**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,D.C. 20549**

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**FORM 10-Q**

**(MARK ONE)**

**x**                              QUARTERLYREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIESEXCHANGE ACT OF 1934

**ForThe Quarterly Period Ended December 31, 2006**

**OR**

**o**                                 TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACTOF 1934

**Forthe transition periodfrom               to                 **

**CommissionFile Number 001-31825**

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**The First Marblehead Corporation**

(Exact Name of Registrantas Specified in Its Charter)

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

 

Registrant’s telephonenumber, including area code: **(617) 638-2000**

Indicate by check markwhether the registrant: (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required tofile such reports), and (2) has been subject to such filing requirementsfor the past 90 days. Yes x    No o

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

| Large accelerated filer x | Accelerated filer o | Non-accelerated filer o |
|---------------------------|---------------------|-------------------------|

 

Indicate by check mark whether the registrant is ashell company (as defined in Rule 12b-2 of the Exchange Act).

Yes o    No x

As of January 31, 2007, the registrant had 94,609,549shares of Common Stock, $0.01 par value per share, outstanding.

 

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**THE FIRSTMARBLEHEAD CORPORATION AND SUBSIDIARIES**

**Tableof Contents**

| Part I. Financial  Information |   |   |
|-------------------------------------|--------|--------|
| Item 1                              | — |   | Financial  Statements |   | 3 |
|                                |   |   | Condensed  Consolidated Balance Sheets as of December 31, 2006 and June 30,  2006 |   | 3 |
|                                |   |   | Condensed  Consolidated Statements of Operations for the three months and six months  ended December 31, 2006 and 2005 |   | 4 |
|                                |   |   | Condensed  Consolidated Statement of Changes in Stockholders’ Equity for the  six months ended December 31, 2006 |   | 5 |
|                                |   |   | Condensed  Consolidated Statements of Cash Flows for the six months ended  December 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 |   | 17 |
| Item  3                             | — |   | Quantitative  and Qualitative Disclosures About Market Risk |   | 40 |
| Item 4                              | — |   | Controls  and Procedures |   | 41 |
| Part II.  Other Information    |   |   |
| Item 1A                             | — |   | Risk Factors |   | 42 |
| Item  2                             | — |   | Unregistered  Sales of Equity Securities and Use of Proceeds |   | 57 |
| Item  4                             | — |   | Submission  of Matters to a Vote of Security Holders |   | 58 |
| Item 6                              | — |   | Exhibits |   | 58 |
| SIGNATURES                          |   | 59     |
| EXHIBIT INDEX                       |   | 60     |

 

2

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**Part I.   FinancialInformation**

**Item 1—FinancialStatements**

**THE FIRST MARBLEHEAD CORPORATION AND SUBSIDIARIESCONDENSED CONSOLIDATED BALANCE SHEETS(unaudited)(in thousands, except per share amounts)**

| ** **                                                                                                                                                                                                                                                                                                                       | ** ** | **December 31,  2006** | ** ** | **June 30,  2006** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------|------------|-------------------------|------------|
| **ASSETS**                                                                                                                                                                                                                                                                                                                       |       |                        |       |                    |       |   |   |
| Cash and cash  equivalents                                                                                                                                                                                                                                                                                                       |       |                        | $          | 160,407                 |       |   | $ | 75,711 |   |
| Investments                                                                                                                                                                                                                                                                                                                      |       |                        | 96,210     |                    |       | 67,250 |   |
| Loans held for  sale                                                                                                                                                                                                                                                                                                             |       |                        | 14,929     |                    |       | — |   |
| Service receivables:                                                                                                                                                                                                                                                                                                             |       |                        |       |                    |       |   |   |
| Structural  advisory fees                                                                                                                                                                                                                                                                                                        |       |                        | 116,637    |                    |       | 88,297 |   |
| Residuals                                                                                                                                                                                                                                                                                                                        |       |                        | 583,666    |                    |       | 452,823 |   |
| Processing fees  from The Education Resources Institute (TERI)                                                                                                                                                                                                                                                                   |       |                        | 11,247     |                    |       | 10,447 |   |
| Total service  receivables                                                                                                                                                                                                                                                                                                       |       |                        | 711,550    |                    |       | 551,567 |   |
| Property and  equipment                                                                                                                                                                                                                                                                                                          |       |                        | 68,257     |                    |       | 60,358 |   |
| Less accumulated  depreciation and amortization                                                                                                                                                                                                                                                                                  |       |                        | (31,208    | )                       |       | (23,615 | ) |
| Property and  equipment, net                                                                                                                                                                                                                                                                                                     |       |                        | 37,049     |                    |       | 36,743 |   |
| Goodwill                                                                                                                                                                                                                                                                                                                         |       |                        | 4,878      |                    |       | 3,176 |   |
| Intangible assets,  net                                                                                                                                                                                                                                                                                                          |       |                        | 2,966      |                    |       | 1,897 |   |
| Prepaid income  taxes                                                                                                                                                                                                                                                                                                            |       |                        | —     |                    |       | 11,649 |   |
| Other prepaid expenses                                                                                                                                                                                                                                                                                                           |       |                        | 14,148     |                    |       | 17,272 |   |
| Other assets                                                                                                                                                                                                                                                                                                                     |       |                        | 4,898      |                    |       | 5,081 |   |
| Total assets                                                                                                                                                                                                                                                                                                                     |       |                        | $          | 1,047,035               |       |   | $ | 770,346 |   |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                                                                                                                                                                                    |       |                        |       |                    |       |   |   |
| Liabilities:                                                                                                                                                                                                                                                                                                                     |       |                        |       |                    |       |   |   |
| Deposits                                                                                                                                                                                                                                                                                                                         |       |                        | $          | 36,511                  |       |   | $ | — |   |
| Accounts payable  and other accrued expenses                                                                                                                                                                                                                                                                                     |       |                        | 37,135     |                    |       | 34,430 |   |
| Income taxes  payable                                                                                                                                                                                                                                                                                                            |       |                        | 5,446      |                    |       | — |   |
| Net deferred  income tax liability                                                                                                                                                                                                                                                                                               |       |                        | 179,744    |                    |       | 144,240 |   |
| Capital lease  obligations                                                                                                                                                                                                                                                                                                       |       |                        | 6,941      |                    |       | 8,789 |   |
| Notes payable to  TERI                                                                                                                                                                                                                                                                                                           |       |                        | 4,141      |                    |       | 4,537 |   |
| Other liabilities                                                                                                                                                                                                                                                                                                                |       |                        | 2,309      |                    |       | 2,181 |   |
| Total liabilities                                                                                                                                                                                                                                                                                                                |       |                        | 272,227    |                    |       | 194,177 |   |
| 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 December 31, 2006  and June 30, 2006; 100,798 and 100,334 shares issued at  December 31, 2006 and June 30, 2006, respectively; 94,591 and  94,564 shares outstanding at December 31, 2006 and   June 30, 2006, respectively |       |                        | 1,008      |                    |       | 1,004 |   |
| Additional paid-in  capital                                                                                                                                                                                                                                                                                                      |       |                        | 228,936    |                    |       | 217,620 |   |
| Retained earnings                                                                                                                                                                                                                                                                                                                |       |                        | 680,319    |                    |       | 479,090 |   |
| Treasury stock,  6,207 and 5,770 shares held at December 31, 2006 and June 30, 2006,  respectively, at cost                                                                                                                                                                                                            |       |                        | (135,471   | )                       |       | (121,545 | ) |
| Accumulated other  comprehensive income                                                                                                                                                                                                                                                                                          |       |                        | 16         |                    |       | — |   |
| Total  stockholders’ equity                                                                                                                                                                                                                                                                                                 |       |                        | 774,808    |                    |       | 576,169 |   |
| Total liabilities and  stockholders’ equity                                                                                                                                                                                                                                                                                 |       |                        | $          | 1,047,035               |       |   | $ | 770,346 |   |

 

See accompanying notes to unaudited condensed consolidated financial statements.

