $0.01 per share; 20,000 shares authorized; no shares issued or  outstanding                                                                                                                                                                                                        |       | —                         |       | —                        |       |
| Common stock, par  value $0.01 per share; 150,000 shares authorized at March 31, 2006 and  June 30, 2005; 66,746 and 66,368 shares issued at March 31, 2006  and June 30, 2005, respectively; 62,899 and 64,900 shares outstanding at  March 31, 2006 and June 30, 2005, respectively |       | 667                            |       | 664                           |       |
| Additional  paid-in capital                                                                                                                                                                                                                                                                                         |       | 211,456                        |       | 206,452                       |       |
| Retained  earnings                                                                                                                                                                                                                                                                                                  |       | 415,832                        |       | 273,589                       |       |
| Deferred  compensation                                                                                                                                                                                                                                                                                              |       | —                         |       | (3,131                        | )          |
| Treasury stock,  3,847 and 1,469 shares held at March 31, 2006 and June 30, 2005,  respectively, at cost                                                                                                                                                                                                  |       | (121,545                       | )          | (55,665                       | )          |
| Accumulated  other comprehensive loss                                                                                                                                                                                                                                                                               |       | (343                           | )          | (343                          | )          |
| Total  stockholders’ equity                                                                                                                                                                                                                                                                                    |       | 506,067                        |       | 421,566                       |       |
| Total  liabilities and stockholders’ equity                                                                                                                                                                                                                                                                    |       | $                              | 682,175    |                          | $          | 558,193 |   |

 

Seeaccompanying notes to unaudited condensed consolidated financial statements.

 

3

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**THEFIRST MARBLEHEAD CORPORATION AND SUBSIDIARIES**

** **

**CONDENSEDCONSOLIDATED STATEMENTS OF OPERATIONS(unaudited)(in thousands, except per share amounts)**

** **
| ** **                                    | ** ** | **Three months ended   March 31,** | ** ** | **Nine months ended   March 31,** | ** ** |
|-----------------------------------------------|------------|--------------------------------------------------------|------------|-------------------------------------------------------|------------|
| ** **                                    | ** ** | **2006**                                               | ** ** | **2005**                                              | ** ** | **2006** | ** ** | **2005** | ** ** |
| Service  revenues:                            |       |                                                   |       |                                                  |       |   |   |   |   |
| Up-front  structural advisory fees            |       | $                                                      | 58,457     |                                                  | $          | 55,000 |   | $ | 154,627 |   | $ | 120,050 |   |
| Additional  structural advisory fees:         |       |                                                   |       |                                                  |       |   |   |   |   |
| From new  securitizations                     |       | 8,764                                                  |       | 7,970                                                 |       | 23,542 |   | 17,901 |   |
| Trust updates                                 |       | (37                                                    | )          | (28                                                   | )          | 1,403 |   | 782 |   |
| Total additional  structural advisory fees    |       | 8,727                                                  |       | 7,942                                                 |       | 24,945 |   | 18,683 |   |
| Residuals:                                    |       |                                                   |       |                                                  |       |   |   |   |   |
| From new  securitizations                     |       | 47,432                                                 |       | 31,345                                                |       | 125,648 |   | 88,402 |   |
| Trust updates                                 |       | 5,623                                                  |       | 3,808                                                 |       | 25,596 |   | 13,434 |   |
| Total residual  revenue                       |       | 53,055                                                 |       | 35,153                                                |       | 151,244 |   | 101,836 |   |
| Processing fees  from TERI                    |       | 26,583                                                 |       | 20,610                                                |       | 77,779 |   | 54,547 |   |
| Administrative  and other fees                |       | 2,352                                                  |       | 829                                                   |       | 6,145 |   | 2,660 |   |
| Total service  revenues                       |       | 149,174                                                |       | 119,534                                               |       | 414,740 |   | 297,776 |   |
| Operating  expenses:                          |       |                                                   |       |                                                  |       |   |   |   |   |
| Compensation and  benefits                    |       | 25,107                                                 |       | 17,322                                                |       | 66,009 |   | 47,523 |   |
| General and  administrative expenses          |       | 24,140                                                 |       | 20,391                                                |       | 72,956 |   | 51,702 |   |
| Total operating  expenses                     |       | 49,247                                                 |       | 37,713                                                |       | 138,965 |   | 99,225 |   |
| Income from  operations                       |       | 99,927                                                 |       | 81,821                                                |       | 275,775 |   | 198,551 |   |
| Other income  (expense):                      |       |                                                   |       |                                                  |       |   |   |   |   |
| Interest expense                              |       | (203                                                   | )          | (131                                                  | )          | (633 | ) | (366 | ) |
| Interest income                               |       | 1,572                                                  |       | 1,177                                                 |       | 4,866 |   | 2,532 |   |
| Other                                         |       | 25                                                     |       | —                                                |       | 2,526 |   | — |   |
| Net other income                              |       | 1,394                                                  |       | 1,046                                                 |       | 6,759 |   | 2,166 |   |
| Income before  income tax expense             |       | 101,321                                                |       | 82,867                                                |       | 282,534 |   | 200,717 |   |
| Income tax  expense                           |       | 42,099                                                 |       | 35,429                                                |       | 117,393 |   | 84,100 |   |
| Net income                                    |       | $                                                      | 59,222     |                                                  | $          | 47,438 |   | $ | 165,141 |   | $ | 116,617 |   |
|                                          |       |                                                   |       |                                                  |       |   |   |   |   |
| Net income per  share, basic                  |       | $                                                      | 0.94       |                                                  | $          | 0.72 |   | $ | 2.59 |   | $ | 1.80 |   |
| Net income per  share, diluted                |       | 0.93                                                   |       | 0.71                                                  |       | 2.56 |   | 1.74 |   |
| Dividends declared per share                  |       | 0.12                                                   |       | —                                                |       | 0.36 |   | — |   |
| Weighted average  shares outstanding, basic   |       | 62,856                                                 |       | 65,684                                                |       | 63,780 |   | 64,871 |   |
| Weighted average  shares outstanding, diluted |       | 63,364                                                 |       | 67,216                                                |       | 64,392 |   | 66,937 |   |

 

Seeaccompanying notes to unaudited condensed consolidated financial statements.

 

4

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**THEFIRST MARBLEHEAD CORPORATION AND SUBSIDIARIES**

** **

**CONDENSEDCONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY(unaudited)(in thousands, except per share amounts)**

 
| ** **                                            | ** ** | ** **            | ** ** | ** **           | ** ** | ** **  | ** ** | ** **   | ** ** | ** **   | ** ** | ** **        | ** ** | ** **             | ** ** | **Accumulated**                     | ** ** | ** ** | ** ** |
|-------------------------------------------------------|------------|-----------------------|------------|----------------------|------------|-------------|------------|--------------|------------|--------------|------------|-------------------|------------|------------------------|------------|-------------------------------------|------------|------------|------------|
| ** **                                            | ** ** | **Common stock** | ** ** | **Additional**       | ** ** | ** **  | ** ** | ** **   | ** ** | **other**    | ** ** | **Total**         | ** ** |
| ** **                                            | ** ** | **Issued**            | ** ** | **In treasury** | ** ** | **Paid-in** | ** ** | **Retained** | ** ** | **Deferred** | ** ** | **comprehensive** | ** ** | **stockholders’** | ** ** |
| ** **                                            | ** ** | **Shares**            | ** ** | **Amount**           | ** ** | **Shares**  | ** ** | **Amount**   | ** ** | **capital**  | ** ** | **earnings**      | ** ** | **compensation**       | ** ** | **loss, net of tax** | ** ** | **equity** | ** ** |
| **Balance  at June 30, 2005**                    |       | 66,368                |       | $                    | 664        |        | (1,469     | )            | $          | (55,665      | )          | $                 | 206,452    |                   | $          | 273,589                             |       | $          | (3,131     | ) | $ | (343 | ) | $ | 421,566 |   |
| Adoption of FAS  123 (R)                              |       | —                |       | —               |       | —      |       | —       |       | (3,131       | )          | —            |       | 3,131                  |       | —                              |       | —     |       |
| Net income                                            |       | —                |       | —               |       | —      |       | —       |       | —       |       | 165,141           |       | —                 |       | —                              |       | 165,141    |       |
| Options exercised                                     |       | 353                   |       | 3                    |       | —      |       | —       |       | 917          |       | —            |       | —                 |       | —                              |       | 920        |       |
| Stock issuances  through employee stock purchase plan |       | 25                    |       | —               |       | —      |       | —       |       | 710          |       | —            |       | —                 |       | —                              |       | 710        |       |
| Repurchase of  common stock                           |       | —                |       | —               |       | (2,378      | )          | (65,880      | )          | —       |       | —            |       | —                 |       | —                              |       | (65,880    | )          |
| Recognition of  stock-based compensation              |       | —                |       | —               |       | —      |       | —       |       | 2,229        |       | —            |       | —                 |       | —                              |       | 2,229      |       |
| Cash dividends  ($0.36 per share)                     |       | —                |       | —               |       | —      |       | —       |       | —       |       | (22,898           | )          | —                 |       | —                              |       | (22,898    | )          |
| Tax benefit from  employee stock options              |       | —                |       | —               |       | —      |       | —       |       | 4,279        |       | —            |       | —                 |       | —                              |       | 4,279      |       |
| **Balance  at March 31, 2006**                        |       | 66,746                |       | $                    | 667        |        | (3,847     | )            | $          | (121,545     | )          | $                 | 211,456    |                   | $          | 415,832                             |       | $          | —     |   | $ | (343 | ) | $ | 506,067 |   |

 

Seeaccompanying notes to unaudited condensed consolidated financial statements.

 

5

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**THEFIRST MARBLEHEAD CORPORATION AND SUBSIDIARIES**

 

**CONDENSEDCONSOLIDATED STATEMENTS OF CASH FLOWS(unaudited)(in thousands)**

 
| ** **                                                                                               | ** ** | **Nine months ended   March 31,** | ** ** |
|----------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------|------------|
| ** **                                                                                               | ** ** | **2006**                                              | ** ** | **2005** | ** ** |
| Cash flows from  operating activities:                                                                   |       |                                                  |       |   |   |
| Net income                                                                                               |       | $                                                     | 165,141    |   | $ | 116,617 |   |
| Adjustments to  reconcile net income to net cash provided by operating activities:                       |       |                                                  |       |   |   |
| Depreciation and  amortization                                                                           |       | 10,478                                                |       | 5,524 |   |
| Deferred income  tax expense                                                                             |       | 43,492                                                |       | 30,278 |   |
| Tax benefit from  employee stock options                                                                 |       | —                                                |       | 30,448 |   |
| Stock-based  compensation                                                                                |       | 2,229                                                 |       | 332 |   |
| Change in  assets/liabilities:                                                                           |       |                                                  |       |   |   |
| (Increase) in  structural advisory fees                                                                  |       | (24,945                                               | )          | (8,433 | ) |
| (Increase) in  residuals                                                                                 |       | (151,244                                              | )          | (101,837 | ) |
| Decrease  (increase) in processing fees from TERI                                                        |       | 1                                                     |       | (2,306 | ) |
| Decrease in  prepaid income taxes                                                                        |       | 2,594                                                 |       | 3,152 |   |
| (Increase) in  other prepaid expenses                                                                    |       | (2,084                                                | )          | (518 | ) |
| (Increase) in  other assets                                                                              |       | (824                                                  | )          | (1,220 | ) |
| (Decrease)  increase in accounts payable, accrued expenses, income taxes payable, and  other liabilities |       | (1,060                                                | )          | 3,627 |   |
| Net cash  provided by operating activities                                                               |       | 43,778                                                |       | 75,664 |   |
| Cash flows from  investing activities:                                                                   |       |                                                  |       |   |   |
| Purchases of  property and equipment                                                                     |       | (7,493                                                | )          | (21,548 | ) |
| Payments to TERI  for loan database updates                                                              |       | (558                                                  | )          | (561 | ) |
| Net cash used in  investing activities                                                                   |       | (8,051                                                | )          | (22,109 | ) |
| Cash flows from  financing activities:                                                                   |       |                                                  |       |   |   |
| Repayment of  capital lease obligations                                                                  |       | (3,524                                                | )          | (593 | ) |
| Repayment of  notes payable                                                                              |       | (562                                                  | )          | (7,780 | ) |
| Tax benefit from  employee stock options                                                                 |       | 4,279                                                 |       | — |   |
| Issuances of  common stock                                                                               |       | 1,630                                                 |       | 4,573 |   |
| Repurchases of  common stock                                                                             |       | (65,880                                               | )          | — |   |
| Cash dividends  on common stock                                                                          |       | (22,898                                               | )          | — |   |
| Net cash used in  financing activities                                                                   |       | (86,955                                               | )          | (3,800 | ) |
| Net (decrease)  increase in cash and cash equivalents                                                    |       | (51,228                                               | )          | 49,755 |   |
| Cash and cash  equivalents, beginning of period                                                          |       | 193,796                                               |       | 168,712 |   |
| Cash and cash  equivalents, end of period                                                                |       | $                                                     | 142,568    |   | $ | 218,467 |   |
| Supplemental  disclosures of cash flow information:                                                      |       |                                                  |       |   |   |
| Interest paid                                                                                            |       | $                                                     | 633        |   | $ | 616 |   |
| Income taxes  paid                                                                                       |       | $                                                     | 65,206     |   | $ | 20,221 |   |
| Supplemental  disclosure of non-cash activities:                                                         |       |                                                  |       |   |   |
| Acquisition of  property and equipment through capital leases                                            |       | $                                                     | 1,135      |   | $ | 6,116 |   |

 

See accompanying notes tounaudited condensed consolidated financial statements.

 

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**THE FIRST MARBLEHEADCORPORATION AND SUBSIDIARIESNOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(dollars and shares in thousands, except per share amounts)**

** **

**(1)   Nature of Business and Summary ofSignificant Accounting Policies**

 

***Natureof Business***

*** ***

The First MarbleheadCorporation (FMC, and together with its subsidiaries, the Company) providesoutsourcing services for private education lending in the United States. TheCompany helps meet the growing demand for private education loans by providingnational and regional financial institutions and educational institutions, aswell as businesses and other enterprises, with an integrated suite of servicesfor designing and implementing student loan programs for their respectivecustomers, students, employees and members. The Company focuses primarily onprivate student loan programs for undergraduate, graduate and professionaleducation, and, to a lesser degree, on continuing education programs, theprimary and secondary school market, career training and study abroad programs.The Company is entitled to receive structural advisory fees and residuals forits services in connection with securitizations of loans generated by the loanprograms that it facilitates. The Company facilitates two primary loanprograms, private label and Guaranteed Access to Education, or GATE. TheCompany also receives reimbursement from The Education Resources Institute, Inc.(TERI) for outsourced services the Company performs on TERI’s behalf, fees formarketing coordination services it provides to certain clients and fees foradministrative services that the Company provides to the discrete trustvehicles that the Company forms for securitizations it facilitates. From timeto time the Company also receives fees for its services in securitizing privatestudent loan portfolios for third parties.

 

***Basisof Presentation***

*** ***

The Company’saccompanying unaudited condensed consolidated financial statements have beenprepared in accordance with accounting principles generally accepted in theUnited States of America (GAAP) for interim financial information. Accordingly,they do not include all of the information and footnotes required by GAAP forcomplete consolidated financial statements. In the opinion of management, alladjustments (consisting of normal recurring accruals and mark to marketadjustments for service receivables) considered necessary for a fair statementof the results for the interim periods have been included. The preparation offinancial statements in conformity with GAAP requires management to makeestimates and assumptions that affect the amounts reported in the consolidatedfinancial statements and accompanying notes. Interim results are notnecessarily indicative of results to be expected for the entire fiscal year.All significant intercompany balances and transactions have been eliminated inconsolidation. These unaudited financial statements should be read in conjunctionwith the audited consolidated financial statements and related notes for theyear ended June 30, 2005 included in the Company’s Annual Report onForm 10-K filed with the Securities and Exchange Commission onSeptember 7, 2005.

 

***StudentLoan Market Seasonality and Revenue Related to Securitization Transactions***

*** ***

Origination of studentloans is generally subject to seasonal trends, with the volume of loanapplications increasing with the approach of tuition payment dates. In general,the Company processes the greatest application volume during the summer months,as students and their families seek to borrow money in order to pay tuitioncosts for the fall semester or the entire school year. The Company also tendsto process an increased volume of loan applications during December andJanuary, as students and their families seek to borrow money to pay tuitioncosts for the spring semester.

 

The Company did notconduct a securitization transaction during the first quarter of either fiscal2006 or fiscal 2005. The Company closed one securitization transaction in eachof the second and third quarters of fiscal 2006 and expects to close twosecuritization transactions in the fourth quarter of fiscal 2006. During fiscal2005, the Company closed one securitization transaction in the second quarter,one securitization transaction in the third quarter and three securitizationtransactions in the fourth quarter.

 

7

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***Concentrations***

*** ***

**TERI**

** **

TERI is a private,not-for-profit Massachusetts organization as described undersection 501(c)(3) of the Internal Revenue Code. Incorporated in 1985,TERI is the oldest and largest guarantor of alternative, or private, studentloans. In its role as guarantor in the private education lending market, TERIagrees to reimburse lenders or securitization trusts for unpaid principal andinterest on defaulted loans. TERI is the exclusive third-party provider ofborrower default guarantees for the Company’s clients’ private student loans.As of March 31, 2006, TERI had a Baa3 counterparty rating from Moody’sInvestors Service, which is the lowest investment grade rating, and an insurerfinancial strength rating of A+ from Fitch Ratings. If these ratings arelowered, FMC’s clients may not wish to enter into guarantee arrangements withTERI. In addition, FMC may receive lower structural advisory fees because thecosts of obtaining financial guarantee insurance for the asset-backedsecuritizations that FMC structures could increase.

 

InFebruary 2001, FMC and TERI entered into a two-year Master Loan GuarantyAgreement, which granted TERI a right of first refusal to guarantee loans underexisting and future private label loan programs facilitated by FMC, as well asnew loan programs jointly created by FMC and TERI. In June 2001, as aresult of the closing of the Company’s acquisition of TERI’s loan processingoperations, the Master Loan Guaranty Agreement was automatically extended for afive-year term from the date of the acquisition closing. The loans guaranteedpursuant to the Master Loan Guaranty Agreement comprise only a portion of TERI’sguarantee business, and the Master Loan Guaranty Agreement does not precludeTERI from continuing to provide its guarantees to loan originators notassociated with FMC. Under the terms of the original Master Loan GuarantyAgreement, FMC also agreed to provide a beneficial interest for TERI of 25% ofthe residual value of TERI-guaranteed loans owned by the securitization truststhat purchase the loans.

 

InOctober 2004, FMC renewed its Master Loan Guaranty Agreement and certainadditional agreements with TERI, in each case for an additional term throughJune 2011. Under the terms of the Master Loan Guaranty Agreement, TERI isrequired to place into a segregated reserve the majority of the guarantee feesit receives for loans that are originated and securitized by the Company. Thesegregated reserve amounts are then pledged to each trust that purchases loansat the time of securitization. TERI is entitled to retain as an administrativefee a portion of the guarantee fees, calculated based on the principal balanceof loans originated and securitized. In October 2004, FMC entered into afourth supplement to the Master Loan Guaranty Agreement, under which FMCgranted to TERI a right to elect once each fiscal year to increase the amountof its administration fee by 25 basis points, with a correspondingreduction from 25% to 20% in TERI’s ownership of the residual value of theTERI-guaranteed loans purchased during that year by the securitization trustsand a resulting increase from 75% to 80% in FMC’s residual ownership. TERI madesuch an election for fiscal 2005. In October 2005, FMC entered into afifth supplement to the Master Loan Guaranty Agreement. Under the terms of thisfifth supplement, for securitizations of TERI-guaranteed loans in fiscal 2006,TERI’s administrative fee will increase, and the amount deposited in thesegregated reserve will decrease, by 90 basis points. In addition, TERI’sresidual interest in the trusts created at the time of securitization will becorrespondingly reduced to account for the 90 basis point reduction in theamount placed in the segregated reserve. Therefore, TERI’s administrative feefor securitizations of TERI-guaranteed loans in fiscal 2006 will be240 basis points multiplied by the principal balance of loans originatedand securitized. For the securitizations completed during the first nine monthsof fiscal 2006, TERI’s ownership of the residual value of the TERI-guaranteedloans securitized has been approximately 12%.

 

Undera Master Servicing Agreement with a term through June 2011, FirstMarblehead Educational Resources, Inc. (FMER), a wholly owned subsidiaryof FMC, provides to TERI underwriting, documentation and other origination services,as well as technical support, disbursements, customer service, collections,default prevention, default processing, accounting services and guaranteeclaims management and administrative services, in support of TERI’s loanguarantee function. FMC guarantees the full and timely performance by FMER ofits 

 

8

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obligations pursuant tothis Master Servicing Agreement. FMC uses the acquired TERI assets, includinghistorical loan data, to support the design and implementation of loan programsfacilitated by FMC and loan programs jointly created by FMC and TERI. Inaddition, TERI has the right to designate one of three representatives to serveon the board of directors of FMER.