3

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**THE FIRST MARBLEHEAD CORPORATION AND SUBSIDIARIESCONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS(unaudited)(in thousands, except per share amounts)**

| ** **                                    | ** ** | **Three months ended  December 31,** | ** ** | **Six months ended  December 31,** | ** ** |
|-----------------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                    | ** ** | **2006**                                            | ** ** | **2005**                                          | ** ** | **2006** | ** ** | **2005** | ** ** |
| Service Revenues:                             |       |                                                |       |                                              |       |   |   |   |   |
| Up-front structural advisory fees             |       | $                                                   | 88,618     |                                              | $          | 96,170 |   | $ | 261,928 |   | $ | 96,170 |   |
| Additional  structural advisory fees:         |       |                                                |       |                                              |       |   |   |   |   |
| From new securitizations                      |       | 8,861                                               |       | 14,778                                            |       | 25,447 |   | 14,778 |   |
| Trust updates                                 |       | 928                                                 |       | 1,241                                             |       | 2,893 |   | 1,440 |   |
| Total additional structural advisory fees     |       | 9,789                                               |       | 16,019                                            |       | 28,340 |   | 16,218 |   |
| Residuals:                                    |       |                                                |       |                                              |       |   |   |   |   |
| From new securitizations                      |       | 48,315                                              |       | 78,216                                            |       | 105,070 |   | 78,216 |   |
| Trust updates                                 |       | 13,865                                              |       | 12,491                                            |       | 25,773 |   | 19,973 |   |
| Total residual revenue                        |       | 62,180                                              |       | 90,707                                            |       | 130,843 |   | 98,189 |   |
| Processing fees from TERI                     |       | 29,608                                              |       | 25,268                                            |       | 66,679 |   | 51,196 |   |
| Administrative and other fees                 |       | 4,727                                               |       | 2,331                                             |       | 8,953 |   | 3,793 |   |
| Total service revenues                        |       | 194,922                                             |       | 230,495                                           |       | 496,743 |   | 265,566 |   |
| Net interest income                           |       | 2,844                                               |       | 1,635                                             |       | 3,968 |   | 2,864 |   |
| Total revenues                                |       | 197,766                                             |       | 232,130                                           |       | 500,711 |   | 268,430 |   |
| Non-interest  expenses:                       |       |                                                |       |                                              |       |   |   |   |   |
| Compensation and benefits                     |       | 25,895                                              |       | 21,160                                            |       | 57,503 |   | 40,902 |   |
| General and administrative expenses           |       | 33,088                                              |       | 22,891                                            |       | 67,079 |   | 48,816 |   |
| Total non-interest expenses                   |       | 58,983                                              |       | 44,051                                            |       | 124,582 |   | 89,718 |   |
| Income from  operations                       |       | 138,783                                             |       | 188,079                                           |       | 376,129 |   | 178,712 |   |
| Other income                                  |       | —                                              |       | 2,501                                             |       | — |   | 2,501 |   |
| Income before income tax expense              |       | 138,783                                             |       | 190,580                                           |       | 376,129 |   | 181,213 |   |
| Income tax  expense                           |       | 57,632                                              |       | 79,219                                            |       | 153,970 |   | 75,294 |   |
| Net income                                    |       | $                                                   | 81,151     |                                              | $          | 111,361 |   | $ | 222,159 |   | $ | 105,919 |   |
| Net income per share, basic                   |       | $                                                   | 0.86       |                                              | $          | 1.17 |   | $ | 2.35 |   | $ | 1.10 |   |
| Net income per share, diluted                 |       | 0.85                                                |       | 1.16                                              |       | 2.34 |   | 1.09 |   |
| Cash dividends declared per share             |       | 0.12                                                |       | 0.08                                              |       | 0.22 |   | 0.16 |   |
| Weighted average shares outstanding, basic    |       | 94,496                                              |       | 95,324                                            |       | 94,393 |   | 96,348 |   |
| Weighted average  shares outstanding, diluted |       | 95,069                                              |       | 96,266                                            |       | 95,020 |   | 97,343 |   |

 

See accompanying notes to unaudited condensed consolidated financial statements.

4

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**THE FIRST MARBLEHEAD CORPORATION AND SUBSIDIARIESCONDENSED CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY(unaudited)(in thousands, except per share amounts)**

| ** **                                                       | ** ** | ** **            | ** ** | ** **           | ** ** | ** **        | ** ** | ** **              | ** ** | ** **                         | ** ** | ** **             | ** ** | **Accumulated** | ** ** | ** ** | ** ** |
|------------------------------------------------------------------|------------|-----------------------|------------|----------------------|------------|-------------------|------------|-------------------------|------------|------------------------------------|------------|------------------------|------------|-----------------|------------|------------|------------|
| ** **                                                       | ** ** | ** **            | ** ** | ** **           | ** ** | ** **        | ** ** | ** **              | ** ** | ** **                         | ** ** | ** **             | ** ** | **other ** | ** ** | ** ** | ** ** |
| ** **                                                       | ** ** | **Common stock** | ** ** | **Additional ** | ** ** | ** **        | ** ** | **comprehensive ** | ** ** | **Total**                          | ** ** |
| ** **                                                       | ** ** | **Issued**            | ** ** | **In treasury** | ** ** | **paid-in ** | ** ** | **Retained**            | ** ** | **income, net of ** | ** ** | **stockholders’** | ** ** |
| ** **                                                       | ** ** | **Shares**            | ** ** | **Amount**           | ** ** | **Shares**        | ** ** | **Amount**              | ** ** | **capital**                        | ** ** | **earnings**           | ** ** | **tax**         | ** ** | **equity** | ** ** |
| **Balance  at June 30, 2006**                               |       | 100,334               |       |                 | $          | 1,004             |       |                    | (5,770     | )                                  | $          | (121,545               | )          |            | $          | 217,620    |       |   | $ | 479,090 |   |   | $ | — |   |   |   | $ | 576,169 |   |   |
| Comprehensive income                                             |       |                  |       |                 |       |              |       |                    |       |                               |       |                   |       |            |       |       |       |   |   |   |   |   |   |   |   |
| Net income                                                       |       | —                |       |                 | —     |              |       | —                  |       | —                             |       |                   | —     |            |       | 222,159    |       |   | — |   |   |   | 222,159 |   |   |
| Unrealized gains on investments, net                             |       | —                |       |                 | —     |              |       | —                  |       | —                             |       |                   | —     |            |       | —     |       |   | 16 |   |   |   | 16 |   |   |
| Total  comprehensive income                                      |       | —                |       |                 | —     |              |       | —                  |       | —                             |       |                   | —     |            |       | —     |       |   | — |   |   |   | 222,175 |   |   |
| Options exercised                                                |       | 398                   |       |                 | 4          |              |       | —                  |       | —                             |       |                   | 1,227      |            |       | —     |       |   | — |   |   |   | 1,231 |   |   |
| Stock issuances through employee stock purchase plan             |       | 22                    |       |                 | —     |              |       | —                  |       | —                             |       |                   | 401        |            |       | —     |       |   | — |   |   |   | 401 |   |   |
| Stock issuances from vesting of restricted stock  units          |       | 47                    |       |                 | —     |              |       | —                  |       | —                             |       |                   | —     |            |       | —     |       |   | — |   |   |   | — |   |   |
| Repurchase of common stock                                       |       | —                |       |                 | —     |              |       | (437                    | )          | (13,926                            | )          |                   | —     |            |       | —     |       |   | — |   |   |   | (13,926 | ) |   |
| Stock-based compensation                                         |       | —                |       |                 | —     |              |       | —                  |       | —                             |       |                   | 3,779      |            |       | —     |       |   | — |   |   |   | 3,779 |   |   |
| Cash dividend ($0.22 per share)                                  |       | —                |       |                 | —     |              |       | —                  |       | —                             |       |                   | —     |            |       | (20,783    | )          |   | — |   |   |   | (20,783 | ) |   |
| Cash paid in lieu of fractional shares in effecting  stock split |       | (3                    | )          |                 | —     |              |       | —                  |       | —                             |       |                   | —     |            |       | (147       | )          |   | — |   |   |   | (147 | ) |   |
| Tax benefit from employee stock options                          |       | —                |       |                 | —     |              |       | —                  |       | —                             |       |                   | 5,909      |            |       | —     |       |   | — |   |   |   | 5,909 |   |   |
| **Balance at December 31,  2006**                           |       | 100,798               |       |                 | $          | 1,008             |       |                    | (6,207     | )                                  | $          | (135,471               | )          |            | $          | 228,936    |       |   | $ | 680,319 |   |   | $ | 16 |   |   |   | $ | 774,808 |   |   |

 

See accompanying notes to unaudited condensed consolidated financialstatements.

5

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**THE FIRST MARBLEHEAD CORPORATION AND SUBSIDIARIESCONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS(unaudited)(in thousands)**

| ** **                                                                         | ** ** | **Six months ended  December 31,** | ** ** |
|------------------------------------------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                                         | ** ** | **2006**                                          | ** ** | **2005** | ** ** |
| Cash flows from operating  activities:                                             |       |                                              |       |   |   |
| Net income                                                                         |       | $                                                 | 222,159    |   | $ | 105,919 |   |
| Adjustments to reconcile  net income to net cash provided by operating activities: |       |                                              |       |   |   |
| Depreciation and amortization                                                      |       | 7,862                                             |       | 6,805 |   |
| Deferred income tax expense                                                        |       | 35,504                                            |       | 23,300 |   |
| Stock-based compensation                                                           |       | 3,779                                             |       | 1,535 |   |
| Change in  assets/liabilities net of effects of acquisition:                       |       |                                              |       |   |   |
| Decrease in loans held for sale                                                    |       | 2,140                                             |       | — |   |
| (Increase) in structural advisory fees                                             |       | (28,340                                           | )          | (16,218 | ) |
| (Increase) in residuals                                                            |       | (130,843                                          | )          | (98,189 | ) |
| (Increase) decrease in processing fees from TERI                                   |       | (800                                              | )          | 102 |   |
| Net change in prepaid/accrual for income taxes                                     |       | 17,095                                            |       | 2,594 |   |
| (Increase) decrease in other prepaid expenses                                      |       | 3,145                                             |       | (2,807 | ) |
| (Increase) decrease in other assets                                                |       | 980                                               |       | (1,877 | ) |
| Increase in accounts payable, accrued expenses, and  other liabilities             |       | 2,520                                             |       | 25,247 |   |
| Net cash provided by operating activities                                          |       | 135,201                                           |       | 46,411 |   |
| Cash flows from investing  activities:                                             |       |                                              |       |   |   |
| Dispositions of investments                                                        |       | 57,543                                            |       | — |   |
| Purchases of investments                                                           |       | (70,500                                           | )          | — |   |
| Net cash paid for acquisition                                                      |       | (471                                              | )          | — |   |
| Purchases of property and equipment                                                |       | (7,777                                            | )          | (6,859 | ) |
| Payments to TERI for loan database updates                                         |       | (124                                              | )          | (372 | ) |
| Net cash used in investing activities                                              |       | (21,329                                           | )          | (7,231 | ) |
| Cash flows from financing  activities:                                             |       |                                              |       |   |   |
| Increase in deposits                                                               |       | 383                                               |       | — |   |
| Repayment of capital lease obligations                                             |       | (1,848                                            | )          | (2,335 | ) |
| Repayment of notes payable due to TERI                                             |       | (396                                              | )          | (372 | ) |
| Tax benefit from stock-based compensation                                          |       | 5,909                                             |       | 2,470 |   |
| Issuances of common stock                                                          |       | 1,632                                             |       | 966 |   |
| Repurchases of common stock                                                        |       | (13,926                                           | )          | (65,879 | ) |
| Cash dividends on common stock                                                     |       | (20,783                                           | )          | (15,350 | ) |
| Cash paid in lieu of fractional shares in effecting  stock split                   |       | (147                                              | )          | — |   |
| Net cash used in financing activities                                              |       | (29,176                                           | )          | (80,500 | ) |
| Net increase  (decrease) in cash and cash equivalents                              |       | 84,696                                            |       | (41,320 | ) |
| Cash and cash  equivalents, beginning of period                                    |       | 75,711                                            |       | 193,796 |   |
| Cash and cash  equivalents, end of period                                          |       | $                                                 | 160,407    |   | $ | 152,476 |   |
| Supplemental disclosures  of cash flow information:                                |       |                                              |       |   |   |
| Interest paid                                                                      |       | $                                                 | 509        |   | $ | 430 |   |
| Income taxes paid                                                                  |       | $                                                 | 95,261     |   | $ | 13,333 |   |
| Supplemental disclosure  of non-cash activities:                                   |       |                                              |       |   |   |
| Acquisition of  property and equipment through capital leases                      |       | $                                                 | 87         |   | $ | 1,135 |   |

 

See accompanying notes to unaudited condensed consolidated financial statements.

6

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**THE FIRST MARBLEHEAD CORPORATION AND SUBSIDIARIES NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (dollars and shares in thousands, except per share amounts)**

**(1)**          Natureof Business and Summary of Significant Accounting Policies

***Nature of 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, educational institutions,businesses, and other enterprises with an integrated suite of services fordesigning 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 loan programsthat it facilitates. From time to time, the Company may also receive fees forits services in securitizing private student loan portfolios purchased fromthird-parties. The Company also receives reimbursement from The EducationResources Institute, Inc. (TERI) for outsourced services the Companyperforms on TERI’s behalf, reimbursement for marketing coordination services itprovides to certain clients and fees for administrative services that theCompany provides to the discrete trust vehicles that the Company forms forsecuritizations it facilitates. FMC’s subsidiary Union Federal Savings Bank (“UnionFederal”) is a federally chartered thrift that offers residential retailmortgage loans, retail savings products and time deposit products. See Note 3.

***Basis of Presentation***

The Company’s accompanyingunaudited condensed consolidated financial statements have been prepared inaccordance with accounting principles generally accepted in the United Statesof America (GAAP) for interim financial information. Accordingly, they do notinclude all of the information and footnotes required by GAAP for completeconsolidated financial statements. In the opinion of management, all adjustments(consisting of only normal recurring accruals) considered necessary for a fairstatement of the results for the interim periods have been included. Thepreparation of financial statements in conformity with GAAP requires managementto make estimates and assumptions, including the determination of the fairvalue of expected future cash flows, that affect the amounts reported in thecondensed consolidated financial statements and accompanying notes. Interimresults are not necessarily indicative of results to be expected for the entirefiscal year. All significant intercompany balances and transactions have beeneliminated in consolidation. These unaudited financial statements should beread in conjunction with the audited consolidated financial statements andrelated notes for the year ended June 30, 2006 included in the Company’sAnnual Report on Form 10-K filed with the Securities and ExchangeCommission on September 12, 2006.

***Student Loan Market Seasonality and Revenue Related toSecuritization Transactions***

Origination of student loans is generally subject toseasonal trends, with the volume of loan applications increasing with theapproach of tuition payment dates. In general, the Company processes thegreatest application volume during the summer months, as students and theirfamilies seek to borrow money in order to pay tuition costs for the fallsemester or the entire school year. The Company also tends to process anincreased volume of loan applications during November, December andJanuary, as students 

7

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**THE FIRST MARBLEHEAD CORPORATION AND SUBSIDIARIES NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) (dollars and shares in thousands, except per share amounts)**

and their families seek toborrow money to pay tuition costs for the spring semester. This seasonality ofloan originations impacts the amount of processing fees from TERI that theCompany earns in a particular quarter. The timing and size of the Company’splanned securitization activities may also be affected by the seasonality ofstudent loan applications and loan originations.

The Company closed asecuritization transaction in each of the first and second quarters of fiscal2007 and expects to close securitization transactions in each of the third andfourth quarters of fiscal 2007. During fiscal 2006, the Company closed onesecuritization transaction in the second quarter, one securitizationtransaction in the third quarter and two securitization transactions in thefourth quarter. Variations in the size of securitization transactions theCompany facilitates will also contribute to variability in quarterly operatingresults.