 

**PHEAA**

** **

As of March 31, 2006,there were eight TERI-approved loan servicers. Servicers provide administrativeservices relating to loans, including processing deferment and forbearancerequests, sending out account statements and accrual notices, responding toborrower inquiries, and collecting and crediting payments received fromborrowers. As of March 31, 2006, the Company utilized five of these servicers.As of March 31, 2006, Pennsylvania Higher Education Assistance Agency (PHEAA)serviced a majority of the loans for which the Company facilitates origination.PHEAA also operates under the name American Education Services (AES). Thisarrangement allows the Company to increase the volume of loans in the Company’sclients’ loan programs without incurring the overhead investment of servicingoperations. As with any external service provider, there are risks associatedwith inadequate or untimely services. In addition, if the Company’srelationship with PHEAA terminates, the Company would either need to expand ordevelop a relationship with one or more other TERI-approved loan servicers,which could be time-consuming and costly.

 

**SignificantCustomers**

** **

Duringthe three and nine months ended March 31, 2006, processing fees from TERIrepresented approximately 18% and 19%, respectively, of total service revenue.Securitization-related fees from trusts created in October 2005 and March 2006 representedapproximately 45% and 28%, respectively, of total service revenue for the firstnine months of fiscal 2006. These trusts purchased private label loans fromseveral lenders, including JP Morgan Chase Bank, N.A., Bank of America, N.A.,PNC Bank, N.A. and Charter One Bank N.A., in securitizations that the Companyfacilitated in the second and third quarters of fiscal 2006. The Company didnot recognize more than 10% of total service revenue from any other customerfor the three or nine months ended March 31, 2006.

 

***SignificantAccounting Policies and Estimates***

** **

Thepreparation of the Company’s consolidated financial statements requires theCompany to make estimates, assumptions and judgments that affect the reportedamounts of assets and liabilities and the reported amounts of income andexpenses during the reporting periods. The Company bases its estimates andjudgments on historical experience and on various other factors, and actualresults may differ from these estimates under varying assumptions orconditions. On an ongoing basis, the Company evaluates its estimates andjudgments, particularly as they relate to accounting policies that the Companybelieves are most important to the portrayal of the Company’s financialcondition and results of operations, such as its accounting policies involvingthe recognition and valuation of the Company’s securitization-related servicerevenue and receivables, and with respect to the determination of whether ornot to consolidate the financial results of the securitization trusts that itfacilitates. See “Management’s Discussion and Analysis of Financial Conditionand Results of Operations—Executive Summary—Application of Critical AccountingPolicies and Estimates”.

 

***Cashand Cash Equivalents***

*** ***

Cash and cashequivalents at March 31, 2006 included primarily $98,064 held in a moneymarket fund that invests in short-term obligations of the U.S. Treasury andrepurchase agreements fully collateralized by obligations of the U.S. Treasuryand $24,955 invested in Variable Rate Demand Notes. Included in cash and cashequivalents are compensating balances supporting various financing arrangementsof $12,510 and $23,309 at March 31, 2006 and June 30, 2005,respectively.

 

9

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***IncomeTaxes***

*** ***

In determining aquarterly provision for income taxes, the Company uses an estimated annualeffective tax rate which is based on its expected annual income, statutory taxrates and tax planning opportunities available to it in the variousjurisdictions in which it operates. The Company has a net deferred income taxliability primarily because, under GAAP, it recognizes residuals in financialstatement income earlier than they are recognized for income tax purposes.

 

**(2)   StockOptions**

** **

At March 31, 2006,the Company had four stock-based compensation plans, which are described morefully in Note 9 and Note 13 of the Company’s Annual Report on Form 10-K filedwith the Securities and Exchange Commission on September 7, 2005. Prior toJuly 1, 2005, the Company accounted for those plans under the recognitionand measurement provisions of Accounting Principles Board (APB) OpinionNo. 25, *Accounting for Stock Issued to Employees*(Opinion25), and related Interpretations, as permitted by Financial AccountingStandards Board (FASB) Statement No. 123, *Accountingfor Stock-Based Compensation*(Statement 123). The Company did notrecognize any compensation cost related to option grants in its consolidated statementsof operations for the years ended on or prior to June 30, 2005, as optionsgranted under the plans had an exercise price equal to or greater than themarket value of the underlying common stock on the date of grant. EffectiveJuly 1, 2005, the Company adopted the fair value recognition provisions ofFASB Statement No. 123(R), *Share-Based Payment*(Statement123(R)), using the modified-prospective transition method. Under thistransition method, compensation cost recognized in the first nine months offiscal 2006 includes: (a) compensation cost for all share-based paymentsgranted prior to, but not yet vested, as of July 1, 2005, based on thegrant date fair value estimated in accordance with the original provisions ofStatement 123 and (b) compensation cost for all share-based paymentsgranted on or subsequent to July 1, 2005, based on the grant-date fairvalue estimated in accordance with the provisions of Statement 123(R). Resultsfor prior periods have not been restated. As a result of adopting Statement123(R) on July 1, 2005, the Company’s income before income taxes forthe first nine months of fiscal 2006 was approximately $503 lower, and netincome for the first nine months of fiscal 2006 was approximately $383 lower,than if it had continued to account for share-based compensation under Opinion25. The Company’s basic earnings per share for the first nine months of fiscal2006 would have been $2.60 if it had continued to account for share-basedcompensation under Opinion 25. The Company’s diluted earnings per share for thefirst nine months of fiscal 2006 would have been $2.57 if it had continued toaccount for share-based compensation under Opinion 25.

 

Asrequired, prior to the adoption of Statement 123(R), the Company presented alltax benefits of deductions resulting from the exercise of stock options asoperating cash flows in its consolidated statements of cash flows. Statement123(R) requires the Company to present as financing cash flows all taxbenefits from tax deductions in excess of the compensation cost recognized for stockoptions (excess tax benefits). The $4,279 excess tax benefits classified as afinancing cash inflow during the first nine months of fiscal 2006 would havebeen classified as an operating cash inflow if the Company had not adoptedStatement 123(R).

 

10

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Forpurposes of pro forma disclosures for periods prior to July 1, 2005, theestimated fair value of the stock options is amortized to expense over thevesting period of the options. The Company’s consolidated pro forma net incomeand net income per share for the three and nine-month periods ended March 31,2005, had the Company elected to recognize compensation expense for the grantingof options under Statement 123 using the Black-Scholes option pricingmodel, is as follows:

 
| ** **                                                                                                                      | ** ** | **Three months ended****March 31, 2005** | ** ** | **Nine months ended ****March 31, 2005** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------|------------|-------------------------------------------------------------------|------------|
| Net income—as  reported                                                                                                    |       | $                                                            | 47,438     |                                                              | $          | 116,617 |   |
| Add: Total  stock-based employee compensation expense included in reported net income,  net of tax                              |       | 112                                                          |       | 193                                                               |       |
| Less: Total  stock-based employee compensation expense determined under the fair value  based method for all awards, net of tax |       | (239                                                         | )          | (1,084                                                            | )          |
| Net income—pro  forma                                                                                                      |       | $                                                            | 47,311     |                                                              | $          | 115,726 |   |
| Net income per  share—basic—as reported                                                                               |       | $                                                            | 0.72       |                                                              | $          | 1.80 |   |
| Net income per  share—basic—pro forma                                                                                 |       | $                                                            | 0.72       |                                                              | $          | 1.78 |   |
| Net income per  share—diluted—as reported                                                                             |       | $                                                            | 0.71       |                                                              | $          | 1.74 |   |
| Net income per  share—diluted—pro forma                                                                               |       | $                                                            | 0.70       |                                                              | $          | 1.73 |   |

 

**(3)**   Service Receivables

** **

Structuraladvisory fees and residuals receivable represent the estimated fair value ofadditional structural advisory fees and residuals expected to be collected overthe lives of the securitization trusts that have purchased student loansfacilitated by the Company, net of prepayment, default and recovery estimates forthe student loans. The fees are paid to the Company from these various separatesecuritization trusts. Private label loans guaranteed by TERI have generallybeen purchased by several private label loan trusts. GATE loans, and a limitednumber of TERI-guaranteed and other loans, have been purchased by separatesecuritization trusts (NCT trusts) established by the National CollegiateTrust. Processing fees receivable from TERI represents amounts due from TERIfor expenses incurred by FMER on TERI’s behalf.

 

The Company, on a quarterly basis, updates itsestimate of the fair value of its structural advisory fees and residualsreceivable to reflect the passage of time, any change in discount rates used toestimate their fair value, and any changes to the trust performance metricsthat the Company considers in its fair value estimates, such as default,recovery, prepayment and forward London Interbank Offered Rate (LIBOR) rates.

 

The Company conducted asecuritization transaction of private label loans in each of the second andthird quarters of fiscal 2006 and fiscal 2005. The following table summarizesthe changes in the structural advisory fees receivable for the first nine monthsof fiscal 2006 and fiscal 2005: 

 
| ** **                                                                | ** ** | **Nine months ended ****March 31,** | ** ** |
|---------------------------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                                                | ** ** | **2006**                                                | ** ** | **2005** | ** ** |
| Fair value of  additional structural advisory fees at beginning of period |       | $                                                       | 53,371     |   | $ | 24,084 | (1) |
| Additions from  structuring new securitizations                           |       | 23,542                                                  |       | 17,901 |   |
| Fair value  adjustments                                                   |       | 1,403                                                   |       | 782 |   |
| Total structural  advisory fees receivable at end of period               |       | $                                                       | 78,316     |   | $ | 42,767 |   |

 

----

(1)    Excludes a $10,250 structural advisoryfee receivable that the Company collected in July 2004 from a securitizationtransaction completed in December 2003.

 

11

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The following tablesummarizes the changes in the residuals receivable for the first nine months offiscal 2006 and fiscal 2005:

 
| ** **                                                 | ** ** | **Nine months ended ****March 31,** | ** ** |
|------------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                                 | ** ** | **2006**                                                | ** ** | **2005** | ** ** |
| Fair value of  residuals receivable at beginning of period |       | $                                                       | 247,275    |   | $ | 108,495 |   |
| Additions from  structuring new securitizations            |       | 125,648                                                 |       | 88,402 |   |
| Fair value  adjustments                                    |       | 25,596                                                  |       | 13,434 |   |
| Total residuals  receivable at end of period               |       | $                                                       | 398,519    |   | $ | 210,331 |   |

 

Fora discussion of the sensitivity of the additional structural fees and residualsto variations in our assumptions and estimates, see “Management’s Discussionand Analysis of Financial Condition and Results of Operations—ExecutiveSummary—Application of Critical Accounting Policies and Estimates—ServiceRevenue and Receivables—Sensitivity Analysis”.

 

**(4)    Related Party Transactions**

** **

At March 31, 2006,the Company had invested approximately $98,064 of cash and cash equivalents ina money market fund. The investment adviser for this fund is Milestone CapitalManagement, LLC (MCM), an institutional money management firm. In addition,approximately $24,955 of cash equivalents was invested by MCM on behalf of theCompany under an investment management agreement. MCM receives a fee for servicesit performs under this agreement. MCM is a wholly owned subsidiary of MilestoneGroup Partners. Members of the immediate family of one of the Company’sdirectors own approximately 65% of Milestone Group Partners.

 

**(5)    Notes Payable to TERI**

** **

The Company entered intoa Note Payable Agreement with TERI on June 20, 2001, in the principalamount of $3,900, to fund the Company’s acquisition of TERI’s loan processingoperations. Of the principal amount, $2,000 related to the acquisition of TERI’ssoftware and network assets and $1,900 related to the acquiredworkforce-in-place. Under the terms of the note payable, principal and interestat an annual rate of 6% are payable in 120 monthly installments of $43commencing on July 20, 2001 and ending on June 20, 2011. The notepayable is secured by the software and network assets. At March 31, 2006,the outstanding balance of this note payable was $2,335.

 

The Company also enteredinto a second note payable with TERI on June 20, 2001, in the principalamount of $4,000, to fund the acquisition of TERI’s loan database. Principaland interest at an annual rate of 6% are payable in 120 monthlyinstallments of $44 commencing on July 20, 2001 and ending onJune 20, 2011. The note payable is secured by the loan database. At March 31,2006, the outstanding balance of this note payable was $2,395.

 

**(6)    Other Borrowings**

** **

***(a)Revolving Line of Credit***

*** ***

In August 2003, theCompany entered into an agreement with Fleet National Bank to establish arevolving line of credit in the amount of $10,000, which included a sub-limitfor letters of credit. Fleet National Bank was acquired by Bank of America, andthe Company’s agreement related to this facility was assigned to Bank ofAmerica. The revolving credit facility, which matured on August 28, 2005,contained certain financial covenants and restrictions, including a restrictionon the Company’s ability to pay cash dividends in the event it was in default.No amounts were outstanding under this revolving line of credit atJune 30, 2005.

 

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***(b)   EquipmentLine of Credit***

*** ***

In January 2005,the Company entered into an equipment financing lease agreement which it usedto finance purchases of furniture and equipment. The agreement, which expiredon December 30, 2005, allowed the Company to finance up to $20,000 worthof furniture and equipment purchased before December 30, 2005. The Companyexpects to repay amounts drawn down on the line of credit at terms ranging fromthree to five years. At March 31, 2006, the outstanding principal balanceon amounts borrowed under this line of credit was $8,693.

 

**(7)    Stockholders’ Equity**

** **

***2002Director Stock Plan***

*** ***

In September 2002,the board of directors of the Company (Board of Directors) approved, and inAugust 2003, the Company’s stockholders approved, the 2002 Director StockPlan and reserved 200 shares of common stock, $0.01 par value per share (CommonStock), for issuance to the Company’s non-employee directors. As of March 31,2006, options to purchase 88 shares of Common Stock have been issued under thisplan.

 

***2003Stock Incentive Plan***

*** ***

In September 2003,the Board of Directors and stockholders approved the 2003 Stock Incentive Planand reserved 1,200 shares of Common Stock for issuance under this plan. OnAugust 9, 2005, the Board of Directors authorized, subject to stockholderapproval, an amendment increasing the number of shares of Common Stock reservedfor issuance under the 2003 Stock Incentive Plan from 1,200 to 2,700. OnOctober 27, 2005, the Company’s stockholders approved this amendment. Asof March 31, 2006, there were 386 restricted stock units outstanding underthis plan. Each restricted stock unit represents the right to receive at nocost one share of Common Stock upon vesting.

 

***2003Employee Stock Purchase Plan***

*** ***

In October 2003,the Board of Directors and stockholders approved the 2003 Employee StockPurchase Plan (Stock Purchase Plan). A total of 400 shares of Common Stock areauthorized for issuance under this plan. The Stock Purchase Plan permitseligible employees to purchase shares of Common Stock at the lower of 85% ofthe fair market value of the Common Stock at the beginning or at the end ofeach offering period. Employees who own 5% or more of the Common Stock are noteligible to participate in the Stock Purchase Plan. Participation is voluntary.Under the Stock Purchase Plan, 13, 12, 10, and 40, shares of Common Stock wereissued in January 2006, July 2005, January 2005 andJuly 2004, respectively.

 

***Share Repurchase Program***

*** ***

In the fourth quarter offiscal 2005, the Board of Directors approved the repurchase of up to 1,500shares of Common Stock from time to time on the open market or in privatelynegotiated transactions. In September 2005, the Board of Directorsapproved the repurchase of up to an additional 5,000 shares of Common Stock. Asof March 31, 2006, the Company had repurchased in aggregate 3,847 sharesof Common Stock at an aggregate cost of $121,545.

 

13

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**(8)    Net Income per Share**

** **

Thefollowing table sets forth the computation of basic and diluted net income pershare of Common Stock:

 
| ** **                                                         | ** ** | **Three months ended  March 31,** | ** ** | **Nine months ended  March 31,** | ** ** |
|--------------------------------------------------------------------|------------|--------------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                                                         | ** ** | **2006**                                         | ** ** | **2005**                                        | ** ** | **2006** | ** ** | **2005** | ** ** |
| Net income                                                         |       | $                                                | 59,222     |                                            | $          | 47,438 |   | $ | 165,141 |   | $ | 116,617 |   |
| Shares used in  computing net income per common share—basic   |       | 62,856                                           |       | 65,684                                          |       | 63,780 |   | 64,871 |   |
| Effect of  dilutive securities:                                    |       |                                             |       |                                            |       |   |   |   |   |
| Stock options                                                      |       | 447                                              |       | 1,519                                           |       | 593 |   | 2,063 |   |
| Restricted stock  units                                            |       | 61                                               |       | 13                                              |       | 19 |   | 3 |   |
| Dilutive  potential common shares                                  |       | 508                                              |       | 1,532                                           |       | 612 |   | 2,066 |   |
| Shares used in  computing net income per common share—diluted |       | 63,364                                           |       | 67,216                                          |       | 64,392 |   | 66,937 |   |
| Net income per  common share:                                      |       |                                             |       |                                            |       |   |   |   |   |
| Basic                                                              |       | $                                                | 0.94       |                                            | $          | 0.72 |   | $ | 2.59 |   | $ | 1.80 |   |
| Diluted                                                            |       | $                                                | 0.93       |                                            | $          | 0.71 |   | $ | 2.56 |   | $ | 1.74 |   |

 

**(9)    Pension Plan**

 

**FMER has a non-contributorydefined benefit pension plan that covers substantially all FMER employees employedon or before December 31, 2004. During the second quarter of fiscal 2005,the benefits under the plan were frozen. The following table sets forth theamounts recognized related to FMER’s defined benefit pension plan in theCompany’s unaudited condensed consolidated financial statements for the three- andnine-month periods ended March 31, 2006 and 2005:**

 
| ** **                                    | ** ** | **Three months ended****March 31,** | ** ** | **Nine months ended  March 31,** | ** ** |
|-----------------------------------------------|------------|----------------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                                    | ** ** | **2006**                                           | ** ** | **2005**                                        | ** ** | **2006** | ** ** | **2005** | ** ** |
| **Components  of net periodic pension cost:** |       |                                               |       |                                            |       |   |   |   |   |
| Service cost                                  |       | $                                                  | —     |                                            | $          | — |   | $ | — |   | $ | 315 |   |
| Interest on  projected benefit obligations    |       | 44                                                 |       | 40                                              |       | 132 |   | 163 |   |
| Loss recognized                               |       | 5                                                  |       | —                                          |       | 15 |   | 18 |   |
| Expected return  on plan assets               |       | (47                                                | )          | (50                                             | )          | (141 | ) | (134 | ) |
| Net periodic  pension cost before curtailment |       | 2                                                  |       | (10                                             | )          | 6 |   | 362 |   |
| Curtailment gain                              |       | —                                             |       | —                                          |       | — |   | (655 | ) |
| Net periodic  pension cost (gain)             |       | $                                                  | 2          |                                            | $          | (10 | ) | $ | 6 |   | $ | (293 | ) |

 

***Employer Contributions***

 

During the first ninemonths of fiscal 2006, the Company made contributions of $50 to FMER’s definedbenefit pension plan. The Company does not expect to make any additionalcontributions during the final quarter of fiscal 2006.

 

14

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**(10)   NewAccounting Pronouncements**

** **

The FASB has issuedexposure drafts that would amend FASB Statement No. 140, *Accounting for the Transfers and Servicing ofFinancial Assets and Extinguishments of Liabilities*. The proposedamendments would, among other things, change the requirements that an entitymust meet to be considered a qualified special-purpose entity. The FASB hasannounced that it expects to issue final guidance in the first calendar quarterof 2007. The Company is monitoring the status of the exposure drafts to assesstheir impact, if any, on its financial statements.

 

15

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**Item2.**         Management’sDiscussion and Analysis of Financial Condition and Results of Operations

 

*Youshould read the following discussion and analysis of our financial conditionand results of operations together with our unaudited condensed consolidatedfinancial statements and accompanying notes included elsewhere in this filing.In addition to the historical information, the discussion contains certainforward-looking statements that involve risks and uncertainties. Our actualresults could differ materially from those expressed or implied by theforward-looking statements due to the application of our critical accountingpolicies and other important factors including, but not limited to, those setforth under “Risk Factors” below.*

* *

**ExecutiveSummary**

** **

***Overview***

*** ***

We provide outsourcingservices for private education lending in the United States. We provideservices in connection with each of the five typical phases of the student loanlifecycle, offering our clients a single point of interface for:

 

•  program design and marketing;

 

•  borrower inquiry and application;

 

•  loan origination and disbursement;

 

•  loan securitization; and

 

•  loan servicing.

 

We receive fees for theservices we provide in connection with our clients’ private student loans,including processing, and structuring and administering securitizations, ofthose loans. Securitization refers to the technique of pooling loans andselling them to a special purpose, bankruptcy remote entity, typically a trust,which issues securities to investors backed by those loans.

 

We do not take a directownership interest in the loans our clients generate, nor do we serve as alender or guarantor with respect to any loan programs that we facilitate. Weassist the lenders in our loan programs in selecting the underwriting criteriaused in deciding whether a student loan will be made to an applicant. However,each lender has ultimate control over the selection of these criteria, and inproviding our services, we are obligated by contract to observe them. Lendersthat wish to have their loans guaranteed by The Education Resources Institute,or TERI, are required to meet TERI’s underwriting criteria. Although we overseeloan servicing as a component of our administrative duties, we do not act as aloan servicer.