***Concentrations***

**TERI**

TERI is a private, not-for-profit Massachusettsorganization as described under section 501(c)(3) of the InternalRevenue Code. Incorporated in 1985, TERI is the oldest and largest guarantor ofalternative, or private, student loans. In its role as guarantor in the privateeducation lending market, TERI agrees to reimburse lenders or securitizationtrusts for unpaid principal and interest on defaulted loans. TERI is theexclusive third-party provider of borrower default guarantees for the Company’sclients’ private student loans. As of December 31, 2006, TERI had a Baa3counterparty rating from Moody’s Investors Service, which is the lowestinvestment grade rating, and an insurer financial strength rating of A+ fromFitch Ratings. If these ratings are lowered, FMC’s clients may not wish toenter into guarantee arrangements with TERI. In addition, market conditionscould dictate that FMC obtain additional credit enhancement for theasset-backed securitizations that it structures, the cost of which could resultin lower structural advisory fees.

In February 2001, FMC and TERI entered into aMaster Loan Guaranty Agreement, which granted TERI a right of first refusal toguarantee student loans under existing and future private label loan programsfacilitated by FMC, as well as new loan programs jointly created by FMC andTERI. In June 2001, the Company acquired TERI’s loan processing operationsand 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. In October 2004, the Company renewed the Master LoanGuaranty Agreement and certain additional agreements with TERI, in each casefor an additional term through June 2011.

The Master Loan Guarantee Agreement generally providesthat the guarantee fees earned by TERI upon the disbursement of student loansare placed in a segregated reserve account which is held as collateral tosecure TERI’s obligation to purchase defaulted student loans. This account isheld by a third-party financial institution for the benefit of theprogram lender until the student loans are securitized, at which point theaccount is pledged to the securitization trust that purchases the loans. TheMaster Loan Guarantee Agreement, as implemented through guaranty agreementswith individual lenders, entitles TERI to retain a portion of its guaranty feesas an administrative fee rather than place them in the pledged account.

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**THE FIRST MARBLEHEAD CORPORATION AND SUBSIDIARIES NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) (dollars and shares in thousands, except per share amounts)**

In October 2005, the Company entered into asupplement to the Master Loan Guarantee Agreement. Under the terms of the 2005supplement, for securitizations of TERI-guaranteed loans during fiscal 2006,TERI’s administrative fee of 150 basis points increased, and the amountdeposited by TERI into the pledged account decreased, by 90 basis points. Inaddition, TERI’s residual interest in the trusts created at the time of thesecuritizations was correspondingly reduced to account for the 90 basis pointreduction in the pledged account. As a result, the administrative fee forsecuritizations of TERI-guaranteed loans in fiscal 2006 was 240 basis points multipliedby the principal balance of the loans originated and securitized. Forsecuritizations completed during fiscal 2006, TERI’s ownership of the residualvalue of the TERI-guaranteed loans securitized ranged between 12 and 15percent.

In August 2006,the Company entered into a supplement to the Master Loan Guarantee Agreementthat provides as follows:

·       Foreach securitization closing between August 1, 2006 and June 30, 2007,TERI will be entitled to elect to adjust the amount of its administrative fee,and adjust the amount deposited into the pledged account, within specifiedparameters. As a result, the amount of the administrative fee applicable tosecuritizations closing between August 1, 2006 and June 30, 2007 mayrange from 150 basis points to 240 basis points, at TERI’s election. TheCompany has agreed to attempt in good faith to structure its securitizationtransactions to accommodate TERI’s election.

·       Foreach securitization for which TERI elects to adjust the administrative fee, theCompany will make a corresponding adjustment to the relative ownershippercentages of the residual interests in the applicable securitization trust.To the extent TERI elects to increase the amount of its administrative feeabove 150 basis points, such an adjustment would result in an increase in theCompany’s ownership percentage, and a decrease in the ownership interest ofTERI, by a percentage that will result in an equivalent dollar reduction in thefair value of TERI’s residual ownership interest at the time of thesecuritization.

TERI received an administrative fee of 175 basispoints for the securitization transaction the Company completed in the firstquarter of fiscal 2007 and 221 basis points for the securitization transactionthe Company completed in the second quarter of fiscal 2007. TERI elected toreceive an administrative fee of 240 basis points for the securitizationtransaction the Company plans to complete in the third quarter of fiscal 2007.

Under a Master ServicingAgreement with a term through June 2011, First Marblehead EducationResources, Inc. (FMER), a wholly owned subsidiary of FMC, provides to TERIunderwriting, documentation and other origination services, as well astechnical support, disbursements, customer service, collections, default prevention,default processing, accounting services, guarantee claims management andadministrative services, in support of TERI’s loan guarantee function. FMCguarantees the full and timely performance by FMER of its obligations pursuantto this Master Servicing Agreement. FMC uses the acquired TERI assets,including historical loan data, to support the design and implementation ofloan programs facilitated by FMC and loan programs jointly created by FMC andTERI. In addition, TERI has the right to designate one of three representativesto serve on the board of directors of FMER. During the three and six monthsended December 31, 2006, processing fees from TERI representedapproximately 15% and 13%, respectively, of the Company’s total revenue.

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**THE FIRST MARBLEHEAD CORPORATION AND SUBSIDIARIES NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) (dollars and shares in thousands, except per share amounts)**

**PHEAA**

As of December 31,2006, there were eight TERI-approved student loan servicers. Servicers provideadministrative services relating to loans, including processing deferment andforbearance requests, sending out account statements and accrual notices,responding to borrower inquiries, and collecting and crediting paymentsreceived from borrowers. As of December 31, 2006, the Company utilized sixof these servicers. These arrangements allow the Company to increase the volumeof loans in the Company’s clients’ loan programs without incurring the overheadinvestment of servicing operations. As with any external service provider,there are risks associated with inadequate or untimely services. As of December 31,2006, Pennsylvania Higher Education Assistance Agency (PHEAA) serviced amajority of the student loans for which the Company facilitates origination.PHEAA also operates under the name American Education Services (AES). If theCompany’s relationship with PHEAA terminates, the Company would either need toexpand or develop a relationship with another TERI-approved student loanservicer, which could be time-consuming and costly.

**SignificantCustomers**

Securitization-relatedfees from the private label loan trusts used to securitize student loans in September 2006and December 2006 represented approximately 49% and 29%, respectively oftotal revenue for the first six months of fiscal 2007. These securitizationtrusts purchased private student loans from several lenders including JP MorganChase Bank, N.A., Bank of America, N.A., and Charter One Bank, N.A. Charter OneBank, N.A. serves as program lender for several education loan marketers. TheCompany did not recognize more than 10% of total revenue from any othercustomer.

***Significant Accounting Policies and Estimates***

The preparation of theCompany’s consolidated financial statements requires the Company to makeestimates, assumptions and judgments that affect the reported amounts of assetsand liabilities and the reported amounts of income and expenses during thereporting periods. The Company bases its estimates and judgments on historicalexperience and on various other factors, and actual results may differ fromthese estimates under varying assumptions or conditions. On an ongoing basis,the Company evaluates its estimates and judgments, particularly as they relateto accounting policies that the Company believes are most important to theportrayal of the Company’s financial condition and results of operations, suchas its accounting policies involving the recognition and valuation of theCompany’s securitization-related service revenue, and with respect to thedetermination of whether or not to consolidate the securitization trusts thatit facilitates. See “Management’s Discussion and Analysis of FinancialCondition and Results of Operations—Application of Critical Accounting Policiesand Estimates”.

***Cash and Cash Equivalents***

Cash and cash equivalentsat December 31, 2006 included $151,503 held in money market funds and$8,904 of federal funds sold. Included in cash and cash equivalents arecompensating balances held in money market funds supporting various financingarrangements of $9,989 and $10,158 at December 31, 2006 and June 30,2006, respectively.

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**THE FIRST MARBLEHEAD CORPORATION AND SUBSIDIARIES NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) (dollars and shares in thousands, except per share amounts)**

***Income Taxes***

In determining a quarterlyprovision for income taxes, the Company uses an estimated annual effective taxrate which is based on its expected annual income, statutory tax rates and taxplanning opportunities available to it in the various jurisdictions in which itoperates. The Company’s estimated annual effective tax rate also includes itsbest estimate of the ultimate outcome of tax audits. The Company has a netdeferred income tax liability primarily because, under GAAP, it recognizesresiduals in financial statement income earlier than they are recognized forincome tax purposes.