 

We currently focus onfacilitating private student loans for undergraduate, graduate and professionaleducation, although we also provide service offerings for continuing educationprograms, the primary and secondary school market, career training and studyabroad programs. During the first nine months of fiscal 2006, we processed over702,000 loan applications and facilitated approximately $2.7 billion in loansat approximately 5,400 schools. During all of fiscal 2005, we processed over876,000 loan applications and facilitated approximately $2.7 billion in loansat over 5,300 schools. We have provided structural, advisory and other servicesfor 29 securitization transactions since our formation in 1991.

 

We offer services inconnection with two primary loan programs:

 

•  *Private label* programsthat are:

 

•   “direct to consumer,” or marketeddirectly to prospective student borrowers and their families by:

 

•  lenders;

 

•  third parties who are not themselveslenders but use referral lenders to make loans under their programs; and

 

•  businesses, unions, affinity groups andother organizations.

 

•   “school channel,” or marketed directly toeducational institutions by:

 

16

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•  lenders; and

 

•  third parties who are not themselveslenders but use referral lenders to make loans under their programs.

 

•  *Guaranteed Access toEducation*, or *GATE*,programs that educational institutions offer directly to their students.

 

During fiscal 2005, wesecuritized both private label loans and GATE loans. During the first ninemonths of fiscal 2006, we only facilitated the securitization of private labelloans. We expect that we will securitize GATE loans, including those we havefacilitated during the first nine months of our current fiscal year, as well asprivate label loans, in the fourth fiscal quarter. During fiscal 2005, ourprivate label programs, including processing fees from TERI, contributed $405.1million or 97% of our total service revenue, while our GATE programscontributed $12.8 million or 3% of our total service revenue.

 

In June 2001, wesignificantly enhanced our risk management and loan processing capabilitiesthrough a strategic relationship with TERI, the nation’s oldest and largestguarantor of private student loans. We acquired TERI’s loan processingoperations, including its historical database, but not its investment assets orguarantee liabilities. In connection with this acquisition, 161 members ofTERI’s staff became our employees. In addition, we entered into a masterservicing agreement pursuant to which TERI engages us to provide loanorigination and processing services with respect to the loans generated throughthe private label programs we facilitate, as well as other TERI-guaranteedloans. TERI reimburses us for the expenses we incur in providing theseservices. Under the terms of a master loan guaranty agreement that we haveentered into with TERI, we have also agreed to provide a beneficial interestfor TERI of a portion of the residual value of TERI-guaranteed loans owned bythe securitization trusts that purchase the loans, and granted to TERI a rightof first refusal to provide a third-party guarantee of our private labelclients’ existing and future loan programs. In October 2004, we renewedour master servicing agreement, master loan guaranty agreement and certainadditional agreements with TERI, in each case for an additional term throughJune 2011.

 

The primary driver ofour results of operations and financial condition is the volume of loans forwhich we provide outsourcing services from loan origination throughsecuritization. The following table shows the volume of loans facilitatedduring the first nine months of fiscal 2006 and fiscal 2005:

 
| ** **                                                                                          | ** ** | **Nine months ended  March 31,** | ** **   |
|-----------------------------------------------------------------------------------------------------|------------|-------------------------------------------------|--------------|
| ** **                                                                                          | ** ** | **2006**                                        | ** **   | **2005** | ** ** |
| Approximate  number of loans facilitated that were also available to us for securitization          |       | 246,000                                         |         | 196,000 |   |
| Approximate  number of loans facilitated                                                            |       | 301,000                                         |         | 255,000 |   |
| Aggregate  principal amount of loans facilitated that were also available to us for  securitization |       | $                                               | 2.35 billion |   | $ | 1.80 billion |   |
| Aggregate  principal amount of loans facilitated                                                    |       | $                                               | 2.74 billion |   | $ | 2.22 billion |   |

 

The dollar volume ofloans that we facilitated that were available to us for securitizationincreased 30% in the first nine months of fiscal 2006 as compared to the firstnine months of fiscal 2005. The total dollar volume of loans that wefacilitated in the first nine months of fiscal 2006 increased 23% as comparedto the first nine months of fiscal 2005.

 

Although we offer ourclients a fully integrated suite of outsourcing services, we do not chargeseparate fees for many of these services. Moreover, although we receive feesfor providing loan processing services to TERI in connection withTERI-guaranteed loans, these fees represent reimbursement of the directexpenses we incur. Accordingly, we do not earn a profit on these fees. Althoughwe provide these various services without charging a separate fee, or at “cost”in the case of processing services for TERI-guaranteed loans, we generallyenter into agreements with the private label lenders giving us the exclusiveright to securitize the loans that they do not intend to hold. We receivestructural advisory fees and residuals for facilitating securitizations ofthese loans. Our level of profitability depends on these structural advisoryfees and residuals. We discuss the manner in which we recognize them as revenuein greater detail below. We may in the future enter into arrangements withprivate label lenders under which we provide outsourcing services, but do nothave the exclusive right to securitize the loans that they originate.

 

17

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Changes in any of thefollowing factors can materially affect our financial results:

 

•  the demand for private educationfinancing;

 

•  the competition for providing privateeducation financing;

 

•  the education financing preferences ofstudents and their families;

 

•  applicable laws and regulations, whichmay affect the terms upon which our clients agree to make private student loansand the cost and complexity of our loan facilitation operations;

 

•  the private student loan securitizationmarket, including the costs or availability of financing;

 

•  the general interest rate environment,including its effect on our discount rates;

 

•  our critical accounting policies andestimates;

 

•  borrower default rates and our ability torecover principal and interest from such borrowers;

 

•  prepayment rates on private studentloans, including prepayments through loan consolidation; and

 

•  the availability of student loans throughfederal programs.

 

***Securitizationsand Related Revenue***

*** ***

We structure andfacilitate securitization transactions for our clients through a series ofbankruptcy remote, qualified special purpose statutory trusts. The trustsobtain through the securitization process private student loans from theoriginating lenders, which relinquish to the trust their ownership interest inthe loans. The debt instruments that the trusts issue to finance the purchaseof these student loans are obligations of the trusts, rather than ourobligations or those of originating lenders. We utilize special purposeentities for the securitization of TERI-guaranteed private label loans. Werefer to these trusts as private label loan trusts. In addition, National**CollegiateTrust, or NCT, wasformed in fiscal 1993 and has established separate securitization trusts, whichwe refer to as the NCT trusts, which have purchased primarily GATE loans and alimited number of TERI-guaranteed and other loans. In the future, we maysecuritize private label or GATE loans using NCT trusts, private label loantrusts or new trust vehicles.

 

Under the terms of someof our contracts with key lender clients, we have an obligation to securitizeperiodically the private student loans that these clients originate. If we donot honor our obligations to these lenders, we may be required to payliquidated damages, generally not exceeding an amount equal to 1% of the faceamount of the loans available for securitization.

 

We receive several typesof fees in connection with our securitization services:

 

•       *Structural advisory fees*. We charge structural advisoryfees that are paid in two portions:

 

•       *Up-front*. We receive a portion of thestructural advisory fees at the time the securitization trust purchases theloans. In exchange for these fees, we structure the debt securities sold in thesecuritization, coordinate the attorneys, accountants, trustees, loanservicers, loan originators and other transaction participants and prepare thecash flow modeling for rating agencies as needed. In securitizations we havefacilitated since the beginning of fiscal 2005, these fees have ranged from1.6% to 8.5% of the principal and capitalized interest of the loanssecuritized; and

 

•       *Additional*. We receive a portion of thestructural advisory fees over time, based on the amount of loans outstanding inthe trust from time to time over the life of the trust. This portionaccumulates monthly from the date of a securitization transaction at a rate of15 to 30 basis points per year. We begin to receive this additionalportion, plus interest, once the ratio of trust assets to trust liabilities,which we refer to as the “parity ratio,” reaches a stipulated level, whichranges from 103.0% to 105.0%. The level applicable to a particular trust isdetermined at the time of securitization. We currently expect to receive theadditional fees beginning five to seven years after the date of a particularsecuritization transaction*.*

 

18

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•       *Residual.* Wealso have the right to receive a portion of the residual interests that thesetrusts create. This interest is junior in priority to the rights of the holdersof the debt sold in the securitizations and entitles us to receive:

 

•       in connection with the securitizations ofexclusively private label loans, 75% to 88% of the residual cash flows once aparity ratio of 103.0% to 103.5%, depending on the particular trust, is reachedand maintained;

 

•       in connection with securitizations in theNCT trusts, our share of residual cash flows once all of the debt-holders ofthe securitization trust have been repaid, plus, in the case of GATE loanssecuritized in fiscal years prior to fiscal 2005, an additional 10% of theresidual cash flows. We are entitled to receive 100% of the residual cash flowsfor GATE loans securitized in fiscal 2005.

 

Our residual interestderives almost exclusively from the services we perform in connection with eachsecuritization rather than from a direct cash contribution to thesecuritization trust. In the case of securitizations of exclusively privatelabel loans, we currently expect to receive the residuals beginningapproximately five to six years after the date of a particular securitization.In the case of securitizations in the NCT trusts that occurred prior to fiscal2005, we expect to receive the residuals beginning 12 to 15 years after thedate of a particular securitization. In the case of the securitization in theNCT trusts that occurred in fiscal 2005, we currently expect to receiveresiduals beginning five to six years after the date of securitization.

 

•       *Administrative and other fees*. Ouradministrative and other fees represent primarily the administrative fees wereceive from the trusts for their daily management and services we provide inobtaining information from the loan servicers and reporting this and otherinformation to the parties related to the securitization. We receive feesranging from 5 to 20 basis points per year of the student loan balance inthe trust. Our administrative and other fees also include fees we receive fromthe securitization trusts for the marketing coordination services we provide tosome of our clients.

 

***ProcessingFees from TERI***

*** ***

We provide outsourcingservices to TERI, including loan origination, customer service, defaultprocessing, default prevention and administrative services under a masterservicing agreement between TERI and us. We recognize as revenue the monthlyreimbursement that TERI provides us for the expenses we incur in providingthese services.

 

***Recognitionand Valuation of Service Revenue***

*** ***

We recognize up-frontstructural advisory fees as revenue at the time the securitization trustpurchases the loans. In order for the securitization trust to purchase theloans, all of the applicable services must be performed, rating agencies mustdeliver their ratings letters, transaction counsel must deliver the requiredlegal opinions and the underwriters must receive the debt securities issued bythe securitization trust. These events indicate that the securitizationtransaction has been properly structured and loans have been properly sold tothe securitization trust.

 

As required underaccounting principles generally accepted in the United States of America, or GAAP,we also recognize additional structural advisory fees and residuals as revenueat that time, as they are deemed to be earned at the time of the securitizationbut before we actually receive payment. These amounts are deemed earned becauseevidence of an arrangement exists, we have provided the services, the fee isfixed and determinable based upon a discounted cash flow analysis, there are nofuture contingencies or obligations and collection is reasonably assured.

 

Under GAAP, we arerequired to estimate the fair value of the additional structural advisory feesand residuals as if they are investments in debt securities classified asavailable-for-sale or trading, similar to retained interests insecuritizations. Accordingly, we record additional structural advisory fees andresiduals receivables on our balance sheet at estimated fair value using adiscounted cash flow model. Because there are no quoted market prices for ouradditional structural advisory fees and residuals receivables, we use certain keyassumptions to estimate their values. See “—Application of Critical AccountingPolicies and Estimates—Service Revenue and Receivables.” We estimate

 

19

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the fair value bothinitially and at each subsequent quarter and reflect the change in the value inearnings for that period.

 

We generally recognizeadministrative and other fees, as well as processing fees from TERI, as revenueat the time that we perform the underlying services. We recognize marketing fees,which are a component of administrative and other fees, at the time thesecuritization trust purchases the loans derived from the related marketingcoordination services.

 

***QuarterlyFluctuations***

*** ***

Our quarterly revenue,operating results and profitability have varied and are expected to continue tovary on a quarterly basis primarily because of the timing and size of thesecuritizations that we structure. In fiscal 2005, we facilitated onesecuritization in the second quarter, one securitization in the third quarterand three securitizations in the fourth quarter. Thus far in fiscal 2006, wehave facilitated one securitization in each of the second and third quarters.We plan to facilitate two securitizations in the fourth quarter of fiscal 2006.The following tables set forth our quarterly service revenue and net income(loss) for the first three quarters of fiscal 2006 and for each of the quartersof fiscal 2005:

 
| ** **              | ** ** | **2006 fiscal quarters** | ** ** |
|-------------------------|------------|------------------------------------|------------|
| ** **              | ** ** | **First**                          | ** ** | **Second** | ** ** | **Third** | ** ** |
| ** **              | ** ** | **(in thousands)**            | ** ** |
| Total service  revenues |       | $                                  | 35,071     |   | $ | 230,495 |   | $ | 149,174 |   |
| Net income  (loss)      |       | (5,442                             | )          | 111,361 |   | 59,222 |   |
|                         |            |                                    |            |  |  |  |  |  |  |  |

 
| ** **              | ** ** | **2005 fiscal quarters** | ** ** |
|-------------------------|------------|------------------------------------|------------|
| ** **              | ** ** | **First**                          | ** ** | **Second** | ** ** | **Third** | ** ** | **Fourth** | ** ** |
| ** **              | ** ** | **(in thousands)**            | ** ** |
| Total service  revenues |       | $                                  | 22,404     |   | $ | 155,837 |   | $ | 119,534 |   | $ | 120,201 |   |
| Net income  (loss)      |       | (5,352                             | )          | 74,530 |   | 47,438 |   | 43,048 |   |
|                         |            |                                    |            |  |  |  |  |  |  |  |  |  |  |

 

***Applicationof Critical Accounting Policies and Estimates***

*** ***

Our condensedconsolidated financial statements have been prepared in accordance with GAAP.The preparation of these financial statements requires us to make estimates,assumptions and judgments that affect the reported amounts of assets andliabilities and the reported amounts of income and expenses during thereporting periods. We base our estimates, assumptions and judgments onhistorical experience and on various other factors that we believe arereasonable under the circumstances. Actual results may differ from theseestimates under varying assumptions or conditions.

 

Our significantaccounting policies are more fully described in Note 2 of the notes to theaudited consolidated financial statements for the fiscal year endedJune 30, 2005, which are included in our Annual Report on Form 10-Kfiled with the Securities and Exchange Commission on September 7, 2005. Onan ongoing basis, we evaluate our estimates and judgments, particularly as theyrelate to accounting policies that we believe are most important to theportrayal of our financial condition and results of operations. We regard anaccounting estimate or assumption underlying our financial statements to be a“critical accounting estimate” where:

 

•  the nature of the estimate or assumptionis material due to the level of subjectivity and judgment necessary to accountfor highly uncertain matters or the susceptibility of such matters to change;and

 

•  the impact of the estimates andassumptions on our financial condition or operating performance is material.

 

We have discussed ouraccounting policies with the audit committee of our board of directors, and webelieve that our estimates relating to the recognition and valuation of oursecuritization-related revenue and receivables, as described below, fit thedefinition of critical accounting estimates. We also consider our policy withrespect to the determination of whether or not to consolidate the financialresults of the securitization trusts that we facilitate to be a criticalaccounting policy.

 

20

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***Service***Revenue andReceivables

*** ***

Fora discussion of our revenue recognition policies, see “—Recognition andValuation of Service Revenue.”

 

Becausethere are no quoted market prices for our additional structural advisory fees orresiduals receivable, we use discounted cash flow modeling techniques and thefollowing key assumptions to estimate their values:

 

•  the discount rate, which we use tocalculate the fair value of our additional structural advisory fees andresiduals;

 

•  the annual rate of student loanprepayments;

 

•  the trend of interest rates over the lifeof the loan pool, including the forward London Interbank Offered Rate, orLIBOR, and the spread between LIBOR and auction rates; and

 

•  expected loan defaults, net ofrecoveries.

 

Webase these estimates on our proprietary historical data, third-party data andour industry experience, adjusting for specific program and borrowercharacteristics such as loan type and borrower creditworthiness. We alsomonitor trends in loan performance over time and make adjustments we believeare necessary to value properly our receivables balances at each balance sheetdate.

 

Thefollowing table shows the approximate weighted average loan performanceassumptions for the remaining life of the securitization trusts at March 31,2006:

 
| ** **                | ** ** | ** **         | ** ** | **Percentage rate** | ** ** | **Percentage discount rate** | ** ** |
|---------------------------|------------|--------------------|------------|--------------------------|------------|----------------------------------------|------------|
| **Trust**                 | ** ** | **Loan type** | ** ** | **Default**              | ** ** | **Recovery**                           | ** ** | **Prepayments** | ** ** | **Structural  advisory fees** | ** ** | **Residuals** | ** ** |
| Private label loan trusts |       | Private label      |       | 8.77                     | %          | 40                                     | %          | 7 | % | 6.85 | % | 12 | % |
| NCT trusts                |       | Private label      |       | 7.11                     |       | 46                                     |       | 7 |   | 6.85 |   | 12 |   |
| NCT trusts                |       | GATE               |       | 21.00                    |       | 47                                     |       | 4 |   | 6.85 |   | 12 |   |

 

In selecting loanperformance assumptions, we consider the underlying creditworthiness of thestudent loan borrowers as well as the type of loans being securitized. Weanalyze creditworthiness in several tiers, and select what we believe to be appropriateloan performance assumptions based on these tiers. We recently beganfacilitating loans under a new program for borrowers who have Fair, Isaac andCompany, or FICO, scores within our current program parameters, but haveinformation on their credit reports which indicate a higher risk of delinquencyand default. We anlyzed the default and recovery history of loans originatedwith similar characteristics and credit criteria to this new program anddeveloped what we believe are appropriate loan performance assumptions based onthis history. We worked, in consultation with TERI and our bank clients, tostructure and price loan products for this category of borrowers. Loans underthis new program are guaranteed by TERI and borrowers are charged higherinterest rates and fees to cover our projected default assumptions. We expectthe inclusion of these loans in future securitizations will result in higheroverall default rate assumptions for the trusts used to securitize these loans.

 

Ourprivate label loan programs, under which approximately 80% of the borrowershave creditworthy co-borrowers, typically a family member, have an extensivecredit underwriting process. GATE programs had a borrower approval rate ofapproximately 89% in fiscal 2005 as a result of the credit support provided bythe participating schools. Accordingly, we believe that borrowers in ourprivate label programs will prepay at a higher rate and default at a lower ratethan borrowers in our GATE programs.

 

AtMarch 31, 2006, we used a 6.85% discount rate for valuing additionalstructural advisory fees, as compared to a 6.51% discount rate at March 31,2005. Based on the priority payment status of additional structural advisoryfees in the flow of funds out of the securitization trust, we believe thesefees are comparable to 10 year spreads on triple-B rated structured finance andcorporate debt securities. Based on market quotes for such securities, webelieve a spread over comparable maturity U.S. Treasury Notes of 200basis points is an appropriate discount rate in valuing these projectedcash flows.

 

Toour knowledge, there have been no public market transactions involving the saleof residuals generated by a pool of securitized student loans. In determiningan appropriate discount rate for valuing our residuals, we review the ratesused by student loan securitizers as well as rates used in the much broaderasset-backed securities, or ABS,

 

21

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market.We believe that the 12% discount rate we use is appropriate given the maximum24-year life of the trust assets and residuals.

 

Twoprivate label loan trusts have issued predominately senior auction rate notesto finance the purchase of student loans. Interest rates for the auction ratenotes are determined from time to time at auction. At March 31, 2006, weused a 10 basis point spread over LIBOR to project the future cost of fundingof the senior auction rate notes in the trusts. Since inception of the firsttrust, the average spread over LIBOR for the senior auction rate notes of thattrust has been 6.6 basis points. Since the inception of the second trust,the average spread over LIBOR for the senior auction rate notes of that trusthas been 7.4 basis points.

 

Exceptfor the change to the discount rate applied to additional structural advisoryfees to account for the change in the market rate of 10-year U.S. TreasuryNotes, we did not materially change any loan performance assumptions regardingdefault rates, recovery rates or discount rates in valuing projected trust cashflows during the first nine months of fiscal 2006 or fiscal 2005. During thesecond quarter of fiscal 2006, we increased our estimate of the fair value ofstructural advisory fees by approximately $0.5 million and increased ourestimate of the fair value of residuals receivables by approximately $3.1million as a result of refinements to our prepayment rate assumptions and useof an enhanced cash flow model.

 

*Sensitivityanalysis*

 

Increasesin our estimates of defaults, prepayments and discount rates, increases in thespread between LIBOR and auction rates indices, as well as decreases in defaultrecovery rates and the multi-year forward estimates of LIBOR would have anegative effect on the value of our additional structural advisory fees andresiduals. Student loan prepayments include either full or partial payments bya borrower in advance of the maturity schedule specified in the note,including payments as a result of loan consolidation activity. Becauseessentially all credit defaults are reimbursable by third parties, increases indefaults generally have the same effect as increases in prepayments. Ifdefaults increase beyond the level of expected third party reimbursement, thenthese changes will have an additional negative effect on the value of ouradditional structural advisory fees and residuals. For purposes of thissensitivity analysis, we have assumed no amounts in excess of the pledge fund establishedat the time of each securitization of private label loans are available toreimburse the trust for defaults. Also, in the case of securitizations of GATEloans in which we have invested a portion of our up-front structural advisoryfees, increases in estimates of defaults would reduce the value of our residualinterests because amounts that we would otherwise receive as residual interestswould be applied to the defaults. LIBOR is the reference rate for a substantialmajority of the loan assets and, we believe, a reasonable index for borrowingsof the trusts. Because the trusts’ student loan assets earn interest based onLIBOR and some trusts have outstanding securities that pay interest based onthe results of auction rates, changes in the spread between LIBOR and theauction rate can affect the performance of the trust.