**(2)**          Service Receivables

Structural advisory fees and residuals receivablesrepresent the estimated fair value of additional structural advisory fees andresiduals expected to be collected over the life of the securitization trusts.The fees are expected to be paid to the Company from the various separatesecuritization trusts that have purchased student loans facilitated by theCompany. Private label loans guaranteed by TERI have generally been purchasedby several private label loan trusts. GATE loans, and a limited number of TERI-guaranteedand other loans, have been purchased by separate securitization trustsestablished by the National Collegiate Trust (NCT trusts). Processing feesreceivable from TERI represents amounts due from TERI for expenses incurred byFMER on TERI’s behalf.

The Company conducted a securitization transaction inthe second quarter of each of fiscal 2007 and fiscal 2006. On a quarterlybasis, the Company updates its estimates of the fair value of its structuraladvisory fees and residuals receivables to reflect the passage of time, anychange in discount rates used to estimate their fair value, any changes in theestimated operational expenses for the separate securitization trusts and anychanges to the trust performance metrics that the Company considers in its fairvalue estimates, such as default, recovery, prepayment and forward LondonInterbank Offered Rate, or LIBOR, rates.

The Company made no changes in its assumptionsregarding default, recovery or prepayment rates in the first six months ofeither fiscal 2007 or fiscal 2006, for either the NCT trusts or the privatelabel loan trusts.

Thefollowing table summarizes changes in the estimated fair value of the Company’sstructural advisory fees receivable during the first six months of fiscal 2007and fiscal 2006:

| ** **                              | ** ** | **Six months ended  December 31,** | ** ** |
|-----------------------------------------|------------|---------------------------------------------------|------------|
| ** **                              | ** ** | **2006**                                          | ** ** | **2005** | ** ** |
| Fair value at beginning  of period      |       | $                                                 | 88,297     |   | $ | 53,371 |   |
| Additions from new  securitizations     |       | 25,447                                            |       | 14,778 |   |
| Trust updates                           |       |                                              |       |   |   |
| Passage of time (fair  value accretion) |       | 3,411                                             |       | 1,804 |   |
| Other factors                           |       | (518                                              | )          | (364 | ) |
| Total fair value  adjustments           |       | 2,893                                             |       | 1,440 |   |
| Fair value at end of period             |       | $                                                 | 116,637    |   | $ | 69,589 |   |

 

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**THE FIRST MARBLEHEAD CORPORATION AND SUBSIDIARIES NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) (dollars and shares in thousands, except per share amounts)**

Thefollowing table summarizes the changes in the estimated fair value of theCompany’s residuals receivable during the first six months of fiscal 2007 andfiscal 2006:

| ** **                             | ** ** | **Six months ended  December 31,** | ** ** |
|----------------------------------------|------------|---------------------------------------------------|------------|
| ** **                             | ** ** | **2006**                                          | ** ** | **2005** | ** ** |
| Fair value at  beginning of period     |       | $                                                 | 452,823    |   | $ | 247,275 |   |
| Additions from new securitizations     |       | 105,070                                           |       | 78,216 |   |
| Trust updates                          |       |                                              |       |   |   |
| Passage of time (fair value accretion) |       | 30,140                                            |       | 16,661 |   |
| Other factors                          |       | (4,367                                            | )          | 3,312 |   |
| Total fair value adjustments           |       | 25,773                                            |       | 19,973 |   |
| Fair value at end of  period           |       | $                                                 | 583,666    |   | $ | 345,464 |   |

 

For a discussion of thesensitivity of the additional structural fees and residuals receivable tovariations in our assumptions and estimates, see “Management’s Discussion andAnalysis of Financial Condition and Results of Operations—Executive Summary—Applicationof Critical Accounting Policies and Estimates—Service Revenue—SensitivityAnalysis”.

**(3)**          Business Combination

On November 30, 2006,the Company completed its acquisition of Union Federal, a community savingsbank located in North Providence, Rhode Island with total assets at the time ofacquisition of approximately $40,853. The financial results of Union Federalare included in the Company’s financial statements subsequent to theacquisition date. The purchase price was allocated to acquired assets andliabilities based on their respective fair values at November 30, 2006.The Company recorded goodwill of $1,701 and a core deposit intangible of $1,311as a result of this acquisition. Goodwill will be reviewed for impairment atleast annually. The core deposit intangible represents the present value of thedifference in expected future cash flows between the cost to replace suchdeposits (based on applicable equivalent borrowing rates) versus thethen-current yield on core deposits acquired. The aggregate future cash flowsare based on the average expected life of the deposits acquired for eachproduct less the cost to service them. The core deposit intangible will beamortized on a straight-line basis over a five year period and will be reviewedfor impairment when it is determined that facts or circumstances may affect therecoverability of the asset.

**(4)**          RelatedParty Transaction

At December 31, 2006,the Company had invested approximately $134,208 of cash equivalents in a moneymarket fund. The investment adviser for this fund is Milestone CapitalManagement, LLC (MCM), an institutional money management firm. In addition,approximately $81,492 of investments were invested by MCM on behalf of theCompany under an investment management agreement. MCM receives a fee forservices it performs under this agreement. MCM is a wholly owned subsidiary ofMilestone Group Partners. Members of the immediate family of one of theCompany’s directors own approximately 65% of Milestone Group Partners.

 

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**THE FIRST MARBLEHEAD CORPORATION AND SUBSIDIARIES NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) (dollars and shares in thousands, except per share amounts)**

**(5)**          NotesPayable to TERI

The Company entered into a Note Payable Agreement withTERI on June 20, 2001, in the principal amount of $3,900, to fund theCompany’s acquisition of TERI’s loan processing operations. Of the principalamount, $2,000 related to the acquisition of TERI’s software and network assetsand $1,900 related to an acquired workforce-in-place. Under the terms of thenote payable, principal and interest at an annual rate of 6% are payable in120 monthly installments of $43 commencing on July 20, 2001 andending on June 20, 2011. The note payable is secured by the software andnetwork assets. The outstanding balance of this note payable at December 31,2006 was $2,045.

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 on June 20,2011. The note payable is secured by the loan database. The outstanding balanceof this note payable at December 31, 2006 was $2,096.

**(6)**          EquipmentLine of Credit

In January 2005, theCompany entered into an equipment financing lease agreement which it used tofinance purchases of furniture and equipment. The agreement, which expired on December 30,2005, allowed the Company to finance up to $20,000 worth of furniture andequipment purchased before December 30, 2005. The Company expects to repayamounts drawn down on the line of credit at terms ranging from three to fiveyears. At December 31, 2006, the outstanding principal balance on amountsborrowed under this line of credit was $6,223.

**(7)**          Stockholders’Equity

***2003 Stock Incentive Plan***

In September 2003,the Board of Directors and stockholders approved the 2003 Stock Incentive Planand reserved 1,800 shares of FMC’s common stock (Common Stock) for issuanceunder this plan. On August 9, 2005, the Board of Directors authorized,subject to stockholder approval, an amendment increasing the number of sharesof Common Stock reserved for issuance under the 2003 Stock Incentive Plan from1,800 to 4,050. On October 27, 2005, the Company’s stockholders approvedthis amendment. During the first six months of fiscal 2007, the Company granted358 restricted stock units. As of December 31, 2006, there were 894restricted stock units outstanding and 3,108 shares available for future grantunder this plan.

***2003 Employee Stock Purchase Plan***

In October 2003, theBoard of Directors and stockholders approved the 2003 Employee Stock PurchasePlan (Stock Purchase Plan). A total of 600 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. Participation is voluntary. Under the Stock PurchasePlan, 15 and 21 shares of Common Stock were issued in January 2007 and July 2006,respectively.