 

22

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Thefollowing tables show the estimated change in our structural advisory fees andresiduals receivable balances at March 31, 2006 based on changes in theseloan performance assumptions:

 
| ** **                             | ** ** | **Percentage change in   assumptions** | ** ** | **Receivables**   | ** ** | **Percentage change in   assumptions** | ** ** |
|----------------------------------------|------------|-------------------------------------------------------|------------|-------------------|------------|-------------------------------------------------------|------------|
| **Structural advisory fees** | ** ** | **Down 20%**                                     | ** ** | **Down 10%** | ** ** | **balance**                                           | ** ** | **Up 10%** | ** ** | **Up 20%** | ** ** |
| ** **                             | ** ** | **(dollars in thousands)**                  | ** ** |
| Default rate:                          |       |                                                  |       |              |       |                                                  |       |   |   |   |   |
| Private label loan trusts              |       | $                                                     | 72,409     |              | $          | 72,136                                                |       | $ | 71,862 |   | $ | 71,588 |   | $ | 71,315 |   |
| GATE loan trusts(1)                    |       | 6,665                                                 |       | 6,559             |       | 6,454                                                 |       | 6,350 |   | 6,243 |   |
| Total                                  |       | $                                                     | 79,074     |              | $          | 78,695                                                |       | $ | 78,316 |   | $ | 77,938 |   | $ | 77,558 |   |
| Change in receivables balance:         |       | 0.97                                                  | %          | 0.48              | %          |                                                  |       | (0.48 | )% | (0.97 | )% |
| Default recovery rate:                 |       |                                                  |       |              |       |                                                  |       |   |   |   |   |
| Private label loan trusts              |       | $                                                     | 71,862     |              | $          | 71,862                                                |       | $ | 71,862 |   | $ | 71,862 |   | 71,862 |   |
| GATE loan trusts(1)                    |       | 6,287                                                 |       | 6,371             |       | 6,454                                                 |       | 6,545 |   | 6,637 |   |
| Total                                  |       | $                                                     | 78,149     |              | $          | 78,233                                                |       | $ | 78,316 |   | $ | 78,407 |   | $ | 78,499 |   |
| Change in receivables balance:         |       | (0.21                                                 | )%         | (0.11             | )%         |                                                  |       | 0.12 | % | 0.23 | % |
| Annual prepayment rate:                |       |                                                  |       |              |       |                                                  |       |   |   |   |   |
| Private label loan trusts              |       | $                                                     | 75,335     |              | $          | 73,426                                                |       | $ | 71,862 |   | $ | 70,245 |   | $ | 68,702 |   |
| GATE loan trusts(1)                    |       | 6,724                                                 |       | 6,588             |       | 6,454                                                 |       | 6,324 |   | 6,199 |   |
| Total                                  |       | $                                                     | 82,059     |              | $          | 80,014                                                |       | $ | 78,316 |   | $ | 76,569 |   | $ | 74,901 |   |
| Change in receivables balance:         |       | 4.78                                                  | %          | 2.17              | %          |                                                  |       | (2.23 | )% | (4.36 | )% |
| Discount rate:                         |       |                                                  |       |              |       |                                                  |       |   |   |   |   |
| Private label loan trusts              |       | $                                                     | 77,811     |              | $          | 74,759                                                |       | $ | 71,862 |   | $ | 69,111 |   | $ | 66,496 |   |
| GATE loan trusts(1)                    |       | 6,955                                                 |       | 6,698             |       | 6,454                                                 |       | 6,221 |   | 5,993 |   |
| Total                                  |       | $                                                     | 84,766     |              | $          | 81,457                                                |       | $ | 78,316 |   | $ | 75,332 |   | $ | 72,489 |   |
| Change in receivables balance:         |       | 8.24                                                  | %          | 4.01              | %          |                                                  |       | (3.81 | )% | (7.44 | )% |

 
| ** **                     | ** ** | **Change in assumption**         | ** ** | ** **                                 | ** ** | **Change in assumption** | ** ** |
|--------------------------------|------------|--------------------------------------------|------------|--------------------------------------------|------------|------------------------------------|------------|
| ** **                     | ** ** | **Down 200   basis points** | ** ** | **Down 100   basis points** | ** ** | **Receivables   balance**     | ** ** | **Up 100   basis points** | ** ** | **Up 200   basis points** | ** ** |
| ** **                     | ** ** | **(dollars in thousands)**       | ** ** |
| Forward LIBOR rates:           |       |                                       |       |                                       |       |                               |       |   |   |   |   |
| Private label loan trusts      |       | $                                          | 66,785     |                                       | $          | 69,338                             |       | $ | 71,862 |   | $ | 74,367 |   | $ | 76,937 |   |
| GATE loan trusts(1)            |       | 6,037                                      |       | 6,199                                      |       | 6,454                              |       | 6,547 |   | 6,817 |   |
| Total                          |       | $                                          | 72,822     |                                       | $          | 75,537                             |       | $ | 78,316 |   | $ | 80,914 |   | $ | 83,754 |   |
| Change in receivables balance: |       | (7.02                                      | )%         | (3.55                                      | )%         |                               |       | 3.32 | % | 6.94 | % |

 

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(1)    GATE loan trusts include approximately $447million of GATE loans and $35 million of TERI-guaranteed loans.

 

23

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| ** **                     | ** ** | **Percentage change in   assumptions** | ** ** | **Receivables**   | ** ** | **Percentage change in   assumptions** | ** ** |
|--------------------------------|------------|-------------------------------------------------------|------------|-------------------|------------|-------------------------------------------------------|------------|
| **Residuals**                  | ** ** | **Down 20%**                                     | ** ** | **Down 10%** | ** ** | **balance**                                           | ** ** | **Up 10%** | ** ** | **Up 20%** | ** ** |
| ** **                     | ** ** | **(dollars in thousands)**                  | ** ** |
| Default rate:                  |       |                                                  |       |              |       |                                                  |       |   |   |   |   |
| Private label loan trusts      |       | $                                                     | 394,443    |              | $          | 391,240                                               |       | $ | 388,055 |   | $ | 384,904 |   | $ | 381,684 |   |
| GATE loan trusts(1)            |       | 11,288                                                |       | 10,865            |       | 10,464                                                |       | 10,066 |   | 9,669 |   |
| Total                          |       | $                                                     | 405,731    |              | $          | 402,105                                               |       | $ | 398,519 |   | $ | 394,970 |   | $ | 391,353 |   |
| Change in receivables balance: |       | 1.81                                                  | %          | 0.90              | %          |                                                  |       | (0.89 | )% | (1.80 | )% |
| Default recovery rate:         |       |                                                  |       |              |       |                                                  |       |   |   |   |   |
| Private label loan trusts      |       | $                                                     | 388,056    |              | $          | 388,056                                               |       | $ | 388,055 |   | $ | 388,056 |   | $ | 388,056 |   |
| GATE loan trusts(1)            |       | 8,886                                                 |       | 9,657             |       | 10,464                                                |       | 11,279 |   | 12,094 |   |
| Total                          |       | $                                                     | 396,942    |              | $          | 397,713                                               |       | $ | 398,519 |   | $ | 399,335 |   | $ | 400,150 |   |
| Change in receivables balance: |       | (0.40                                                 | )%         | (0.20             | )%         |                                                  |       | 0.20 | % | 0.41 | % |
| Annual prepayment rate:        |       |                                                  |       |              |       |                                                  |       |   |   |   |   |
| Private label loan trusts      |       | $                                                     | 423,705    |              | $          | 404,140                                               |       | $ | 388,055 |   | $ | 371,362 |   | $ | 355,375 |   |
| GATE loan trusts(1)            |       | 10,911                                                |       | 10,685            |       | 10,464                                                |       | 10,243 |   | 10,032 |   |
| Total                          |       | $                                                     | 434,616    |              | $          | 414,825                                               |       | $ | 398,519 |   | $ | 381,605 |   | $ | 365,407 |   |
| Change in receivables balance: |       | 9.06                                                  | %          | 4.09              | %          |                                                  |       | (4.24 | )% | (8.31 | )% |
| Discount rate:                 |       |                                                  |       |              |       |                                                  |       |   |   |   |   |
| Private label loan trusts      |       | $                                                     | 466,673    |              | $          | 425,199                                               |       | $ | 388,055 |   | $ | 354,720 |   | $ | 324,740 |   |
| GATE loan trusts(1)            |       | 14,062                                                |       | 12,124            |       | 10,464                                                |       | 8,961 |   | 7,816 |   |
| Total                          |       | $                                                     | 480,735    |              | $          | 437,323                                               |       | $ | 398,519 |   | $ | 363,681 |   | $ | 332,556 |   |
| Change in receivables balance: |       | 20.63                                                 | %          | 9.74              | %          |                                                  |       | (8.74 | )% | (16.55 | )% |

 
| ** **                     | ** ** | **Change in assumption**         | ** ** | ** **                                 | ** ** | **Change in assumption** | ** ** |
|--------------------------------|------------|--------------------------------------------|------------|--------------------------------------------|------------|------------------------------------|------------|
| ** **                     | ** ** | **Down 200   basis points** | ** ** | **Down 100   basis points** | ** ** | **Receivables   balance**     | ** ** | **Up 100   basis points** | ** ** | **Up 200   basis points** | ** ** |
| ** **                     | ** ** | **(dollars in thousands)**       | ** ** |
| Forward LIBOR rates:           |       |                                       |       |                                       |       |                               |       |   |   |   |   |
| Private label loan trusts      |       | $                                          | 361,430    |                                       | $          | 375,354                            |       | $ | 388,055 |   | $ | 399,521 |   | $ | 410,427 |   |
| GATE loan trusts(1)            |       | 9,521                                      |       | 9,919                                      |       | 10,464                             |       | 10,957 |   | 11,271 |   |
| Total                          |       | $                                          | 370,951    |                                       | $          | 385,273                            |       | $ | 398,519 |   | $ | 410,478 |   | $ | 421,698 |   |
| Change in receivables balance: |       | (6.92                                      | )%         | (3.32                                      | )%         |                               |       | 3.00 | % | 5.82 | % |

 
| ** **                                                        | ** ** | **Change in assumption**           | ** ** | ** **                                  | ** ** | **Change in assumption** | ** ** |
|-------------------------------------------------------------------|------------|----------------------------------------------|------------|---------------------------------------------|------------|------------------------------------|------------|
| ** **                                                        | ** ** | **Tighten 10   basis points** | ** ** | **Tighten 5   basis points** | ** ** | **Receivables   balance**     | ** ** | **Widen 5   basis points** | ** ** | **Widen 10   basis points** | ** ** |
| ** **                                                        | ** ** | **(dollars in thousands)**         | ** ** |
| Change in assumed spread between LIBOR and auction  rate indices: |       |                                         |       |                                        |       |                               |       |   |   |   |   |
| Private label loan trusts                                         |       | $                                            | 391,926    |                                        | $          | 389,992                            |       | $ | 388,055 |   | $ | 386,120 |   | $ | 384,189 |   |
| GATE loan trusts(1)                                               |       | 10,464                                       |       | 10,464                                      |       | 10,464                             |       | 10,464 |   | 10,464 |   |
| Total                                                             |       | $                                            | 402,390    |                                        | $          | 400,456                            |       | $ | 398,519 |   | $ | 396,584 |   | $ | 394,653 |   |
| Change in receivables balance:                                    |       | 0.97                                         | %          | 0.49                                        | %          |                               |       | (0.49 | )% | (0.97 | )% |

 

----

(1)    GATE loan trusts include approximately $447million of GATE loans and $35 million of TERI-guaranteed loans.

 

24

----

 

Thesesensitivities are hypothetical and should be used with caution. The effect ofeach change in assumption must be calculated independently, holding all otherassumptions constant. Because the key assumptions may not in fact beindependent, the net effect of simultaneous adverse changes in key assumptions may differfrom the sum of the individual effects above.

 

***Consolidation***

*** ***

Ourconsolidated financial statements include the accounts of The First Marblehead Corporationand its subsidiaries, after eliminating inter-company accounts andtransactions. We have not consolidated the financial results of thesecuritization trusts purchasing loans that we have facilitated. Prior to July 1,2003, this accounting treatment was in accordance with various Emerging IssuesTask Force issues and related interpretations. We considered, among otherthings, the following factors in assessing consolidation of the securitizationtrusts:

 

•  we did not have unilateraldecision-making abilities related to significant matters affecting thesecuritization trusts, such as asset acquisition, prepayment of debt, placementof debt obligations and modification of trust documents;

 

•  we did not have substantially all therisks and rewards of ownership, as TERI and the respective colleges providesubstantially all of the student loan guarantees;

 

•  we were a facilitator of securitizationtransactions, for which we receive market-based fees, and we were not thetransferor of assets to the securitization trusts; and

 

•  our continuing involvement in the trustsis limited to a passive residual interest and our role as an administrator forthe trust for which we receive market-based fees.

 

BeginningJuly 1, 2003, and for securitization trusts created after January 31,2003, we applied Financial Accounting Standards Board, or FASB, InterpretationFIN No. 46, “Consolidation of Variable Interest Entities, aninterpretation of ARB No. 51,” or FIN No. 46, in assessingconsolidation. FIN No. 46 provided a new framework for identifyingvariable interest entities and determining when a company should include theassets, liabilities, non-controlling interests and results of activities of avariable interest entity in its consolidated financial statements.

 

OnDecember 24, 2003, the FASB issued FIN No. 46 (revised December 2003),“Consolidation of Variable Interest Entities,” or FIN No. 46R, whichaddressed how a business enterprise should evaluate whether it has acontrolling interest in an entity through means other than voting rights andaccordingly should consolidate the entity. FIN No. 46R has replaced FIN No. 46.At March 31, 2006, the securitization trusts created after January 31,2003 have met the criteria to be a qualified special-purpose entity, or QSPE,as defined in paragraph 35 of FASB Statement No. 140, “Accounting forthe Transfers and Servicing of Financial Assets and Extinguishments ofLiabilities.” Accordingly, we did not consolidate these existing securitizationtrusts in our financial statements. In addition, the securitization trustscreated prior to January 31, 2003 in which the Company holds a variableinterest that could result in the Company being considered the primarybeneficiary of such trust, have been amended in order for them to be consideredQSPEs. The adoption of FIN No. 46R, which we began to apply in December 2003,did not have a material impact on our consolidated financial condition, resultsof operations, earnings per share or cash flows.

 

TheFASB has issued exposure drafts that would amend FASB Statement No. 140.The proposed amendments would, among other things, change the requirements thatan entity must meet to be considered a QSPE. The FASB has announced that itexpects to issue final guidance in the first calendar quarter of 2007. We are monitoringthe status of the exposure drafts to assess their impact, if any, on ourfinancial statements.

 

**Resultsof Operations**

** **

***Threeand Nine Months ended March 31, 2006 and 2005***

*** ***

***RevenueRelated to Securitization Transactions***

*** ***

Thefollowing table sets forth for the first nine months of fiscal 2006 and 2005:

 

•  the total volume of private label loanssecuritized;

 

25

----

 

•  the securitization-related servicerevenue components, other than administrative and other fees, by dollar amountand as a percentage of the total volume of loans securitized; and

 

•  updates to reflect any fair valueadjustment to additional structural advisory fees and residuals for priortrusts.

 
| **First nine months of fiscal year:** | ** ** | **Total volume   of loans   securitized (1)** | ** ** | **Up front   structural  advisory fees** | ** ** | **Additional   structural   advisory fees** | ** ** | ** ** | ** ** | **Total   structural   advisory fees** | ** ** | **Residuals** | ** ** |
|----------------------------------------------------------------|------------|------------------------------------------------------------------------|------------|---------------------------------------------------------|------------|------------------------------------------------------------|------------|------------|------------|-------------------------------------------------------|------------|---------------|------------|
| ** **                                                     | ** ** | **(dollars in thousands)**                                   | ** ** |
| 2006                                                           |       |                                                                   |       |                                                    |       |                                                       |       |       |       |                                                  |       |          |       |   |   |   |   |
| Private label loans                                            |       | $                                                                      | 2,006,642  |                                                    | $          | 154,109                                                    |       | 7.7        | %          | $                                                     | 23,542     |          | 1.2        | % | $ | 177,651 |   | $ | 125,648 |   | 6.3 | % |
| Trust updates(2)                                               |       | —                                                                 |       | —                                                  |       |                                                       |       | 1,403      |       |                                                  |       | 1,403         |       | 25,596 |   |   |   |
| Other(3)                                                       |       | —                                                                 |       | 518                                                     |       |                                                       |       | —     |       |                                                  |       | 518           |       | — |   |   |   |
| Total                                                          |       | $                                                                      | 2,006,642  |                                                    | $          | 154,627                                                    |       |       |       | $                                                     | 24,945     |          |       |   | $ | 179,572 |   | $ | 151,244 |   |   |   |
| 2005                                                           |       |                                                                   |       |                                                    |       |                                                       |       |       |       |                                                  |       |          |       |   |   |   |   |
| Private label loans                                            |       | $                                                                      | 1,522,254  |                                                    | $          | 119,095                                                    |       | 7.8        | %          | $                                                     | 17,901     |          | 1.2        | % | $ | 136,996 |   | $ | 88,402 |   | 5.8 | % |
| Trust updates(2)                                               |       | —                                                                 |       | —                                                  |       |                                                       |       | 782        |       |                                                  |       | 782           |       | 13,434 |   |   |   |
| Other(3)                                                       |       | —                                                                 |       | 955                                                     |       |                                                       |       | —     |       |                                                  |       | 955           |       | — |   |   |   |
| Total                                                          |       | $                                                                      | 1,522,254  |                                                    | $          | 120,050                                                    |       |       |       | $                                                     | 18,683     |          |       |   | $ | 138,733 |   | $ | 101,836 |   |   |   |

 

----

(1)    Represents total principal and accruedinterest.

 

(2)    Trust updates reflect changes resultingfrom the passage of time, which results in accretion of the discountinginherent in the fair value estimates of additional structural advisory fees andresiduals, as well as changes in the assumptions, if any, underlying ourestimates of the fair value of these service revenue components.

 

(3)    Represents the receipt of funds fromvarious trusts’ cost of issuance accounts once it was determined that the trustno longer needs such cost of issuance funds.

 

Theprincipal balance of loans facilitated and available to us for latersecuritization totaled $746.9 million at March 31, 2006.

 

Ourprivate label loan products are marketed through two marketing channels: directto consumer, which generally refers to programs that lenders, businesses,unions, affinity groups or other organizations market directly to prospectiveborrowers, and school channel, which refers to programs that lenders or thirdparties market indirectly through educational institutions. Our estimates ofthe allocation by marketing channel of our securitization revenues for thefirst nine months of fiscal 2006 and 2005, expressed as a percentage of thestudent loan balances securitized in each channel, are as follows:

 

26

----

 
|                                                                                 |       |                         |       |                                          |       |                                                     |       | **Percentage yield**                                  |       |
|--------------------------------------------------------------------------------------|------------|------------------------------|------------|-----------------------------------------------|------------|----------------------------------------------------------|------------|------------------------------------------------------------|------------|
| **Month and year of   private label   securitization** |       | **Marketing   channel** |       | **Volume of loans  securitized(1)** |       | **Up-front   structural   advisory fees** |       | **Additional   structural   advisory fees** |       | **Residuals** |   | **Total** |   |
| **Fiscal 2006**                                                                      |       |                         |       |                                          |       |                                                     |       |                                                       |       |   |   |   |   |   |   |
| March 2006                                                                      |       | Direct to consumer           |       | 527                                           |       | (71                                                      | )%         | 8.7                                                        | %          | 1.2 | % | 7.7 | % |   |   |
|                                                                                 |       | School channel               |       | 214                                           |       | (29                                                      | )%         | 5.9                                                        |       | 1.2 |   | 3.2 |   |   |   |
|                                                                                 |       | Total                        |       | 741                                           |       |                                                     |       |                                                       |       |   |   |   |   |   |   |
|                                                                                 |       | Blended yield (2)            |       |                                          |       |                                                     |       | 7.9                                                        | %          | 1.2 | % | 6.4 | % | 15.5 | % |
|                                                                                 |       |                         |       |                                          |       |                                                     |       |                                                       |       |   |   |   |   |   |   |
| October 2005                                                                    |       | Direct to consumer           |       | 921                                           |       | (73                                                      | )%         | 8.8                                                        | %          | 1.2 | % | 7.5 | % |   |   |
|                                                                                 |       | School channel               |       | 344                                           |       | (27                                                      | )%         | 4.1                                                        |       | 1.2 |   | 2.6 |   |   |   |
|                                                                                 |       | Total                        |       | 1,265                                         |       |                                                     |       |                                                       |       |   |   |   |   |   |   |
|                                                                                 |       | Blended yield (2)            |       |                                          |       |                                                     |       | 7.5                                                        | %          | 1.2 | % | 6.2 | % | 14.9 | % |
| Total for first nine months of fiscal 2006                                           |       |                         |       | 2,006                                         |       |                                                     |       |                                                       |       |   |   |   |   |   |   |
|                                                                                 |       | Blended yield (2)            |       |                                          |       |                                                     |       | 7.7                                                        | %          | 1.2 | % | 6.3 | % | 15.1 | % |
| **Fiscal 2005**                                                                      | ** ** | ** **                   | ** ** | ** **                                    | ** ** | ** **                                               | ** ** | ** **                                                 | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| February 2005                                                                   | ** ** | Direct to consumer           | ** ** | 445                                           | ** ** | (62                                                      | )%         | 9.6                                                        | %          | 1.1 | % | 6.1 | % | ** ** | ** ** |
|                                                                                 |       | School channel               |       | 270                                           |       | (38                                                      | )%         | 4.4                                                        |       | 1.1 |   | 1.4 |   |   |   |
|                                                                                 |       | Total                        |       | 715                                           |       |                                                     |       |                                                       |       |   |   |   |   |   |   |
|                                                                                 |       | Blended yield (2)            |       |                                          |       |                                                     |       | 7.6                                                        | %          | 1.1 | % | 4.4 | % | 13.1 | % |
|                                                                                 |       |                         |       |                                          |       |                                                     |       |                                                       |       |   |   |   |   |   |   |
| October 2004                                                                    |       | Direct to consumer           |       | 744                                           |       | (92                                                      | )%         | 8.4                                                        | %          | 1.2 | % | 7.5 | % |   |   |
|                                                                                 |       | School channel               |       | 63                                            |       | (8                                                       | )%         | 4.3                                                        |       | 1.0 |   | 2.2 |   |   |   |
|                                                                                 |       | Total                        |       | 807                                           |       |                                                     |       |                                                       |       |   |   |   |   |   |   |
|                                                                                 |       | Blended yield (2)            |       |                                          |       |                                                     |       | 8.1                                                        | %          | 1.2 | % | 7.1 | % | 16.4 | % |
| Total for first nine months of fiscal 2005                                           |       |                         |       | 1,522                                         |       |                                                     |       |                                                       |       |   |   |   |   |   |   |
|                                                                                 |       | Blended yield (2)            |       |                                          |       |                                                     |       | 7.8                                                        | %          | 1.2 | % | 5.8 | % | 14.8 | % |

 

----

(1)    Dollars in millions

 

(2)    Blended yield represents securitizationrevenues as a percentage of the total principal and accrued interest of loanssecuritized from all marketing channels.

 

These yields by marketing channel represent anallocation of revenues and costs based on various estimates and assumptionsregarding the relative profitability of these loans, and should be read withcaution. Furthermore, these yields are dependent on a number of factors,including the mix of loans between marketing channels that are included in aparticular securitization, the average life of loans, which can be impacted bythe time of year that the loans are securitized and the relative mix of loansfrom students with various expected terms to graduation, the structure of, andprevailing market conditions at the time of a securitization, the marketingfees which our clients earn on loans we securitize for them, along with anumber of other factors. Therefore, readers are cautioned that the blendedyields and yields by marketing channel above may not be indicative ofyields that we may be able to achieve in future securitizations.

 

*Structuraladvisory fees*

* *

Structuraladvisory fees increased to $179.6 million for the first nine months of fiscal2006 from $138.7 million for the first nine months of fiscal 2005. Structuraladvisory fees increased to $67.2 million in the third quarter of fiscal 2006from $62.9 million for the third quarter of fiscal 2005. The increases instructural advisory fees in the 2006 periods compared to the 2005 periods wereprimarily a result of an increase in securitization volume.

 

27

----

 

*Up-frontstructural advisory fees*

* *

Theup-front component of structural advisory fees increased to $154.6 million forthe first nine months of fiscal 2006 from $120.1 million for the first ninemonths fiscal 2005. Up-front structural advisory fees increased to $58.5million for the third quarter of fiscal 2006 from $55.0 million for the thirdquarter of fiscal 2005. The increase in up-front structural advisory feesbetween periods was primarily a result of an increase in loan facilitationvolume, which enabled us to securitize a greater amount of loans. A decrease inup-front structural advisory fees as a percentage of the loan volumesecuritized, or up-front structural advisory fee yield, for the first ninemonths of fiscal 2006 as compared to the prior year period, partially offsetthe impact of the increase in loan facilitation volume. The up-front structuraladvisory fee yield decreased because school channel loans comprised a largerproportion of the loans securitized in the first nine months of fiscal 2006than in the first nine months of fiscal 2005. School channel loans generallyhave a lower upfront structural advisory fee yield than direct-to-consumerloans.

 

Thefollowing table reflects the increases in up-front structural advisory fees attributableto the increases in securitization volume and changes in the fee yield and loanmix, excluding cost of issuance funds received:

 
| ** **                                                                       | ** ** | ** **                                                    | ** ** | **Up-front structural advisory fees**                                    | ** ** |
|----------------------------------------------------------------------------------|------------|---------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------|------------|
| ** **                                                                       | ** ** | **Total volume   of loans   securitized** | ** ** | **Change attributable   to increased   securitization volume** | ** ** | **Change attributable to   change in fee yield   and loan mix** | ** ** | **Total increase** | ** ** |
| ** **                                                                       | ** ** | **(in thousands)**                                       | ** ** |
| Nine months ended March 31, 2006 vs. nine  months ended March 31, 2005 |       | $                                                             | 2,006,642  |                                                                                    | $          | 37,897 |   | $ | (2,883 | ) | $ | 35,014 |   |
|                                                                                  |            |                                                               |            |                                                                                         |            |  |  |  |  |  |  |  |  |

 

*Additionalstructural advisory fees*

* *

Theadditional component of structural advisory fees increased to $24.9 million forthe first nine months of fiscal 2006 from $18.7 million for the first ninemonths of fiscal 2005. Additional structural advisory fees increased to $8.7million for the third quarter of fiscal 2006 from $7.9 million for the thirdquarter of fiscal 2005. The increases in additional structural advisory feesbetween periods were primarily a result of increases in securitization volume.

 

Thefollowing table summarizes the changes in our estimate of the fair value of thestructural advisory fees receivable for the three and nine months ended March 31,2006 and 2005:

 
| ** **                                     | ** ** | **Three months ended   March 31,** | ** ** |
|------------------------------------------------|------------|--------------------------------------------------------|------------|
| ** **                                     | ** ** | **2006**                                               | ** ** | **2005** | ** ** |
| ** **                                     | ** ** | **(in thousands)**                                | ** ** |
| Fair value at beginning of period              |       | $                                                      | 69,589     |   | $ | 34,825 |   |
|                                           |       |                                                   |       |   |   |
| Additions from structuring new securitizations |       | 8,764                                                  |       | 7,970 |   |
|                                           |       |                                                   |       |   |   |
| Fair value adjustments                         |       |                                                   |       |   |   |
| Passage of time (present value accretion)      |       | 1,163                                                  |       | 593 |   |
| Other factors                                  |       | (1,200                                                 | )          | (621 | ) |
| Total fair value adjustments                   |       | (37                                                    | )          | (28 | ) |
| Fair value at end of period                    |       | $                                                      | 78,316     |   | $ | 42,767 |   |

 

28

----

 
| ** **                                     | ** ** | **Nine months ended   March 31,** | ** ** |
|------------------------------------------------|------------|-------------------------------------------------------|------------|
| ** **                                     | ** ** | **2006**                                              | ** ** | **2005** | ** ** |
| ** **                                     | ** ** | **(in thousands)**                               | ** ** |
| Fair value at beginning of period              |       | $                                                     | 53,371     |   | $ | 24,084 | (1) |
|                                           |       |                                                  |       |   |   |
| Additions from structuring new securitizations |       | 23,542                                                |       | 17,901 |   |
|                                           |       |                                                  |       |   |   |
| Fair value adjustments                         |       |                                                  |       |   |   |
| Passage of time (present value accretion)      |       | 2,967                                                 |       | 1,469 |   |
| Other factors                                  |       | (1,564                                                | )          | (687 | ) |
| Total fair value adjustments                   |       | 1,403                                                 |       | 782 |   |
| Fair value at end of period                    |       | $                                                     | 78,316     |   | $ | 42,767 |   |

 

----

(1)    Excludes a $10.25 million structuraladvisory fee receivable that we collected in July 2004 from a December 2003securitization transaction.

 

Duringthe first nine months of fiscal 2006, our estimate of the fair value of ouradditional structural advisory fees resulted in an increase in their carryingvalue of approximately $1.4 million. This increase was primarily due to theaccretion of the discounting inherent in our fair value estimates. During thefirst nine months of fiscal 2005, our estimate of the fair value of ouradditional structural advisory fees resulted in an increase in their carrying valueof approximately $0.8 million. This increase was primarily due to theaccretion of the discounting inherent in our fair value estimates. During thethree months ended March 31, 2006 and 2005, fair value adjustments to ouradditional structural advisory fees were not material.

 

Ona quarterly basis, we update our estimate of the fair value of our additionalstructural advisory fees, which have an estimated average life of approximatelysix to eight years. In doing so, we give effect to the passage of time, whichresults in the accretion of the discounting inherent in these fair valueestimates, and we also adjust for any changes in the discount rate and otherassumptions that we use in estimating the fair value of these receivables. Wemonitor the performance of trust assets, including default, recovery,prepayment and forward LIBOR rate experience, which we also consider in ourestimates. We use an implied forward LIBOR curve to estimate trust cash flows.For a discussion of the assumptions we make in estimating our additionalstructural advisory fees, see “—Executive Summary—Application of CriticalAccounting Policies—Service Revenue and Receivables.”

 

Webase the discount rate that we use to calculate the fair value of ouradditional structural advisory fees on the 10-year U.S. Treasury rate plus 200basis points. The discount rate was 6.85% at March 31, 2006, 6.36% at December 31,2005, 6.33% at September 30, 2005, 5.96% at June 30, 2005, 6.51% at March 31,2005, 6.22% at December 31, 2004, 6.12% at September 30, 2004, and6.58% at June 30, 2004. A decrease in the 10-year U.S. Treasury rate hasthe effect of increasing the fair value of our structural advisory feesreceivable, while an increase in the rate has the opposite effect on ourestimate of their fair value.

 

Wemade no changes in our assumptions regarding default rates or recovery ratesfor the private label loan trusts or NCT trusts during either the first ninemonths of fiscal 2006 or fiscal 2005. During our second quarter of fiscal 2006,we increased our estimate of the fair value of additional structural advisoryfees by approximately $0.5 million as a result of refinements to our prepaymentrate assumptions and use of an enhanced cash flow model.

 

*Residuals*

* *

Servicerevenues from residuals increased to $151.2 million for the first nine monthsof fiscal 2006 from $101.8 million for the first nine months of fiscal2005, and increased to $53.1 million for the three months ended March 31,2006, compared to $35.2 million for the three months ended March 31, 2005.The increases in residuals in the 2006 periods compared to the 2005 periodswere primarily a result of an increase in securitization volume and, to alesser extent, changes attributable to trust updates. In estimating the fairvalue of our residuals, we used a discount rate of 12% throughout the first ninemonths of fiscal 2006 and all of fiscal 2005.

 

29

----

 

Thefollowing table reflects the increases in service revenues from residualsattributable to the increase in securitization volume and loan mix and thechange attributable to updates to prior trusts: 

 
| ** **                                                                       | ** ** | ** **                                                    | ** ** | **Residuals**                                                                                                                                   | ** ** |
|----------------------------------------------------------------------------------|------------|---------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| ** **                                                                       | ** ** | **Total volume   of loans   securitized** | ** ** | **Change   attributable to   increased   securitization   volume and   change in loan   mix** | ** ** | **Change   attributable to   trust updates(1)** | ** ** | **Total increase** | ** ** |
| ** **                                                                       | ** ** | **(in thousands)**                                       | ** ** |
| Nine months ended March 31, 2006 vs. nine  months ended March 31, 2005 |       | $                                                             | 2,006,642  |                                                                                                                                            | $          | 37,246 |   | $ | 12,162 |   | $ | 49,408 |   |
|                                                                                  |            |                                                               |            |                                                                                                                                                 |            |  |  |  |  |  |  |  |  |

 

----

(1)    The change attributable to trust updatesin fiscal 2006 and 2005 was primarily the result of the passage of time and theresulting accretion of the discounting inherent in these fair value estimatesof residuals and an increased underlying receivable balance as a result ofadditional securitizations, rather than changes in our assumptions.

 

Thefollowing tables summarize the changes in our estimate of the fair value of theresiduals receivable for the three and nine months ended March 31, 2006and 2005: 

 
| ** **                                     | ** ** | **Three months ended   March 31,** | ** ** |
|------------------------------------------------|------------|--------------------------------------------------------|------------|
| ** **                                     | ** ** | **2006**                                               | ** ** | **2005** | ** ** |
| ** **                                     | ** ** | **(in thousands)**                                | ** ** |
| Fair value at beginning of period              |       | $                                                      | 345,464    |   | $ | 175,178 |   |
|                                           |       |                                                   |       |   |   |
| Additions from structuring new securitizations |       | 47,432                                                 |       | 31,345 |   |
|                                           |       |                                                   |       |   |   |
| Fair value adjustments                         |       |                                                   |       |   |   |
| Passage of time (present value accretion)      |       | 10,917                                                 |       | 5,647 |   |
| Other factors                                  |       | (5,294                                                 | )          | (1,839 | ) |
| Total fair value adjustments                   |       | 5,623                                                  |       | 3,808 |   |
| Fair value at end of period                    |       | $                                                      | 398,519    |   | $ | 210,331 |   |

 
| ** **                                     | ** ** | **Nine months ended   March 31,** | ** ** |
|------------------------------------------------|------------|-------------------------------------------------------|------------|
| ** **                                     | ** ** | **2006**                                              | ** ** | **2005** | ** ** |
| ** **                                     | ** ** | **(in thousands)**                               | ** ** |
| Fair value at beginning of period              |       | $                                                     | 247,275    |   | $ | 108,495 |   |
|                                           |       |                                                  |       |   |   |
| Additions from structuring new securitizations |       | 125,648                                               |       | 88,402 |   |
|                                           |       |                                                  |       |   |   |
| Fair value adjustments                         |       |                                                  |       |   |   |
| Passage of time (present value accretion)      |       | 27,578                                                |       | 13,402 |   |
| Other factors                                  |       | (1,982                                                | )          | 32 |   |
| Total fair value adjustments                   |       | 25,596                                                |       | 13,434 |   |
| Fair value at end of period                    |       | $                                                     | 398,519    |   | $ | 210,331 |   |

 

Duringthe first nine months of fiscal 2006, our estimate of the fair value of ourresiduals receivable resulted in an increase in their carrying value of approximately$25.6 million, and, during the first nine months of fiscal 2005, our estimateof the fair value of our residuals receivable resulted in an increase in the theircarrying value of approximately $13.4 million. During the third quarter offiscal 2006, our estimate of the fair value of our residuals receivableincreased approximately $5.6 million, and, during the third quarter of fiscal2005, our estimate of the fair value of our residuals receivable increasedapproximately $3.8 million. These increases in the 2006 periods compared to the2005 periods were primarily due to the passage of time. The amount of thesefair value adjustments also increased between periods as the underlyingreceivable balance increased. We expect that adjustments for the passage oftime will continue to increase as we conduct more securitization transactionsand thereby add to the residual interests that we discount to fair value.

 

30

----

 

Aswe do with our additional structural advisory fees, on a quarterly basis, weupdate our estimate of the fair value of our residuals. In doing so, we giveeffect for the passage of time, which results in the accretion of thediscounting inherent in these fair value estimates, and we also adjust for anychange in the discount rate that we use in estimating the fair value of thesereceivables. We used a 12% discount factor during the first nine months offiscal 2006 and throughout fiscal 2005. We also monitor the performance oftrust assets, including default, recovery, prepayment and forward LIBOR ratesexperience, which we also consider in our estimates. We use an implied forwardLIBOR curve to estimate trust cash flows. For a discussion of the assumptionswe make in estimating our residuals, see “—Executive Summary—Application ofCritical Accounting Policies and Estimates—Service Revenue and Receivables.”

 

Indetermining an appropriate discount rate for valuing residuals, we review therates used by student loan securitizers, as well as rates used in the muchbroader asset-backed securities, or ABS, market. We believe that the 12%discount rate we use is appropriate given the maximum 24-year life of the trustassets and residuals.

 

*Processingfees from TERI*

* *

Processingfees from TERI increased to $77.8 million for the first nine months of fiscal2006 from $54.5 million for the first nine months of fiscal 2005 andincreased to $26.6 million for the third quarter of fiscal 2006 from $20.6million for the third quarter of fiscal 2005. The increase reflects theadditional reimbursed expenses required to process the volume of private labelloans that we facilitated during the fiscal 2006 period, which increased to$2.63 billion for the first nine months of fiscal 2006 from $2.12 billion forthe first nine months of fiscal 2005 and to $800.6 million for the thirdquarter of fiscal 2006 from $585.4 million for the third quarter of fiscal2005. We expect that our processing fees from TERI will continue to increase aswe devote additional personnel and other resources to facilitate expectedincreases in private label loan volumes. The increase was also due to theexpansion of our loan processing facilities and information technology platform whichwere partially reimbursed by TERI.

 

*Administrativeand other fees*

* *

Administrativeand other fees increased to $6.1 million for the first nine months of fiscal2006 from $2.7 million for the first nine months of fiscal 2005 and increasedto $2.4 million for the third quarter of fiscal 2006 from $0.8 million for thethird quarter of fiscal 2005. The increases in the current year periods wereprimarily due to fees we generated from marketing coordination servicesprovided to some of our clients. To a lesser extent, the increase was due toincreasing student loan balances in the securitization trusts during the fiscal2006 period compared to the fiscal 2005 period.

 

***OperatingExpenses***

*** ***

Totaloperating expenses increased to $139.0 million for the first nine months offiscal 2006 from $99.2 million for the first nine months of fiscal 2005 andincreased to $49.2 million in the third quarter of fiscal 2006 from $37.7million in the third quarter of fiscal 2005. Compensation and benefitsincreased to $66.0 million for the first nine months of fiscal 2006 from $47.5million for the first nine months of fiscal 2005, and increased to $25.1million in the third quarter of fiscal 2006 from $17.3 million in the thirdquarter of fiscal 2005. General and administrative expenses increased to $73.0million for the first nine months of fiscal 2006 from $51.7 million for thefirst nine months of fiscal 2005, and increased to $24.1 million in the third quarterof fiscal 2006 from $20.4 million in the third quarter of fiscal 2005.

 

Compensationand benefits and general and administrative expenses increased in the fiscal2006 periods compared to the fiscal 2005 periods primarily as a result of anincrease in personnel. Our average total number of employees was 22% higherduring the first nine months of fiscal 2006 than during the corresponding prioryear period and 16% higher during the third quarter of fiscal 2006 than duringthe third quarter of fiscal 2005. We hired additional personnel to meet theoperating and information systems requirements from our growing loan processingand securitization activities.

 

Generaland administrative expenses increased during the first nine months of fiscal2006 as compared to the first nine months of fiscal 2005 as a result ofincreases in several categories of expenses, offset in part by a decreasein consulting fees. Marketing coordination expense increased from $1.5 millionfor the first nine months of fiscal 2005 to $8.8 million for the first ninemonths of fiscal 2006. The increase in marketing coordination expense wasprimarily due to our additional efforts to increase loan facilitation volumesfor our clients. Depreciation and amortization expense increased from $5.5 millionfor the first nine months of fiscal 2005 to $10.6 million for the first ninemonths of fiscal 2006. Occupancy costs increased from $7.6 million for thefirst nine months of fiscal 2005 to $10.8 million for the first nine months offiscal 2006. The increase in depreciation and occupancy expense is primarily

 

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dueto the expansion of our loan processing operations and corporate headquarterswhich resulted in increased office space under lease and additional purchasesof fixed assets. Equipment expense increased from $3.8 million for the firstnine months of fiscal 2005 to $8.2 million for the first nine months of fiscal2006. The increase in equipment expense was primarily due to an increase in softwaremaintenance and license costs and an increase in leased equipment costs.Temporary employment expense increased from $2.2 million for the first ninemonths of fiscal 2005 to $3.5 million for the first nine months of fiscal 2006.External call center costs increased from $4.0 million for the first ninemonths of fiscal 2005 to $6.2 million for the first nine months of fiscal 2006.The increases in temporary employment services expense and external call centercosts were primarily due to increases in personnel necessary to process thevolume of loans facilitated during the fiscal 2006 period. Consulting feesdecreased from $11.7 million for the first nine months of fiscal 2005 to $9.0million for the first nine months of fiscal 2006. This decrease was primarilydue to a decrease in external consultants involved in the evaluation andimprovement of our loan facilitation systems.

 

Generaland administrative expense increased during the third quarter of fiscal 2006 ascompared to the third quarter of fiscal 2005 as a result of increase in severalcategories of expenses, offset in part by a decrease in travel andentertainment expense. Marketing coordination expense increased from $0.6million for the third quarter of fiscal 2005 to $2.9 million for the third quarterof fiscal 2006. The increase in marketing coordination expense was primarilydue to our additional efforts to increase loan facilitation volumes for ourclients. Depreciation and amortization expense increased from $3.0 million forthe third quarter of fiscal 2005 to $3.6 million for the third quarter offiscal 2006. Occupancy costs increased from $3.3 million for the third quarterof fiscal 2005 to $3.8 million for the third quarter of fiscal 2006. Theincrease in depreciation and occupancy expense was due to the expansion of ourloan processing operations and corporate headquarters which resulted inincreased office space under lease and additional purchases of fixed assets.Travel and entertainment expense decreased from $1.1 million for the thirdquarter of fiscal 2005 to $0.7 million for the third quarter of fiscal 2006.