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**THE FIRST MARBLEHEAD CORPORATION AND SUBSIDIARIES NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) (dollars and shares in thousands, except per share amounts)**

***Share Repurchase Program***

On September 29,2005, the Board of Directors approved the repurchase of up to 7,500 shares ofCommon Stock from time to time on the open market or in privately negotiatedtransactions. Through December 31, 2006, the Company had repurchased anaggregate of 3,957 shares of its Common Stock under this program. As of December 31,2006, 3,543 shares of the Company’s Common Stock may be purchased under thisprogram, which does not have a fixed expiration date.

***Cash Dividend***

On September 7, 2006,the Board of Directors declared a cash dividend of $0.10 per share on theCommon Stock. The dividend was paid on September 25, 2006 to stockholdersof record at the close of business on September 18, 2006. On November 9,2006, the Board of Directors declared a cash dividend of $0.12 per share on theCommon Stock. The dividend was paid on December 4, 2006 to stockholders ofrecord at the close of business on November 20, 2006.

***Stock Split***

On November 9, 2006,the Board of Directors approved a three-for-two split of the Common Stock whichwas effected in the form of a stock dividend distributed on December 4,2006 to stockholders of record at the close of business on November 20,2006. As such, all prior period share data have been retroactively adjusted toreflect the stock split.

**(8)**          NetIncome per Share

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

| ** **                                                           | ** ** | **Three months ended   December 31,** | ** ** | **Six months ended   December 31,** | ** ** |
|----------------------------------------------------------------------|------------|-----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                                           | ** ** | **2006**                                                  | ** ** | **2005**                                                | ** ** | **2006** | ** ** | **2005** | ** ** |
| Net income                                                           |       | $                                                         | 81,151     |                                                    | $          | 111,361 |   | $ | 222,159 |   | $ | 105,919 |   |
| Shares used in  computing net income per common   share—basic   |       | 94,496                                                    |       | 95,324                                                  |       | 94,393 |   | 96,348 |   |
| Effect of dilutive  securities:                                      |       |                                                      |       |                                                    |       |   |   |   |   |
| Stock options                                                        |       | 268                                                       |       | 934                                                     |       | 363 |   | 990 |   |
| Restricted stock units                                               |       | 305                                                       |       | 8                                                       |       | 264 |   | 5 |   |
| Dilutive potential common shares                                     |       | 573                                                       |       | 942                                                     |       | 627 |   | 995 |   |
| Shares used in  computing net income per common   share—diluted |       | 95,069                                                    |       | 96,266                                                  |       | 95,020 |   | 97,343 |   |
| Net income per common  share:                                        |       |                                                      |       |                                                    |       |   |   |   |   |
| Basic                                                                |       | $                                                         | 0.86       |                                                    | $          | 1.17 |   | $ | 2.35 |   | $ | 1.10 |   |
| Diluted                                                              |       | $                                                         | 0.85       |                                                    | $          | 1.16 |   | $ | 2.34 |   | $ | 1.09 |   |

 

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**THE FIRST MARBLEHEAD CORPORATION AND SUBSIDIARIES NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) (dollars and shares in thousands, except per share amounts)**

**(9)**          NewAccounting Pronouncements

In September 2006, the SEC issued StaffAccounting Bulletin (SAB) No. 108, which provides interpretiveguidance on how the effects of carryover or reversal of prior yearmisstatements should be considered in quantifying a current year misstatement.The SEC staff believes that errors should be quantified using both a balancesheet and income statement approach and evaluated as to whether either approachresults in quantifying a misstatement that, when all relevant quantitative andqualitative factors are considered, is material. The SEC staff has stated thatit will not object if there is a one-time cumulative effect adjustment recordedto correct errors existing in prior years that previously had been consideredimmaterial—quantitatively and qualitatively - based on appropriate use of theregistrant’s previous approach. SAB No. 108 describes the circumstances inwhich such an adjustment would be appropriate, as well as the required disclosures,and is effective for fiscal years ending after November 15, 2006. TheCompany will be required to apply this Bulletin in the year ending June 30,2007. The adoption of SAB No. 108 is not expected to have anymaterial impact on the Company’s consolidated financial condition or results ofoperations.

In September 2006, the Financial AccountingStandards Board (FASB) issued Statement of Financial Accounting Standards(SFAS) No. 158, *Employers’ Accounting forDefined Benefit Pension and Other Postretirement Plans, an amendment of FASBStatements No. 87, 88, 106 and 132(R).*SFAS No. 158requires an entity to recognize in its statement of financial position an assetfor a defined benefit postretirement plan’s overfunded status or a liabilityfor a plan’s underfunded status, measure a defined benefit postretirement plan’sassets and obligations that determine its funded status as of the end of theemployer’s fiscal year, and recognize changes in the funded status of a definedbenefit postretirement plan in comprehensive income in the year in which thechanges occur. SFAS No. 158 will be effective for the Company beginning inthe fourth quarter of fiscal 2007. The adoption of SFAS No. 158 is notexpected to have any material impact on the Company’s consolidated financialcondition or results of operations.

In September 2006, the FASB issued SFAS No. 157,*Fair Value Measurements*, whichprovides guidance for using fair value to measure assets and liabilities. Thestandard also responds to investors’ requests for expanded information aboutthe extent to which companies measure assets and liabilities at fair value, theinformation used to measure fair value, and the effect of fair valuemeasurements on earnings. SFAS No. 157 applies whenever other standardsrequire (or permit) assets or liabilities to be measured at fair value. Thestandard does not expand the use of fair value in any new circumstances. UnderSFAS No. 157, fair value refers to the price that would be received fromthe sale of an asset or paid to transfer a liability in an orderly transactionbetween market participants in the market in which the reporting entitytransacts. SFAS No. 157 clarifies the principle that fair value should bebased on the assumptions market participants would use when pricing the assetor liability and establishes a fair value hierarchy that prioritizes theinformation used to develop those assumptions. The fair value hierarchy givesthe highest priority to quoted prices in active markets and the lowest priorityto unobservable data, for example, the reporting entity’s own data. Fair valuemeasurements would be separately disclosed by level within the fair valuehierarchy. SFAS No. 157 is effective for financial statements issued forfiscal years beginning after November 15, 2007, and interim periods withinthose fiscal years. The Company does not expect the adoption of SFAS No. 157to have a material impact on its results of operations or financial position.

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**THE FIRST MARBLEHEAD CORPORATION AND SUBSIDIARIES NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) (dollars and shares in thousands, except per share amounts)**

In July 2006, the FASB issued FASB InterpretationNo. 48, *Accounting for Uncertainty inIncome Taxes*—*an interpretation ofFASB Statement No. 109*(FIN No. 48). FIN No. 48clarifies the accounting for uncertainty in income taxes recognized in anentity’s financial statements in accordance with SFAS No. 109, *Accounting for Income Taxes*. It prescribesa recognition threshold and measurement attribute for financial statementdisclosure of tax positions taken or expected to be taken on a tax return. Thisinterpretation is effective for fiscal years beginning after December 15,2006. Consistent with its requirements, the Company will adopt FIN No. 48on July 1, 2007. The Company is currently evaluating the provisions of FINNo. 48 and has not yet determined the impact, if any, on its consolidatedfinancial statements.

In March 2006, the FASB issued SFAS No. 156,*Accounting For Servicing of Financial Assets, anAmendment of FASB Statement No. 140, Accounting for Transfers andServicing of Financial Assets and Extinguishments of Liabilities*(SFAS No. 156), which requires that all separately recognized servicingassets and liabilities be initially measured at fair value, if practicable, andrequires entities to elect either fair value measurement with changes in fairvalue reflected in earnings or the amortization and impairment requirements ofFASB Statement No. 140 for subsequent measurement. SFAS No. 156 willbe effective for the Company beginning in the first quarter of fiscal 2008. Theadoption of SFAS No. 156 is not expected to have any material impact onthe Company’s consolidated financial condition or results of operations.