 

Weexpect that our operating expenses will continue to increase as we devoteadditional resources to the expected increasing loan volumes facilitated forour existing and new clients.

 

Thefollowing table summarizes the components of operating expenses, both thosereimbursed and not reimbursed by TERI, for the three and nine months ended March 31,2006 and 2005:

 
| ** **                            | ** ** | **Operating expenses**                    | ** ** |
|---------------------------------------|------------|------------------------------------------------|------------|
| ** **                            | ** ** | **Expenses reimbursed by TERI** | ** ** | **Expenses not reimbursed by TERI** | ** ** |
| ** **                            | ** ** | **Compensation  and benefits**            | ** ** | **General and  administrative  expenses** | ** ** | **Subtotal  operating  expenses** | ** ** | **Compensation  and benefits** | ** ** | **General and  administrative  expenses** | ** ** | **Subtotal  operating  expenses** | ** ** | **Total  operating  expenses** | ** ** |
| ** **                            | ** ** | ** **                                     | ** ** | ** ** | ** ** | ** ** | ** ** | **(in thousands)** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Three months ended March 31,** |       |                                           |       |   |   |   |   |   |   |   |   |   |   |   |   |
| 2006                                  |       | $                                              | 13,454     |   | $ | 13,008 |   | $ | 26,462 |   | $ | 11,653 |   | $ | 11,132 |   | $ | 22,785 |   | $ | 49,247 |   |
| 2005                                  |       | 10,271                                         |       | 10,293 |   | 20,564 |   | 7,051 |   | 10,098 |   | 17,149 |   | 37,713 |   |
| **Nine months ended March 31,**  |       |                                           |       |   |   |   |   |   |   |   |   |   |   |   |   |
| 2006                                  |       | $                                              | 39,383     |   | $ | 38,010 |   | $ | 77,393 |   | $ | 26,626 |   | $ | 34,946 |   | $ | 61,572 |   | $ | 138,965 |   |
| 2005                                  |       | 27,418                                         |       | 27,024 |   | 54,442 |   | 20,105 |   | 24,678 |   | 44,783 |   | 99,225 |   |

 

***OtherIncome (Expense)***

*** ***

*Interestincome (expense), net*

* *

Netinterest income was $4.2 million for the first nine months of fiscal 2006as compared to net interest income of $2.2 million for the first nine months offiscal 2005. Net interest income was $1.4 million for the third quarter offiscal 2006 as compared to $1.0 million for the third quarter of fiscal 2005.Interest income was

 

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$4.9 millionfor the first nine months of fiscal 2006 and $2.5 million for the first ninemonths of fiscal 2005. Interest income was $1.6 million for the third quarterof fiscal 2006 and $1.2 million for the third quarter of fiscal 2005. Theincreases in interest income in the fiscal 2006 periods were primarily due toincreases in average yields on investments. Interest expense was $0.6 millionfor the first nine months as fiscal 2006 and $0.4 million for the first ninemonths of fiscal 2005. Interest expense was $0.2 million for the third quarterof fiscal 2006 and $0.1 million for the third quarter of fiscal 2005. Interestexpense for all periods is due primarily to our capital lease obligations andour notes issued to TERI in 2001 to finance our purchase of TERI’s loanprocessing operations and loan database.

 

*Other*

* *

Duringthe second quarter of fiscal 2006, we realized a gain of $2.5 million upon theearly termination of an operating lease for a corporate aircraft. The terms ofthe lease allowed us the ability to benefit from the appreciation in value ofthe leased aircraft upon its termination.

 

***IncomeTax Expense***

*** ***

Incometax expense increased to $117.4 million for the first nine months of fiscal2006 from approximately $84.1 million for the first nine months of fiscal 2005.Income tax expense increased to $42.1 million for the third quarter of fiscal2006 from $35.4 million for the third quarter of fiscal 2005. The increase inincome tax expense was primarily the result of an increase in the amount ofincome before income tax expense between periods.

 

**FinancialCondition, Liquidity and Capital Resources**

** **

Ourliquidity requirements have historically consisted, and we expect that theywill continue to consist, of capital expenditures, working capital, businessdevelopment expenses, general corporate expenses, repurchases of our commonstock, quarterly cash dividends and potential acquisitions.

 

***Short-termFunding Requirements***

*** ***

Weexpect to fund our short-term liquidity requirements through cash flow fromoperations and the proceeds of our initial public offering in November 2003,which resulted in net proceeds to us of approximately $115.1 million. Webelieve, based on our current operating plan, that our cash flows fromoperations and our current cash and cash equivalents will be sufficient to meetour funding requirements through at least fiscal 2007.

 

***Long-termFunding Requirements***

*** ***

Weexpect to fund the growth of our business through cash flow from operations andthrough issuances of common stock, promissory notes or other securities. Weexpect to assess our financing alternatives periodically and access the capitalmarkets opportunistically. If our existing resources are insufficient tosatisfy our liquidity requirements, or if we enter into an acquisition orstrategic arrangement with another company, we may need to sell additionalequity or debt securities. Any sale of additional equity or debt securities may resultin additional dilution to our stockholders, and we cannot be certain thatadditional public or private financing will be available in amounts or on termsacceptable to us, if at all. If we are unable to obtain this additionalfinancing, we may be required to delay, reduce the scope of, or eliminateone or more aspects of our business development activities, which could harmthe growth of our business, or we may be required to delay or eliminateour quarterly cash dividends to our stockholders.

 

Ouractual liquidity and capital funding requirements may depend on a numberof factors, including:

 

•  our facilities expansion needs;

 

•  the extent to which our services gainincreased market acceptance and remain competitive;

 

•  the extent to which we repurchase sharesof our common stock or pay cash dividends to our stockholders;

 

•  the timing, size and composition of theloan pools of the securitization transactions that we structure;

 

•  the timing, and magnitude of income taxpayments; and

 

•  the costsand timing of acquisitions of complementary businesses.

 

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***TreasuryStock***

*** ***

Wehad treasury stock of $121.5 million at March 31, 2006 and $55.7 millionat June 30, 2005. Our treasury stock balance was derived from therepurchases of our common stock in open market transactions. Our board ofdirectors approved the repurchase of 1,500,000 shares of our common stock inthe fourth quarter of fiscal 2005 and approved the repurchase of an additional5,000,000 shares of our common stock in the first quarter of fiscal 2006. As ofMarch 31, 2006, we had repurchased an aggregate of 3,846,800 shares at anaverage price, excluding commissions, of $31.57 per share.

 

***Cashand Cash Equivalents***

*** ***

AtMarch 31, 2006, we had $142.6 million in cash and cash equivalents and at June 30,2005, we had $193.8 million in cash and cash equivalents. The decrease incash and cash equivalents is primarily due to cash used to fund repurchases ofour common stock and the payment of cash dividends during the first nine monthsof fiscal 2006, offset by cash generated from our March 2006 and October 2005securitization transactions. Cash and cash equivalents primarily includeinvestments in Variable Rate Demand Notes and funds deposited in a money marketfund that invests in short-term obligations of the U.S. Treasury and repurchaseagreements fully collateralized by obligations of the U.S. Treasury.

 

***ServiceReceivables***

*** ***

Ourservice receivables increased to $485.8 million at March 31, 2006 from$309.6 million at June 30, 2005, primarily as a result of thestructural advisory fees and residuals generated from the October 2005 andMarch 2006 securitization transactions. The increase in servicereceivables is also due to an increase in our estimate of the fair value of ourresiduals receivable of $25.6 million during the first nine months of fiscal2006 primarily as a result of the accretion of the discounting inherent in thefair value estimates due to the passage of time.

 

***Propertyand Equipment, net***

*** ***

Duringthe first nine months of fiscal 2006, our property and equipment, net decreasedby $0.8 million, as we spent $7.5 million on the expansion and improvement ofour loan processing facilities and systems, offset by $9.4 million ofdepreciation expense recorded during the period. During the first nine monthsof fiscal 2006, we financed the acquisition of $1.1 million in property andequipment through capital leases.

 

***PrepaidIncome Taxes***

*** ***

Wehad no prepaid income taxes at March 31, 2006 as compared to $2.6 millionat June 30, 2005. At June 30, 2005, this balance was primarilyderived from a tax benefit of $34.3 million from employee stock optionexercises, principally in connection with a stock option exercise at the timeof our follow-on offering in January 2005.

 

***OtherPrepaid Expenses***

*** ***

Wehad other prepaid expenses of $6.2 million at March 31, 2006 compared to$4.2 million at June 30, 2005. The increase in other prepaid expenses wasprimarily due to an increase in prepaid insurance of approximately $1.0 million,an increase of in prepaid marketing costs of approximately $0.5 million and anincrease in prepaid rent of $0.3 million.

 

***OtherAssets***

*** ***

Wehad other assets of $4.0 million at March 31, 2006 and $3.2 million at June 30,2005. The increase in other assets is primarily due to an increase in prepaidfees to be reimbursed to us by future securitization trusts of $0.5 million.

 

***AccountsPayable and Accrued Expenses***

*** ***

Wehad accounts payable and accrued expenses of $28.6 million at March 31,2006 and $33.3 million at June 30, 2005. Our accrued bonuses wereapproximately $1.9 million lower at March 31, 2006 as compared to June 30,2005. Our accrued consulting expenses were approximately $0.6 million lower at March 31,2006, as compared to June 30, 2005. Our accounts payable were $1.5 millionlower at March 31, 2006 as compared to June 30,

 

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2005,primarily due to the timing of the receipt and processing of invoices.

 

***IncomeTaxes Payable***

*** ***

Wehad income taxes payable of $1.8 million at March 31, 2006 while we had noincome taxes payable at June 30, 2005. The increase in income taxespayable is primarily due to the current tax expense generated by our income forthe first nine months of fiscal 2006, offset by estimated tax payments madeduring the current fiscal year.

 

***NetDeferred Income Tax Liability***

*** ***

Wehave a net deferred income tax liability primarily because, under GAAP, werecognize residuals in financial statement income earlier than they arerecognized for income tax purposes. Our net deferred income tax liabilityincreased primarily as a result of the increase in residual revenue recognizedduring the first nine months of fiscal 2006, which more than offset therecognition of our share of taxable income from the securitization trusts.

 

***CapitalLease Obligations***

*** ***

Wehad capital lease obligations of $9.7 million at March 31, 2006 and $12.1million at June 30, 2005. The decrease in capital lease obligations wasdue to scheduled principal payments made during the first nine months of fiscal2006.

 

***NotesPayable to TERI***

*** ***

Wehad notes payable to TERI of $4.7 million at March 31, 2006 and $5.3million at June 30, 2005. The balance relates to two acquisition notes weissued to acquire TERI’s loan processing operations in 2001. The decrease innotes payable to TERI is due to the scheduled principal payments made duringthe first nine months of fiscal 2006.

 

***OtherLiabilities***

*** ***

Wehad other liabilities of $3.5 million at March 31, 2006 and $1.7 millionat June 30, 2005. The balance at both period ends related primarily todeferred rent related to several operating leases for office space.

 

***ContractualObligations***

*** ***

Duringthe first nine months of fiscal 2006, we terminated an operating lease for acorporate aircraft. As a result of this termination, we are no longer requiredto pay the basic annual rent due under the lease of approximately $1.4 millionper year through 2009. Except for this change, our contractual obligations asof March 31, 2006 had not changed materially from those described underManagement’s Discussion and Analysis of Financial Condition and Results ofOperations—Contractual Obligations” in our annual report on Form 10-K forthe fiscal year ended June 30, 2005.

 

***CashFlows***

*** ***

Ournet cash provided by operating activities decreased to $43.8 million for thefirst nine months of fiscal 2006, compared to $75.7 million for the first ninemonths of fiscal 2005. The decrease in cash provided by operations resultedprimarily from a decrease in the tax benefit from stock options and increasesin residual receivables and structural advisory fees receivables, offset inpart by our net income and deferred income tax expense.

 

Weused $8.1 million of net cash in investing activities during the first ninemonths of fiscal 2006 compared to $22.1 million during the first nine months offiscal 2005. The principal uses of net cash during the fiscal 2006 period werecapital expenditures related to the expansion and improvement of our loanprocessing facilities and systems and, to a lesser extent, payments for loandatabase updates from TERI. Net cash used in investing activities decreasedduring the fiscal 2006 period primarily as a result of decreased expendituresrelated to loan processing facilities compared to the fiscal 2005 period.

 

Weused net cash of $87.0 million in financing activities during the first ninemonths of 2006 compared to $3.8 million during the first nine months of fiscal2005. We used cash in financing activities during the fiscal 2006 period

 

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primarilyfor our repurchases of common stock and cash dividends paid to commonstockholders. We did not have similar financing activities in the fiscal 2005period. We expect to make quarterly cash dividend payments to our stockholdersin future periods.

 

Weexpect that our capital expenditure requirements for the final three months offiscal 2006 will be approximately $3.8 million. We expect to use these fundsprimarily for the expansion of our loan processing operations and the purchaseof computer and office equipment.

 

***Borrowings***

*** ***

InJune 2001, we issued two acquisition notes to TERI totaling$7.9 million to acquire TERI’s loan processing operations as well as itsworkforce-in-place. Principal and interest at an annual rate of 6% is payableon these notes in 120 monthly payments of $87,706 commencing on July 20,2001 and ending on June 20, 2011. At March 31, 2006, outstandingprincipal on these notes totaled $4.7 million as compared to $5.3 millionat June 30, 2005.

 

InAugust 2003, we entered into a $10 million revolving credit facilitywith Fleet National Bank. Fleet National Bank was subsequently acquired by Bankof America, and our agreement related to this facility was assigned to Bank ofAmerica. The revolving credit facility matured on August 28, 2005, and wedid not extend it. The revolving credit line contained certain financialcovenants with which we complied throughout the terms of the facility.

 

**Off-BalanceSheet Transactions**

** **

Weoffer outsourcing services in connection with the lifecycle of a privatestudent loan, from program design and marketing through loan administrationand, ultimately, to the sale and securitization of the loans. We also structureand facilitate the securitization of loans for our clients through a series ofbankruptcy remote, qualified special purpose trusts.

 

Wedo not utilize these trusts as a means to transfer assets or liabilities fromour balance sheet to those of the trusts because we are not the originator ofthe securitized student loans or the issuer of the related debt. We do notserve as lender, guarantor or loan servicer. Specifically, these trustspurchase such student loans from third-party financial institutions, thefinancing of which is provided through the issuance of asset-backed securities.

 

Theprincipal uses of these trusts are to:

 

•  generate sources of liquidity for ourclients’ assets sold into such trusts and to reduce their credit risk;

 

•  make available more funds to students andcolleges; and

 

•  leverage the capital markets to reduceborrowing costs to students.

 

See“—Executive Summary—Application of Critical Accounting Policies andEstimates—Consolidation” for a discussion of our determination to notconsolidate these securitization trusts.

 

**Inflation**

** **

Inflationwas not a material factor in either revenue or operating expenses during theperiods presented.

 

**FactorsThat May Affect Future Results**

** **

Thisquarterly report on Form 10-Q includes forward-looking statements withinthe meaning of Section 21E of the Securities Exchange Act of 1934, asamended, or the Exchange Act. For this purpose, any statements contained hereinregarding our strategy, future operations, financial position, future revenues,projected costs, prospects, plans and objectives of management, other thanstatements of historical facts, are forward-looking statements. The words “anticipates,”“believes,” “estimates,” “expects,” “intends,” “may,” “plans,” “projects,” “will,”“would” and similar expressions are intended to identify forward-lookingstatements, although not all forward-looking statements contain theseidentifying words. We cannot provide any assurance that we actually willachieve the plans, intentions or expectations expressed or implied in ourforward-looking statements. There are a number of important factors that couldcause actual results, levels of activity, performance or events to differmaterially from those expressed or implied in the forward-looking statements wemake. These important factors include our “critical accounting estimates” andthe risk factors set forth below under Item 1A of Part II. Although we may electto update forward-looking statements in the future, we specifically disclaimany obligation to do so, even if our estimates change, and

 

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readersshould not rely on those forward-looking statements as representing our viewsas of any date subsequent to the date of this quarterly report.

 

**Item 3—Quantitative andQualitative Disclosures about Market Risk**

** **

***General***

*** ***

Marketrisk is the risk of change in fair value of a financial instrument due tochanges in interest rates, equity prices, creditworthiness, foreign exchangerates or other factors. We manage our market risk through a conservativeinvestment policy, the primary objective of which is preservation of capital.At March 31, 2006, cash and cash equivalents consisted primarily ofbalances in money market funds and investments in Variable Rate Demand Notes.As a result, we do not believe a change in interest rates would have a materialimpact on the fair value of cash and cash equivalents.

 

***MarketRisks Related to Structural Advisory Fees and Residuals***

*** ***

Becausethere are no quoted market prices for our additional structural advisory feesor residuals receivable, we use discounted cash flow modeling techniques andvarious assumptions to estimate their values. We base these estimates on ourproprietary historical data, third-party data and our industry experience,adjusting for specific program and borrower characteristics such as loan typeand borrower creditworthiness. Increases in our estimates of defaults,prepayments and discount rates, increases in the spread between LIBOR andauction rate indices, as well as decreases in default recovery rates and the multi-yearforward estimates of the LIBOR rate, which is the reference rate for the loanassets and borrowings of the securitization trusts, would have a negativeeffect on the value of our additional structural advisory fees and residuals.For an analysis of the estimated change in our structural advisory fees andresiduals receivable balance at March 31, 2006 based on changes in theseloan performance assumptions, see “Management’s Discussion and Analysis ofFinancial Conditions and Results of Operations—Executive Summary—Application ofCritical Accounting Policies and Estimates—Service Revenues andReceivables—Sensitivity Analysis.”

 

**Item 4—Controls andProcedures**

** **

Ourmanagement, with the participation of our chief executive officer and chieffinancial officer, evaluated the effectiveness of our disclosure controls andprocedures as of March 31, 2006. The term “disclosure controls andprocedures,” as defined in Rules 13a-15(e) and 15d-15(e) underthe Exchange Act, means controls and other procedures of a company that aredesigned to ensure that information required to be disclosed by us in thereports that we file or submit under the Exchange Act is recorded, processed,summarized and reported, within the time periods specified in the SEC’s rules andforms. Disclosure controls and procedures include, without limitation, controlsand procedures designed to ensure that information required to be disclosed bya company in the reports that it files or submits under the Exchange Act isaccumulated and communicated to the company’s management, including itsprincipal executive and principal financial officers, as appropriate to allowtimely decisions regarding required disclosure. Management recognizes that anycontrols and procedures, no matter how well designed and operated, can provideonly reasonable assurance of achieving their objectives and managementnecessarily applies its judgment in evaluating the cost-benefit relationship ofpossible controls and procedures. Based on the evaluation of our disclosure controlsand procedures as of March 31, 2006, our chief executive officer and chieffinancial officer concluded that, as of such date, our disclosure controls andprocedures were effective at the reasonable assurance level.

 

Nochange in our internal control over financial reporting occurred during thefiscal quarter ended March 31, 2006 that has materially affected, or isreasonably likely to materially affect, our internal control over financialreporting.

 

**Part II.   OtherInformation**

** **

**Item 1A.—Risk Factors**

** **

***We derive a significant portion of our revenue and substantially all ofour income from structuring securitization transactions; our financial resultsand future growth would be adversely affected if we are unable to structuresecuritizations.***

 

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Securitizationrefers to the technique of pooling loans and selling them to a special purpose,bankruptcy remote entity, typically a trust, which issues securities toinvestors backed by those loans. As of the date of this quarterly report, wehave provided structural advisory and other services for 29 loansecuritizations since our formation in 1991, and we receive fees for theseservices. In connection with securitizations, we receive compensation in the form ofstructural advisory fees, residuals and administrative fees for management ofthe trusts. The amount and timing of the fees we recognize are affected, inpart, by the size and composition of loan pools to be securitized, the returnexpectations of investors and assumptions we make regarding loan portfolioperformance, including defaults, recoveries, prepayments and the cost offunding. Revenue from new securitizations constituted 73% of our total servicerevenue for the first nine months of fiscal 2006, 76% of our total servicerevenue for the first nine months of fiscal 2005 and 78% of our total servicerevenue for the first nine months of fiscal 2004. Substantially all of our netincome in those fiscal periods was attributable to securitization-related revenue.