In February 2006, the FASB issued SFAS No. 155,*Accounting for Certain Hybrid Financial Instruments,an amendment of FASB Statements No. 133 and 140*. SFAS No. 155will be effective for the Company beginning in the first quarter of fiscal2008. The statement permits interests in hybrid financial instruments thatcontain an embedded derivative that would otherwise require bifurcation, to beaccounted for as a single financial instrument at fair value, with changes infair value recognized in earnings. This election is permitted on aninstrument-by-instrument basis for all hybrid financial instruments held,obtained, or issued as of the adoption date. The adoption of SFAS No. 155is not expected to have any material impact on the Company’s consolidatedfinancial condition or results of operations.

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**Item 2.**                        Management’sDiscussion and Analysis of Financial Condition and Results of Operations

*You should read the following discussion and analysisof our financial condition and results of operations together with ourunaudited condensed consolidated financial statements and accompanying notesincluded in this quarterly report. In addition to the historical information,the discussion contains certain forward-looking statements that involve risksand uncertainties. Our actual results could differ materially from thoseexpressed or implied by the forward-looking statements due to applications ofour critical accounting policies and factors including, but not limited to,those set forth under the caption “Risk Factors” in Item 1A of Part II ofthis quarterly report.*

**Executive Summary**

***Overview***

We offer ourclients, national and regional financial institutions, as well as businessesand other organizations, a suite of outsourcing services for private educationlending in the United States. We currently focus on facilitating privatestudent loans for undergraduate, graduate and professional education, althoughwe also provide service offerings for continuing education programs, theprimary and secondary school market, career training and study abroad programs.We provide services in connection with each of the five typical phases of thestudent loan lifecycle, offering our clients a single point of interface for:

·       programdesign and marketing coordination;

·       borrowerinquiry and application;

·       loanorigination and disbursement;

·       loansecuritization; and

·       loanservicing.

We receive fees for the services we provide inconnection with our clients’ private student loans, including processing,structuring and administering securitizations, of those loans. 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. We have provided structural, advisory andother services for 33 securitization transactions since our formation in 1991.

We offer servicesin connection with two primary student loan programs:

·       *Private label* programs that are:

·        “directto consumer,” or marketed directly to prospective student borrowers and theirfamilies by:

·       lenders;

·       businesses,unions, affinity groups and other organizations;

·       thirdparties that are not themselves lenders but which market loans on behalf of thelenders that fund the loans. We refer to these third parties as loan marketers,and we refer to the lenders that fund these loans as program lenders; and

·        “schoolchannel,” or marketed directly to educational institutions by:

·       lenders;and

·       educationloan marketers on behalf of program lenders.

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·       *Guaranteed Access to Education*, or *GATE*, programs that educationalinstitutions offer directly to their students.

During the first six months of fiscal 2007 and 2006,we securitized only private label loans.

We do not take a direct ownership interest in thestudent loans our clients generate, nor do we serve as a lender or guarantorwith respect to any student loan programs that we facilitate. We assist thelenders in our loan programs in selecting the underwriting criteria used indeciding whether a student loan will be made to an applicant. However, eachlender has ultimate control over the selection of these criteria, and inproviding our services, we are obligated by contract to observe them. Ourlender clients have the opportunity to mitigate their credit risk through aloan repayment guarantee by The Education Resources Institute, Inc., orTERI, pursuant to which TERI guarantees repayment of the borrower’s loanprincipal, together with capitalized or accrued interest, on defaulted loans.Lenders that wish to have their loans guaranteed by TERI are required to meetTERI’s underwriting criteria. Although we oversee loan servicing as a componentof our administrative duties, we do not act as a loan servicer.

Theprimary driver of our results of operations and financial condition is thevolume of student loans for which we provide outsourcing services from loanorigination through securitization. The following table presents certainfinancial and operating information for the first six months of fiscal 2007 andfiscal 2006.

| ** **                                                                                                       | ** ** | **Six months ended  December 31,** | ** ** | **%**      | ** ** |
|------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------|------------|------------|------------|
| ** **                                                                                                       | ** ** | **2006**                                          | ** ** | **2005**   | ** ** | **Increase** | ** ** |
| ** **                                                                                                       | ** ** | **(dollars in thousands)**              | ** ** | ** ** | ** ** |
| Approximate  student loan applications processed                                                                 |       | 726,000                                           |       | 541,000    |       |   | 34 | % |   |
| Approximate  number of student loans facilitated                                                                 |       | 241,000                                           |       | 200,000    |       |   | 21 | % |   |
| Approximate  number of student loans facilitated that were also available to us  for securitization    |       | 209,000                                           |       | 168,000    |       |   | 24 | % |   |
| Principal amount  of student loans facilitated                                                                   |       | $                                                 | 2,434,834  |       | $          | 1,889,299 |   |   | 29 | % |   |
| Principal amount  of student loans facilitated that were also available to us for securitization                 |       | $                                                 | 2,208,892  |       | $          | 1,644,867 |   |   | 34 | % |   |
| Principal and  accrued interest balance of student loans securitized                                             |       | $                                                 | 2,109,684  |       | $          | 1,265,387 |   |   | 67 | % |   |
| Principal balance of  student loans facilitated and available to us at period end for later  securitization |       | $                                                 | 785,990    |       | $          | 772,962 |   |   | 2 | % |   |

 

The principal balance of loans facilitated andavailable to us for later securitization fluctuates as a result of severalfactors including (a) the timing of securitizations (b) the cut offdate for loan purchases as securitizations take place, (c) the loanpurchase eligibility criteria included in the various note purchase agreementsthat govern the purchase of loans for securitization and (d) the dailyvolume of loans facilitated prior to period end.

In June 2001, we significantly enhanced our riskmanagement and loan processing capabilities through a strategic relationshipwith TERI, the nation’s oldest and largest guarantor of private student loans.We acquired TERI’s loan processing operations, including its historicaldatabase, but not its investment assets or guarantee liabilities. In connectionwith this acquisition, 161 members of TERI’s staff became our employees. Inaddition, we entered into a master servicing agreement pursuant to which TERIengages us to provide loan origination and processing services with respect tothe student loans generated through the private label programs we facilitate,as well as other TERI-guaranteed loans. TERI reimburses us for the expenses weincur in providing these services. Under the terms of a master loan guarantyagreement that we have entered into with TERI, we have also agreed to provide abeneficial interest for TERI in a portion of the residual value ofsecuritization trusts that purchase TERI-guaranteed loans, and granted to TERIa right of first refusal to provide a third-party guarantee of our privatelabel clients’ existing and future loan 

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programs. In October 2004,we renewed our master servicing agreement, master loan guaranty agreement andcertain additional agreements with TERI, in each case for an additional termthrough June 2011.

Although we offer our clients a fully integrated suiteof outsourcing services, we do not charge separate fees for many of theseservices. Moreover, although we receive fees for providing loan processingservices to TERI in connection with TERI-guaranteed loans, and fees fromcertain of our clients for marketing coordination services, these feesrepresent reimbursement of the direct expenses we incur. Accordingly, we do notearn a profit on these fees. Although we provide these various services withoutcharging a separate fee, or at “cost” in the case of processing services forTERI-guaranteed loans and marketing coordination services, we generally enterinto agreements with the private label lenders giving us the exclusive right tosecuritize the student 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 our ability to earn thesestructural advisory fees and residuals. We discuss the manner in which werecognize them as revenue in greater detail below. We may in the future enterinto arrangements with private label lenders under which we would provideoutsourcing services, but would not have the exclusive right to securitize thestudent loans that they originate.

Changes in any ofthe following factors can materially affect our financial results:

·       thedemand for private education financing;

·       thecompetition for providing private education financing;

·       theeducation financing preferences of students and their families;

·       applicablelaws and regulations, which may affect the terms upon which our clients agreeto make private student loans and the cost and complexity of our loanfacilitation operations;

·       theprivate student loan securitization market, including the costs or availabilityof financing;

·       thegeneral interest rate environment, including its effect on our discount andprepayment rates;

·       ourcritical accounting policies and estimates;

·       borrowerdefault rates and our ability to recover principal and interest from suchborrowers;

·       prepaymentrates, including prepayments through loan consolidation of private studentloans held by our trusts; and

·       theavailability of student loans through federal programs.