 

***Thetiming of our securitization activities will greatly affect our quarterlyfinancial results.***

*** ***

Ourquarterly revenue, operating results and profitability have varied and areexpected to continue to vary significantly on a quarterly basis. In fiscal2005, we recognized 5%, 37%, 29% and 29% of our total service revenue in therespective fiscal quarters of fiscal 2005. Our quarterly revenue variesprimarily because of the timing of the securitizations that we structure. Infiscal 2005, we facilitated one securitization in the second quarter, onesecuritization in the third quarter, and three securitizations in the fourthquarter, but none in the first quarter. Thus far in fiscal 2006, we havefacilitated one securitization in each of the second and third quarters. Thetiming of our securitization activities is affected to some degree by theseasonality of student loan applications and loan originations. Origination ofstudent loans is generally subject to seasonal trends, with the volume of loanapplications increasing with the approach of tuition payment dates. In fiscal2005, we processed 39% of our total loan facilitation volume in the firstquarter ended September 30, 2004, and 21%, 24% and 17% of our total loanfacilitation volume in the respective successive quarters.

 

***Anumber of factors, some of which are beyond our control, may adverselyaffect our securitization activities and thereby adversely affect our resultsof operations.***

*** ***

Ourfinancial performance and future growth depend in part on our continuedsuccess in structuring securitizations. Several factors may affect bothour ability to structure securitizations and the revenue we generate forproviding our structural advisory and other services, including the following:

 

•  degradation of the credit quality andperformance in the loan portfolios of the trusts we structure could reduce oreliminate investor demand for securitizations that we facilitate in the future;

 

•  prolonged volatility in the capitalmarkets generally or in the student loan sector specifically, which couldrestrict or delay our access to the capital markets;

 

•  unwillingness of financial guaranteeproviders to offer credit insurance in the securitizations that we structure orin student loan-backed securitizations generally;

 

•  adverse performance of, or other problemswith, student loan-backed securitizations that other parties facilitate couldimpact pricing or demand for our securitizations; and

 

•  any material downgrading or withdrawal ofratings given to securities previously issued in securitizations that westructured could reduce demand for additional securitizations that westructure.

 

Aportion of the securities issued since 1998 in securitization transactions thatwe structured were sold to asset-backed commercial paper conduits. If these orsimilar asset-backed conduits cease to purchase securities in thesecuritizations that we structure, we may experience a delay in the timingof our securitizations as we seek to find alternate channels of distribution.

 

Underthe terms of some of our contracts with key lender clients, we have anobligation to securitize loans originated by those lenders periodically. We may agreewith other lenders to securitize more frequently in the future. If we do nothonor these obligations, we may be required to pay liquidated or otherdamages, which could adversely affect our results of operations.

 

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***In connection with our recognition of revenue from securitizationtransactions, if the estimates we make, and the assumptions on which we rely,in preparing our financial statements prove inaccurate, our actual results may varyfrom those reflected in our financial statements.***

 

Wereceive structural advisory fees for our services in connection withsecuritization transactions. We receive an up-front portion of these structuraladvisory fees when the securitization trust purchases the loans or soonthereafter. We receive an additional portion of these structural advisory feesover time, based on the amount of loans outstanding in the trust from time totime over the life of the trust. We also have the right to receive a portion ofthe residual interests that the trust creates. As required under GAAP, werecognize as revenue an estimate of the fair value of the additional portion ofthe structural advisory fees and residuals at the time the securitization trustpurchases the loans because these revenues are deemed to be earned before theyare actually paid to us. We record additional structural advisory fees andresiduals as receivables on our balance sheet at our estimate of their fairvalue. Accounting rules require that these receivables bemarked-to-market. We estimate the fair value both initially and in eachsubsequent quarter and reflect the change in our estimate of fair value inearnings for that period. Our key assumptions to estimate the value includeprepayment and discount rates, interest rate trends, the spread between LIBORand the auction rates on our senior auction rate notes, the expected creditlosses from the underlying securitized loan portfolio, net of recoveries, andthe expected timing of cash flows from the trusts’ underlying student loanassets. If our assumptions are wrong, the additional structural advisory feesand residuals that we receive from the trusts could be significantly less thanreflected in our current financial statements, and we may incur a materialnegative adjustment to our earnings in the period in which our assumptionschange. For a discussion of the sensitivity of the additional structuraladvisory fees and residuals to variations in our assumptions and estimates, see“Management’s Discussion and Analysis of Financial Condition and Results ofOperations—Executive Summary—Application of Critical Accounting Policies andEstimates—Service Revenue and Receivables—Sensitivity Analysis.”

 

Ourresiduals in each securitization we have facilitated are subordinate tosecurities issued to investors in such securitizations and may fail togenerate any cash flow for us if the securitized assets only generate enoughcash flow to pay the debt holders.

 

***Ourfinancial results could be adversely affected if we were required toconsolidate the financial results of the entities that we use forsecuritizations that we facilitate.***

*** ***

Weprovide structural advisory and other services for loan securitizationsundertaken through statutory trusts. We do not consolidate the financialresults of the trusts with our own financial results. For a discussion of ourdecision not to consolidate, see “Management’s Discussion and Analysis ofFinancial Condition and Results of Operations—Executive Summary—Application ofCritical Accounting Policies and Estimates—Consolidation” included in thisquarterly report. Some of the accounting rules relevant to this issue arein the process of being amended. If we were required to consolidate thefinancial results of one or more trusts with our own financial results as aresult of amendments or changes in accounting rules, or if the SEC or otheraccounting authorities do not agree with our current approach, our financialresults could be adversely affected, particularly in the early years of a trustwhen the trust typically experiences losses.

 

***Ifour relationships with key clients terminate, our revenue and results ofoperations would be adversely affected.***

*** ***

Westructure and support private student loan programs for commercial banks,including JPMorgan Chase Bank, N.A. and Bank of America, N.A. We also structureand support private student loan programs for loan marketers such as CollegiateFunding Services, LLC, or CFS, that refer their customers to a particularlending source. We refer to these lenders as referral lenders. Structuraladvisory fees and residuals from securitization of JPMorgan Chase Bank privatelabel loans represented approximately 30% of our total service revenue forfiscal 2005 and approximately 44% of our total service revenue for fiscal 2004.Structural advisory fees and residuals from securitization of Bank of Americaprivate label loans represented approximately 15% of total service revenue forfiscal 2005 and approximately 8% of total service revenue for fiscal 2004. Inaddition, Bank of America is currently the lender for our GATE program clients.Our GATE programs contributed 3% of our total service revenue in fiscal 2005and 4% of our total

 

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servicerevenue in fiscal 2004. Structural advisory fees and residuals fromsecuritization of private label loans funded by Charter One Bank representedapproximately 22% of our total service revenue for fiscal 2005 andapproximately 16% of our total service revenue in fiscal 2004. Charter One Bankserved as a referral lender until May 1, 2006 for CFS loan programs thatwe facilitate. JPMorgan Chase Bank acquired CFS in March 2006 and, since May 1,2006, the funding for approved loan applications for CFS customers has been redirectedfrom Charter One Bank to JPMorgan Chase Bank.

 

Wehave agreements with these commercial banks that govern the purchase of loansfor securitization. Our agreement with JPMorgan Chase Bank is scheduled toterminate in March 2010. Our agreements with Charter One Bank aregenerally scheduled to terminate in May 2007. Subject to specifiedcontinuing obligations, our agreement with Charter One Bank with respect toloans marketed by CFS and funded by Charter One Bank was terminated as of May 1,2006. Our agreement with Bank of America governing the purchase of schoolchannel loans can be terminated at any time upon 180 days notice. Our twoagreements with Bank of America that govern the purchase of GATE loans expireon November 30, 2006. In the absence of termination, both agreements willautomatically renew for successive one-year terms, but can be terminated byeither party with 90 days notice after June 1, 2006. Our agreement withBank of America governing the purchase of direct-to-consumer loans expires on May 31,2008, provided that either party may terminate this agreement on or after June 1,2007, upon 90 days notice. Each client above has the right to terminate itsagreement on short notice, generally 30 days or less, if we materiallybreach our agreement, including our failure to perform at service levelsspecified in those contracts. In addition, under the terms of our lender clients’guaranty agreements with TERI, both the lender and TERI may proposemodifications to loan program guidelines during the first calendar quarter ofeach year. If the parties are unable to agree on a proposed modification, suchas an adjustment of the guarantee fees, the party proposing the modificationhas the option of terminating the guaranty agreement, effective as of May 1of that calendar year. Under its master loan guaranty agreement with us, TERI may notpropose a change to program guidelines without our consent. Similarly, underour agreements with lenders that have multi-year terms, the lender cannotchange the program guidelines without our consent, which we cannot unreasonablywithhold.

 

Asignificant decline in services to JP Morgan Chase, Bank of America or CharterOne Bank, or the termination of guaranty agreements between those lenders andTERI, could reduce the overall volume of loans we facilitate, which could bedifficult to replace through arrangements with other lenders. Our revenue,business and financial results could suffer as a result.

 

***Theoutsourcing services market for education lending is highly competitive and ifwe are not able to compete effectively, our revenue and results of operations may beadversely affected.***

*** ***

Weassist national and regional financial institutions and educationalinstitutions, as well as businesses and other enterprises, in structuring andsupporting their private education loan programs. In providing our services, wereceive fees for services we provide primarily in connection with thesecuritization of our clients’ loans. The outsourcing services market in whichwe operate includes a large number of service providers, some of which havegreater financial, technical and marketing resources, larger customer bases,greater name recognition and more established relationships with their clientsthan we have. Larger competitors with greater financial resources may bebetter able to respond to the need for technological changes, compete forskilled professionals, build upon efficiencies based on a larger volume of loantransactions, fund internal growth and compete for market share generally. We may facecompetition from our clients if they choose, or acquire the ability, to providedirectly the services that we provide. In March 2006, our client J.P.Morgan Chase completed its acquisition of CFS, a marketer of education loans wefacilitate. This acquisition could result in the emergence of a new competitorwith the ability to offer outsourced services, including securitizationservices, for private student loans. In addition, we may face competitionfrom third parties who decide to expand their services to include the suite ofservices that we provide. We are aware of two principal competitors, SLMCorporation, or Sallie Mae, and Servus Financial Corporation, an affiliate ofWells Fargo Company, that offer a similar range of services to lenders. Ourbusiness could also be adversely affected if Sallie Mae’s program to marketprivate student loans directly to consumers continues to grow, if Sallie Maeseeks to market more aggressively to third parties the full range of servicesfor private loan programs that we provide or if Sallie Mae’s recently announcedprivate loan consolidation product results in increased consolidation ofprivate student loans held by the securitization trusts we have facilitated. Ifwe are not able to compete effectively, our revenue and results of operations may beadversely affected. In addition, if third parties choose to provide the range ofservices that we provide, pricing for our services may become morecompetitive, which could lower our profitability.

 

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In addition, there hasbeen significant consolidation within the banking industry. For example,Charter One Financial, Inc., the publicly traded parent company of CharterOne Bank was acquired by Citizens Financial Group, Inc., and Bank One Corporationwas acquired by J.P. Morgan Chase & Co. In addition, Sallie Maeacquired our client, Southwest Student Services Corporation, resulting intermination of our relationship with that client. The merger between JPMorganChase Bank and CFS, could result in a reduction in our business with either orboth of them. The merger may also negatively affect the volume of Charter OneBank loans that we process and securitize, because Charter One Bank no longerserves as a referral lender for CFS loan programs that we facilitate. Furtherconsolidation could result in a loss of business if one or more of our clientswere acquired by a competitor or a lender that is not our client.

 

Historically, lenders inthe education loan market have focused their lending activities on federalloans because of the relative size of the federal loan market and because thefederal government guarantees repayment of these loans, thereby significantlylimiting the lenders’ credit risk. The demand for our services could decline iflenders place additional emphasis on the private education loan market andoffer the services we provide.

 

***Ifour clients do not successfully market and sell student loans, our businesswill be adversely affected.***

*** ***

We provide outsourcingservices to lenders, loan marketers and educational institutions, as well asbusinesses and other organizations, in structuring and supporting their privateeducation loan programs. We rely on our clients to market and sell educationloans to student borrowers. If they do not devote sufficient time and resourcesto their marketing efforts, or if they are otherwise not successful in theseefforts, then we may experience a reduction in the volume of loans that weprocess and securitize, and our business will be adversely affected.

 

***Instructuring and facilitating securitizations of our clients’ loans and asholders of rights to receive residual cash flows in those trusts, we may incurliabilities to investors in the asset-backed securities those trusts issue.***

*** ***

We have facilitated andstructured a number of different special purpose trusts that have been used insecuritizations to finance student loans that our clients originate. Underapplicable state and federal securities laws, if investors incur losses as aresult of purchasing asset-backed securities that those trusts issue, we couldbe deemed responsible and could be liable to those investors for damages. If wefailed to cause the trusts to disclose adequately all material informationregarding an investment in the asset-backed securities or if the trust madestatements that were misleading in any material respect in informationdelivered to investors, it is possible that we could be held responsible forthat information or omission. In addition, under various agreements enteredinto with underwriters or financial guarantee insurers of those asset-backedsecurities, we are contractually bound to indemnify those persons if investorsare successful in seeking to recover losses from those parties and the trustsare found to have made materially misleading statements or to have omittedmaterial information.

 

If we are liable forlosses investors incur in any of the securitizations that we facilitate orstructure and any insurance that we may have does not cover this liability orproves to be insufficient, our profitability or financial position could bematerially adversely affected.

 

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***Ifour relationship with TERI terminates, our business could be adverselyaffected.***

*** ***

In June 2001, wepurchased the loan processing operations of TERI and entered into a series ofagreements to govern future securitizations of TERI-guaranteed loans. TERIcontinues to provide private student loan guarantee, education information andcounseling services for students, and is the exclusive third party provider ofborrower default guarantees for our clients’ private label loans. We haveentered into an agreement to provide various services for TERI and receivedfees from TERI for services performed of $77.8 million, or 19% of total servicerevenue, for the first nine months of fiscal 2006, and $54.5 million or 18% oftotal service revenue for the first nine months of fiscal 2005. In addition, wehave agreed to undertake on a best-efforts basis to arrange or facilitate securitizationsfor a limited category of TERI-guaranteed loans and have the right to receivestructural advisory and other fees in connection with these securitizations. Wealso have entered into an agreement to receive from TERI updated informationabout the performance of the student loans it has guaranteed, to allow us tosupplement our database. Each of these agreements with TERI had an initial termthrough June 2006. In October 2004, we exercised our option to reneweach agreement for an additional five-year term, through June 2011. If ouragreements with TERI terminate for any reason, or if TERI fails to comply withits obligations, our business would be adversely affected and the value of ourintangible assets could be impaired for the following reasons:

 

•  we may not be able to offer our clientsguarantee services from another guarantor and, accordingly, our access to loansand our opportunities to structure securitization transactions may diminishsignificantly;

 

•  we may not be successful in establishingan arrangement with a third party to provide the warranties that TERI currentlyprovides to lenders related to origination services. In such case, we may berequired to provide such warranties; and

 

•  if TERI is unable to provide guaranteeservices, any financial guarantee insurance coverage we obtain insecuritization transactions could be more costly, if it is available at all.

 

In such events, demandfor our services, including opportunities to structure and facilitatesecuritization transactions, could decline, which would adversely affect ourbusiness. In addition, the value of the loan pools in the securitizationtransactions we facilitate could decline and the value of our residuals couldbe reduced.

 

***Ourbusiness could be adversely affected if TERI’s ratings are downgraded.***

*** ***

In its role as guarantorin the private education lending market, TERI agrees to reimburse lenders forunpaid principal and interest on defaulted loans. TERI is the exclusiveprovider of borrower default guarantees for our clients’ private label loans.As of March 31, 2006, TERI had a Baa3 counterparty rating from Moody’sInvestors Service, which is the lowest investment grade rating, and an insurerfinancial strength rating of A+ from Fitch Ratings. If these ratings are lowered,our clients may not wish to enter into guarantee arrangements with TERI. Inaddition, we may receive lower structural advisory fees because the costs ofobtaining financial guarantee insurance for the asset-backed securitizationsthat we structure could increase. In such case, our business would be adverselyaffected.

 

***Ourbusiness could be adversely affected if PHEAA fails to provide adequate ortimely services or if our relationship with PHEAA terminates.***

*** ***

As of March 31, 2006,PHEAA serviced a majority of loans whose origination we facilitate. Thisarrangement allows us to increase the volume of loans in our clients’ loanprograms without incurring the overhead investment in servicing operations. Aswith any external service provider, there are risks associated with inadequateor untimely services. We regularly monitor the servicing portfolio reports,including delinquencies and defaults. A substantial increase in the delinquencyrate could adversely affect our ability to access profitably the securitizationmarkets for our clients’ loans. In addition, if our relationship with PHEAAterminates, we would either need to expand or develop a relationship withanother TERI-approved loan servicer, which could be time consuming and costly.In such event, our business could be adversely affected. Although weperiodically review the costs associated with establishing servicing operationsto service loans, we have no plans to establish and perform servicingoperations at this time.

 

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***Thegrowth of our business could be adversely affected by changes in the annual oraggregate limitations under federal student loan programs or expansions in thepopulation of students eligible for loans under federal student loan programs.***

*** ***

We focus our businessexclusively on the market for private education loans, and more than 90% of ourbusiness is concentrated in loan programs for post-secondary education. Theavailability of loans that the federal government originates or guaranteesaffects the demand for private student loans because students and theirfamilies often rely on private loans to bridge the gap between available funds,including family savings, grants and federal and state loans, and the costs ofpost-secondary education. The federal government currently places both annualand aggregate limitations on the amount of federal loans that any student canreceive and determines the criteria for student eligibility. These guidelinesare adjusted in connection with funding authorizations from the United StatesCongress for programs under the Higher Education Act. During February 2006,Congress passed, and the President signed, the Deficit Reduction Act of 2005.The Deficit Reduction Act of 2005 includes several changes to federal studentloan programs. Although aggregate borrowing limits do not change, the DeficitReduction Act of 2005 increases amounts that first and second year collegestudents may borrow and makes Parent Loans for Undergraduate Students, or PLUSloans, available to graduate and professional students. The loan limitincreases take effect July 1, 2007 while most other provisions take effectJuly 1, 2006. This recent legislation, as well as future legislation,could weaken the demand for private student loans, which could adversely affectthe volume of private loans and the securitization transactions that wefacilitate and structure and, as a result, the growth of our business.

 

***Accessto alternative means of financing the costs of education may reduce demand forprivate student loans.***

*** ***

The demand for privatestudent loans could weaken if student borrowers use other vehicles to bridgethe gap between available funds and costs of post-secondary education. Thesevehicles include, among others:

 

•  home equity loans, under which familiesborrow money based on the value of their real estate;

 

•  pre-paid tuition plans, which allowstudents to pay tuition at today’s rates to cover tuition costs in the future;

 

•  529 plans, which are state-sponsoredinvestment plans that allow a family to save funds for education expenses; and

 

•  education IRAs, now known as CoverdellEducation Savings Accounts, under which a holder can make annual contributionsfor education savings.

 

If demand for privatestudent loans weakens, we would experience reduced demand for our services,which would seriously harm our financial results.

 

***Ifcompetitors acquire or develop a student loan database or advanced loaninformation processing systems, our business could be adversely affected.***

*** ***

We own a proprietarydatabase of historical information on private student loan performance that weuse to help us establish the pricing provisions of new loan programs, determinethe terms of securitization transactions and establish the fair value of thestructural advisory fees and residuals that we recognize as revenue. We alsohave developed a proprietary loan information processing system to enhance ourapplication processing and loan origination capabilities. Our student loandatabase and loan information processing system provide us with a competitiveadvantage in offering our services. Third parties could create or acquiredatabases and systems such as ours. For example, as lenders and otherorganizations in the student loan market originate or service loans, theycompile over time information for their own student loan performance database.If a third party creates or acquires a student loan database or develops a loaninformation processing system, our competitive positioning, ability to attractnew clients and business could be adversely affected.

 

***Changesin interest rates could affect the value of our additional structural advisoryfees and residuals receivables, as well as demand for private student loans andour services.***

*** ***

Student loans typicallycarry floating interest rates. Higher interest rates would increase the cost ofthe loan to the borrower, which in turn, could cause an increase in prepaymentand default rates for outstanding student loans. If this occurs, we mayexperience a decline in the value of our additional structural advisory feesand residuals receivable in connection with the securitizations that wefacilitate. In addition, most of the student loans that our

 

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clients originate carryfloating rates of interest tied to prevailing short-term interest rates. Anincrease in interest rates could reduce borrowing for education generally,which, in turn, could cause the overall demand for our services to decline.

 

***Ifwe are unable to protect the confidentiality of our proprietary database andinformation systems and processes, the value of our services and technologywill be adversely affected.***

*** ***

We rely on trade secretlaws and restrictions on disclosure to protect our proprietary database and informationsystems and processes. We have entered into confidentiality agreements withthird parties and with some of our employees to maintain the confidentiality ofour trade secrets and proprietary information. These methods may neithereffectively prevent disclosure of our confidential information nor providemeaningful protection for our confidential information if there is unauthorizeduse or disclosure.

 

We own no patents andhave filed no patent applications with respect to our proprietary database orloan information processing systems. Accordingly, our technology is not coveredby patents that would preclude or inhibit competitors from entering our market.Monitoring unauthorized use of the systems and processes that we developed isdifficult, and we cannot be certain that the steps that we have taken willprevent unauthorized use of our technology. Furthermore, others mayindependently develop substantially equivalent proprietary information andtechniques or otherwise gain access to our proprietary information. If we areunable to protect the confidentiality of our proprietary information andknow-how, the value of our technology and services will be adversely affected.

 

***Aninterruption in or breach of our information systems may result in lost business.***

*** ***

We rely heavily uponcommunications and information systems to conduct our business. As we implementour growth strategy and increase our volume of business, that reliance willincrease. Any failure or interruption, or breach in security, of our informationsystems or the third party information systems on which we rely could causeunderwriting or other delays and could result in fewer loan applications beingreceived, slower processing of applications and reduced efficiency in loanprocessing. A failure, interruption or breach in security could also result inan obligation to notify clients in states such as California that require suchnotification, with possible civil liability resulting from such failure,interruption or breach. We cannot assure you that such failures, interruptionsor breaches will not occur, or if they do occur that we or the third parties onwhom we rely will adequately address them. We have implemented precautionarymeasures to avoid systems outages and to minimize the effects of any data ortelephone systems interruptions, but we have not instituted redundancy for keysystems. The occurrence of any failure, interruption or breach couldsignificantly harm our business.

 

***If weexperience a data security breach and confidential customer information isdisclosed, we may be subject to penalties imposed by regulators, civil actionsfor damages and negative publicity, which could affect our customerrelationships and have a material adverse effect on our business. In addition,current state and federal legislative proposals, if enacted, may imposeadditional requirements on us to safeguard confidential customer information,which may result in increased compliance costs.***

 

Recently, data securitybreaches suffered by well-known companies and institutions have attracted asubstantial amount of media attention, prompting state and federal legislativeproposals addressing data privacy and security. If some of the currentproposals are adopted, we may be subject to more extensive requirements toprotect the borrower information that we process in connection with the loans.Implementation of systems and procedures to address these requirements wouldincrease our compliance costs. If we were to experience a large-scale datasecurity breach, such breach could generate negative publicity about us andcould adversely affect our relationships with our clients, including thelenders and educational institutions with which we do business. This could havea material adverse effect on our business. In addition, pending legislativeproposals, if adopted, likely would result in substantial penalties forunauthorized disclosure of confidential consumer information.

 

***Theloan origination process is becoming increasingly dependent upon technologicaladvancement, and we could lose clients and market share if we are not able tokeep pace with rapid changes in technology.***

*** ***

Our ability to handle anincreasing volume of transactions is based in large part on the advancedsystems and processes we have implemented and developed. The loan originationprocess is becoming increasingly dependent upon technological advancement suchas the ability to process loans over the Internet, accept electronic signaturesand

 

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provide process updatesinstantly. Our future success depends in part on our ability to develop andimplement technology solutions that anticipate and keep pace with these andother continuing changes in technology, industry standards and clientpreferences. We may not be successful in anticipating or responding to thesedevelopments on a timely basis. If competitors introduce products, services,systems and processes that are better than ours or that gain greater marketacceptance, those that we offer or use may become obsolete or noncompetitive.Any one of these circumstances could have a material adverse effect on ourability to obtain and retain key clients.

 

We may be required toexpend significant funds to develop or acquire new technologies. If we cannotoffer new technologies as quickly as our competitors, we could lose clients andmarket share. We also could lose market share if our competitors develop morecost effective technologies than those we offer or develop.

 

***Wehave expanded our operations rapidly in recent years, and if we fail to manageeffectively our growth, our financial results could be adversely affected.***

*** ***

The number of ouremployees increased to 910 regular employees as of March 31, 2006 from 813regular employees and 18 seasonal employees as of March 31, 2005. Many of theseemployees have very limited experience with us and a limited understanding ofour systems and controls. From our inception to March 31, 2006, our assets havegrown to $682.2 million. Our revenue increased to $414.7 million for the firstnine months of fiscal 2006 from $297.8 million for the first nine months offiscal 2005, and $98.1 million for the first nine months of fiscal 2004.Our growth may place a strain on our management, systems and resources. We mustcontinue to refine and expand our business development capabilities, oursystems and processes and our access to financing sources. As we grow, we mustcontinue to hire, train, supervise and manage new employees.

 

We cannot assure youthat we will be able to:

 

•  expand our systems effectively;

 

•  allocate our human resources optimally;

 

•  identify and hire qualified employees; or

 

•  incorporate effectively the components ofany business that we may acquire in our effort to achieve growth.

 

If we are unable tomanage our growth, our operations and our financial results could be adverselyaffected.

 

***Wemay be subject to state registration or licensing requirements in jurisdictionswhere we are not currently registered or licensed. If we determine that we aresubject to the registration or licensing requirements of any jurisdiction, ourcompliance costs could increase significantly and other adverse consequencesmay result.***

*** ***

Based on the advice ofcounsel and, in some states, additional informal advice from state regulators,we have been operating on the basis that no registrations or licenses for loanbrokers and loan arrangers are required of us. Although we believe that ourprior consultations with national and local counsel identified all materialregistration, licensing and other regulatory requirements then applicable, weare conducting a nationwide review of state registration and licensingrequirements that may be applicable to us now, based on the expansion of thescope of the services we provide and the time that has elapsed since our priorreview. As a result of this current review, we may determine that registrationor licensing is required in jurisdictions where we are not currently registeredor licensed. Even if we are not physically present in a state, its regulatorsmay take the position that registration or licensing is required because weprovide services by mail, telephone, the Internet or other remote means. If weidentify any states in which registration or licensing is required, we willproceed with registration or licensing in the affected state. If any stateasserts jurisdiction over our business, we will consider whether to challengethe assertion or proceed with registration or licensing in the affected state.Compliance with such requirements could involve additional costs, which couldhave a material adverse effect on our business. Our failure to comply withthese laws could lead to, among other things: (a) curtailment of ourability to continue to conduct business in the relevant jurisdiction, pendingprocessing of registration or a license application, (b) administrativeenforcement actions, (c) class action lawsuits, (d) the assertion oflegal defenses delaying or otherwise affecting the enforcement of loans, and(e) criminal as well as civil liability. This could have a materialadverse effect on our business.

 

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***Ifthe regulatory exemptions or rulings that allow us to conduct our businesswithout registration or licensing are modified or revoked, or the statutory andregulatory requirements change in the future, our compliance costs couldincrease substantially.***

*** ***

The MassachusettsDivision of Banks ruled that our business with TERI is not subject to licensingbecause, as a provider of loan origination outsourcing services, we do notconduct a lending business with consumers in our own name and our processingcenters are not generally open to the public. The Massachusetts Small Loan Actrequires any person that is engaged, for compensation, in the business ofmaking small loans, or in aiding or assisting the borrower or the lender inprocuring or making such loans, to obtain a license. Under the statute, thebusiness of making small loans includes the making of loans of $6,000 or lesswith interest rates and expenses of more than 12% per year. The TERI-guaranteedloans that we facilitate include amounts as small as $1,000, and a smallportion of those loans have combined interest rates and fees exceeding 12%. Wecould therefore become subject to the Small Loan Act with respect to theseloans if the Massachusetts Division of Banks revokes its previous determinationthat our operations are exempt or determines that our activities exceed thescope of the determination.

 

We could also becomesubject to registration or licensing requirements due to changes in existingfederal and state laws and regulations. The Massachusetts legislature could,for example, modify the statutory requirements under the Small Loan Act. If theMassachusetts legislature, or any other state or federal regulatory authority,changes existing laws and rules, or enacts new laws or rules, we could beforced to make changes in our relationships with lenders, educationalinstitutions, guarantors, servicers or the trusts involved in the securitizationsthat we facilitate. Specifically, changes in existing laws and rules couldalso require us to implement additional or different programs and informationtechnology systems and could impose licensing, capital and reserve requirementsand additional costs, including administrative, compliance and third-partyservice costs.

 

***Wemay be exposed to liability for failures of third parties with which we dobusiness to comply with the registration, licensing and other requirements thatapply to them.***

*** ***

Third parties with whichwe do business, including federal and state chartered financial institutions aswell as TERI, are subject to registration, licensing and extensive governmentalregulations, including Truth-in-Lending laws and other consumer protection lawsand regulations. For example, some of the third party marketers with which wedo business may be subject to state registration or licensing requirements andlaws and regulations, including those relating to small loans, loan brokers andcredit services organizations. As a result of the activities that we conductfor our clients, it may be asserted that we have some responsibility forcompliance by third parties with which we do business with the laws andregulations applicable to them, whether on contractual or other grounds. If itis determined that we have failed to comply with our obligations with respectto these third parties, we could be subject to civil or criminal liability.

 

***Wecould also become subject to registration or licensing and other regulatoryrequirements in Massachusetts and other states by expanding the scope or extentof our services.***

*** ***

We are in the process ofexpanding the scope of the services we provide on behalf of lenders to includecertain advertising and marketing functions. As a result of this expansion ofour services, or if we expand our services in the future to include, amongothers, loan guarantees, our current exemption from the Massachusetts SmallLoan Act could be invalidated, and consequently, we may need to obtain alicense from the Massachusetts Division of Banks. In addition, we may becomesubject to the laws and regulations of other states governing such expandedservices. We may also become subject to state regulatory requirements if theextent of the activities that we conduct in a particular state expands.Compliance with such requirements could involve additional costs, which couldhave a material adverse effect on our business.

 

***Failureto comply with consumer protection laws could subject us to civil and criminalpenalties and have a material adverse effect on our business.***

*** ***

The federal governmentand state governments regulate extensively the financial institutions and otherentities that originate loans in the student loan market. These regulationsinclude bankruptcy, tax, usury, disclosure, credit reporting, identity theft,privacy, fraud and abuse and other laws to protect borrowers. Changes inconsumer protection laws or related regulations, or in the prevailinginterpretations thereof, may expose us to litigation, adversely affect thecollection of balances due on the loan assets held by securitization trusts orotherwise adversely

 

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affect our business.Moreover, changes in the consumer protection laws and related regulations, orin the prevailing interpretations thereof, could invalidate or call intoquestion the legality of certain of our services and business practices. Recentor future changes in federal and state bankruptcy and debtor relief laws mayincrease credit losses on the loans held by securitization trusts and relatedadministrative expenses. Violations of the laws or regulations governing ouroperations, or the operations of TERI or our other clients, could result in theimposition of civil or criminal penalties, the cancellation of our contracts toprovide services or our exclusion from participating in education loanprograms. These penalties or exclusions, were they to occur, would negativelyimpair our ability to operate our business. In addition, the loan assets heldby securitization trusts that we have structured could be adversely impacted byviolation of tax or consumer protection laws. In such event, the value of ourresidual interests could also be adversely impacted. In some cases, suchviolations may render the loan assets unenforceable.

 

***Recentlitigation has sought to re-characterize “payday loan” and other originators aslenders; if litigation on similar theories were successful against us or anythird party marketer, the loans that we securitize would be subject toindividual state consumer protection laws.***

*** ***

We provide financial andeducational institutions, as well as other organizations, with an integratedsuite of services in support of private student loan programs. The lenders withwhich we work are federally-insured banks and, therefore, are not subject tomany state consumer protection laws, including limitations on interest rates,fees and other charges. In providing our services, we do not act as a lender,guarantor or loan servicer, and the terms of the loans that we securitize areregulated in accordance with the laws and regulations applicable to thelenders.

 

The association betweenloan marketers and out-of-state national banks has come under recent scrutiny,specifically in the context of high-interest “payday loans”. Recent litigationasserts that payday loan marketers use out-of-state lenders in order to evadethe usury and interest rate caps, and other consumer protection laws, imposedby the states where they do business. Such litigation has sought, successfullyin some instances, to re-characterize the loan marketer as the lender forpurposes of state consumer protection law restrictions. Similar civil actionshave been brought in the context of gift cards. We believe that our activities,and the activities of third parties whose marketing on behalf of lenders iscoordinated by us, are distinguishable from the activities involved in thesecases.

 

Although we do not make,guarantee or service the loans and our activities are done in the name of andunder the control and supervision of lenders, additional state consumerprotection laws would be applicable to the loans if we, or any third party loanmarketer whose activities we coordinate, were re-characterized as a lender, andthe loans (or the provisions governing interest rates, fees and other charges)could be unenforceable. In addition, we could be subject to claims byconsumers, as well as enforcement actions by regulators. Even if we were notrequired to cease doing business with residents of certain states or to changeour business practices to comply with applicable laws and regulations, we couldbe required to register or obtain licenses or regulatory approvals that couldimpose a substantial cost on us. To date, there have been no actions taken orthreatened against us on the theory that we have engaged in unauthorizedlending. However, such actions could have a material adverse effect on ourbusiness.

 

***Theprice of our common stock may be volatile.***

*** ***

The trading price of ourcommon stock may fluctuate substantially, depending on many factors, some ofwhich are beyond our control and may not be related to our operatingperformance. These fluctuations could cause you to lose part or all of yourinvestment in our shares of common stock. Those factors that could causefluctuations include, but are not limited to, the following:

 

•  difficulties we may encounter in thesecuritizations that we structure or the loss of opportunities to structuresecuritization transactions;

 

•  price and volume fluctuations in theoverall stock market from time to time;

 

•  significant volatility in the marketprice and trading volume of financial services and process outsourcingcompanies;

 

•  actual or anticipated changes in ourearnings or fluctuations in our operating results or in the expectations ofsecurities analysts;

 

•  general economic conditions and trends;

 

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•  negative publicity about the student loanmarket generally or us specifically;

 

•  major catastrophic events;

 

•  loss of a significant client or clients;

 

•  announcement by us, our competitors orour potential competitors of acquisitions, new products or services,significant contracts, commercial relationships or capital commitments;

 

•  sales of large blocks of our stock; or

 

•  departures of key personnel.

 

In the past, followingperiods of volatility in the market price of a company’s securities, securitiesclass action litigation has often been brought against that company. Due to thepotential volatility of our stock price, we may therefore be the target ofsecurities litigation in the future. Securities litigation could result insubstantial costs and divert management’s attention and resources from ourbusiness.

 

***Ifa substantial number of shares become available for sale and are sold in ashort period of time, the market price of our common stock could decline.***

*** ***

Future sales of asubstantial number of shares of our common stock in the public market, or theperception that such sales may occur, could adversely affect thethen-prevailing market price of our common stock. As of April 30, 2006, wehad 62,899,260 shares of common stock outstanding. Subject to limitations underfederal securities laws, including in some cases the holding periodrequirements and volume limitations of Rule 144, these shares are eligiblefor sale in the public market. The market price of shares of our common stockmay drop significantly if our existing stockholders sell a substantial number ofshares. A decline in the price of shares of our common stock might impede ourability to raise capital through the issuance of additional shares of ourcommon stock or other equity securities.

 

***Insidershave substantial control over us and could limit your ability to influence theoutcome of key transactions, including a change of control.***

*** ***

Our directors andexecutive officers, and entities affiliated with them, beneficially ownapproximately 40% of the outstanding shares of our common stock. As a result,these stockholders, if acting together, could influence or control mattersrequiring approval by our stockholders, including the election of directors andthe approval of mergers or other extraordinary transactions. They may also haveinterests that differ from yours and may vote in a way with which you disagreeand which may be adverse to your interests. The concentration of ownership mayhave the effect of delaying, preventing or deterring a change of control of ourcompany, could deprive our stockholders of an opportunity to receive a premiumfor their common stock as part of a sale of our company and might ultimatelyaffect the market price of our common stock.

 

***Someprovisions in our certificate of incorporation and by-laws may deter thirdparties from acquiring us.***

*** ***

Our certificate ofincorporation and by-laws contain provisions that may make the acquisition ofour company more difficult without the approval of our board of directors,including the following:

 

•  only our board of directors, the chairmanof our board of directors or our president may call special meetings of ourstockholders;

 

•  our stockholders may take action only ata meeting of our stockholders and not by written consent;

 

•  we have authorized undesignated preferredstock, the terms of which may be established and shares of which may be issuedwithout stockholder approval;

 

•  our directors may be removed only forcause by the affirmative vote of a majority of the directors present at ameeting duly held at which a quorum is present, or the holders of 75% of thevotes that all stockholders would be entitled to cast in the election ofdirectors; and

 

•  we impose advance notice requirements forstockholder proposals.

 

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These anti-takeoverdefenses could discourage, delay or prevent a transaction involving a change incontrol of our company. These provisions could also discourage proxy contestsand make it more difficult for you and other stockholders to elect directors ofyour choosing and cause us to take other corporate actions you desire.

 

***Section 203of the Delaware General Corporation Law may delay, defer or prevent a change incontrol that our stockholders might consider to be in their best interests.***

*** ***

We are subject toSection 203 of the Delaware General Corporation Law which, subject tocertain exceptions, prohibits “business combinations” between a Delawarecorporation and an “interested stockholder,” which is generally defined as astockholder who becomes a beneficial owner of 15% or more of a Delawarecorporation’s voting stock, for a three-year period following the date thatsuch stockholder became an interested stockholder. Section 203 could havethe effect of delaying, deferring or preventing a change in control that ourstockholders might consider to be in their best interests.

 

**Item2—Unregistered Sales of Equity Securities and Use of Proceeds**

** **

***(a) RecentSales of Unregistered Securities***

*** ***

***None.***

*** ***

***(b) Useof Proceeds from Registered Securities***

*** ***

In our initial publicoffering, or IPO, we sold 7,906,250 shares of common stock, including anover-allotment option of 1,031,750 shares, pursuant to a registration statementon Form S-1 (File No. 333-108531) that was declared effective by theSEC on October 30, 2003. We received in aggregate net proceeds ofapproximately $115.1 million, after deducting underwriting discounts andcommissions of approximately $8.9 million and expenses of the offering ofapproximately $2.5 million. From the effective date of the registrationstatement through March 31, 2006, we have not spent any of the netproceeds from the IPO, which have been invested in cash and cash equivalents.Accordingly, none of the net proceeds of the IPO has been paid by us, directlyor indirectly, to any director, officer, or general partner of us, or any oftheir associates, or to any person owing ten percent or more of any class ofour equities securities or any of our affiliates.

 

In June 2004, wecompleted a follow-on public offering of 7,406,312 shares of our common stock,including an over-allotment option of 966,041 shares, pursuant to aregistration statement on Form S-1 (File No. 333-116142) that wasdeclared effective by the SEC on June 22, 2004. All of these shares wereoffered by selling stockholders, and we did not receive any of the proceedsfrom the offering. In January 2005, we completed a follow-on publicoffering of 3,933,605 shares of our common stock, including an over-allotmentoption of 513,078 shares, pursuant to a registration statement on Form S-3(File No. 333-120740) that was declared effective on January 12,2005. All of these shares were offered by selling stockholders, and we did notreceive any proceeds from the offering.

 

*** (c) Issuer Purchasesof Equity Securities***

 

On September 29, 2005,we announced a repurchase program of up to 5,000,000 shares of our common stock.We did not repurchase any shares of common stock pursuant to this programduring the three months ended March 31, 2006. Through December 31, 2005, werepurchased an aggregate of 2,346,800 shares under this program at an averageprice paid per share, excluding commissions, of $27.64. As of March 31, 2006,2,653,200 shares of our common stock may yet be purchased under this program,which does not have a fixed expiration date.

 

**Item 6—Exhibits**

** **

See the Exhibit Indexon the page immediately preceding the exhibits for a list of exhibitsfiled as part of this quarterly report which Exhibit Index is incorporatedherein by this reference.

 

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** **

**SIGNATURES**

** **

Pursuant to therequirements of the Securities Exchange Act of 1934, the Registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.

 
|                | **THE  FIRST MARBLEHEAD CORPORATION** |
|---------------------|---------------------------------------|
|                | ** **                            |
| Date: May  10, 2006 | By:                                   | /s/ Donald  R. Peck |   |
|                |                                  | Donald R.  Peck |
|                | * *                              | *Executive  Vice President, Chief Financial  Officer, Treasurer and Secretary* |
|                | * *                              | *(Duly  authorized officer and principal  financial officer)* |

 

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** **

**EXHIBIT INDEX**

** **
| **Exhibit  Number** | ** **   | **Description**                                                                                                                                                                                                                       |
|---------------------|--------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.1                |         | Amended and  Restated Bank of America Direct to Consumer Loan Program: Umbrella Agreement  by and between Bank of America, N.A. and the Registrant, dated as of April 1,  2006.                                                       |
| 10.2                |  † | Note  Purchase Agreement: Bank of America DTC Program by and between Bank of  America, N.A. and the Registrant, dated as of April 1, 2006.                                                                                            |
| 31.1                |         | Chief  Executive Officer—Certification pursuant to Rule 13a-14(a) of the  Securities Exchange Act of 1934, as adopted pursuant to Section 302 of  the Sarbanes-Oxley Act of 2002                                  |
| 31.2                |         | Chief  Financial Officer—Certification pursuant to Rule 13a-14(a) of the  Securities Exchange Act of 1934, as adopted pursuant to Section 302 of  the Sarbanes-Oxley Act of 2002                                  |
| 32.1                |         | Chief  Executive Officer—Certification pursuant to Rule 13a-14(b) of the  Securities Exchange Act of 1934 and 18 U.S.C. Section 1350, as adopted  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002  |
| 32.2                |         | Chief  Financial Officer—Certification pursuant to Rule 13a-14(b) of the  Securities Exchange Act of 1934 and 18 U.S.C. Section 1350, as adopted  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |

 

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†              Confidentialtreatment has been requested for certain provisions of this exhibit pursuant toRule 24b-2 promulgated under the Securities Exchange Act of 1934, as amended.

 

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