On November 30, 2006,we completed the acquisition of Union Federal Savings Bank, a community savingsbank located in North Providence, Rhode Island. Union Federal is a federallychartered thrift that offers residential retail mortgage loans, retail savingsproducts and time deposit products. Union Federal, which had total assets ofapproximately $41 million as of the acquisition date, does not currently offereducation loans as part of its product lines. The financial results of UnionFederal are included in our financial statements subsequent to the acquisitiondate. The purchase price was allocated to acquired assets and liabilities basedon their respective fair values at November 30, 2006. We recorded additionalgoodwill of $1.7 million and a core deposit intangible of $1.3 million as aresult of this acquisition. Goodwill will be reviewed for impairment at leastannually. The core deposit intangible represents the present value of thedifference in expected future cash flows between the cost to replace suchdeposits (based on applicable equivalent borrowing rates) versus thethen-current yield on core deposits acquired. The aggregate future cash flowsare based on the average expected life of the deposits acquired for eachproduct less the cost to service them. The core deposit intangible will beamortized on a straight-line basis over a five year period and will be reviewedfor impairment when it is determined that facts or circumstances may affect therecoverability of the asset.

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***Securitizations and Related Revenue***

We structure and facilitate securitizationtransactions for our clients through a series of bankruptcy remote, qualifiedspecial purpose statutory trusts. The trusts obtain through the securitizationprocess private student loans from the originating lenders or their assignees,which relinquish to the trust their ownership interest in the loans. The debtinstruments that the trusts issue to finance the purchase of these studentloans are obligations of the trusts, rather than our obligations or those oforiginating lenders or their assignees. We utilize special purpose entities forthe securitization of TERI-guaranteed private label loans. We refer to thesetrusts as private label loan trusts. In addition, the National Collegiate Trust, or NCT, was formed in fiscal 1993 and has established separatesecuritization trusts, which we refer to as the NCT trusts, which havepurchased primarily GATE loans and a limited number of TERI-guaranteed andother loans. In the future, we may securitize private label or GATE loans usingNCT trusts, private label loan trusts or new trust vehicles.

Under the terms of some of our contracts with keylender clients, we have an obligation to securitize periodically the privatestudent loans that these clients originate. If we do not honor our obligationsto these lenders, we may be required to pay liquidated damages, generally notexceeding an amount equal to 1% of the face amount of the loans available forsecuritization.

We receive severaltypes of fees in connection with our securitization services:

·       *Structural advisory fees*.   We chargestructural advisory fees that are paid in two portions:

·        *Up-front*.   We receive a portion ofthe structural advisory fees at the time the securitization trust purchases theloans, or shortly thereafter. In exchange for these fees, we structure the debtsecurities sold in the securitization, coordinate the attorneys, accountants,trustees, loan servicers, loan originators and other transaction participantsand prepare the cash flow modeling for rating agencies as needed. For thesecuritizations that we facilitated during the first half of fiscal 2007, thesefees ranged from 12.2% to 12.5% of the aggregate principal and capitalized interestof the loans securitized. For the securitizations we facilitated in fiscal2006, these fees ranged from 7.5% to 8.4% of the aggregate principal andcapitalized interest of the loans securitized; and

·        *Additional*.   We receive a portion of the structuraladvisory fees over time, based on the amount of loans outstanding in the trustfrom time to time over the life of the trust. This portion accumulates monthlyfrom the date of a securitization transaction at a rate of 15 to 30 basispoints per year. We begin to receive this additional portion, plus interest,once the ratio of trust assets to trust liabilities, which we refer to as the “parityratio,” reaches a stipulated level, which ranges from 103% to 105%. The levelapplicable to a particular trust is determined at the time of securitization.We currently expect to receive the additional fees beginning five to sevenyears after the date of a particular securitization transaction*.*

·       *Residual.*   We also have the right to receive a portionof the residual interests that these trusts create. This interest is junior inpriority to the rights of the holders of the debt sold in the securitizationsand additional structural advisory fees, and entitles us to receive:

·        inconnection with the securitizations of exclusively private label loans, 66% to88% of the net cash flows of the particular securitization trust once a parityratio of 103% to 103.5%, depending on the particular trust, is reached andmaintained;

·        inconnection with securitizations in the NCT trusts, our share of residual cashflows once all of the debtholders of the securitization trust have been repaid,plus, in the case of GATE loans securitized in fiscal years prior to fiscal2005, an additional 10% of the residual cash flows. We 

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are entitled to receive100% of the residual cash flows for GATE loans securitized after fiscal 2004.

Our residual interestderives almost exclusively from the services we perform in connection with eachsecuritization rather than from a direct cash contribution to the securitizationtrust. In the case of securitizations of exclusively private label loans, wecurrently expect to receive the residuals beginning approximately five to sevenyears after the date of a particular securitization. In the case ofsecuritizations in the NCT trusts that occurred prior to fiscal 2005, we expectto receive the residuals beginning 12 to 15 years after the date of aparticular securitization. In the case of the securitization in the NCT truststhat occurred after fiscal 2004, we currently expect to receive residualsbeginning five to six years after the date of securitization.

·       *Administrative and other fees*.   Our administrative andother fees represent the reimbursement of out of pocket costs we receive at thetime of securitization related to marketing coordination services performed forsome of our clients. Our administrative and other fees include theadministrative fees we receive from the trusts for their daily management andservices we provide in obtaining information from the loan servicers andreporting this and other information to the parties related to thesecuritization. Our fees for performing these services range from 5 to 20 basispoints per year based on the student loan balance in the trust.

***Processing Fees from TERI***

We provide outsourcingservices for 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.

***Recognition and Valuation of Service Revenue***

We recognize up-front structural advisory fees asrevenue at the time the securitization trust purchases the loans. In order forthe securitization trust to purchase the loans, all of the applicable servicesmust be performed, rating agencies must deliver their ratings letters,transaction counsel must deliver the required legal opinions and theunderwriters must receive the debt securities issued by the securitizationtrust. These events indicate that the securitization transaction has beenproperly structured and loans have been properly sold to the securitizationtrust.

As required under GAAP, we also recognize additionalstructural advisory fees and residuals as revenue at that time, as they aredeemed to be earned at the time of the securitization but before we actuallyreceive payment. These amounts are deemed earned because evidence of anarrangement exists, we have provided the services, the fee is fixed anddeterminable based upon a discounted cash flow analysis, there are no futurecontingencies or obligations and collection is reasonably assured.

Under GAAP, we are required to estimate the fair valueof the additional structural advisory fees and residuals as if they areinvestments in debt securities classified as available-for-sale or trading,similar to retained interests in securitizations. Accordingly, we recordadditional structural advisory fees and residuals receivable on our balancesheet at estimated fair value using a discounted cash flow model. Because thereare no quoted market prices for our additional structural advisory fees andresiduals receivable, we use certain key assumptions to estimate their values.See “—Application of Critical Accounting Policies and Estimates—Service Revenueand Receivables.” We estimate the fair value both initially and at eachsubsequent quarter and reflect the change in the value in earnings for thatperiod.

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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 marketingcoordination fees, which are a component of administrative and other fees, atthe time the securitization trust purchases the loans derived from the relatedmarketing coordination services.

***Quarterly Fluctuations***

Ourquarterly revenue, operating results and profitability have varied and maycontinue to vary on a quarterly basis primarily because of the timing and sizeof the securitizations that we structure. In fiscal 2006, we facilitated onesecuritization in the second quarter, one securitization in the third quarterand two securitizations in the fourth quarter. Thus far in fiscal 2007, we havefacilitated one securitization in each of the first and second quarters. Weexpect to facilitate securitizations in each remaining quarter of fiscal 2007.However, variations in the size of each securitization transaction willcontinue to result in variability of our operating results on a quarterlybasis. The following tables set forth our quarterly revenue and net income(loss) for each of the first two quarters of fiscal 2007 and each quarter offiscal 2006:

| ** **     | ** ** | **2007 fiscal quarters** | ** ** | ** ** | ** ** | ** ** | ** ** |
|----------------|------------|------------------------------------|------------|------------|------------|------------|------------|
| ** **     | ** ** | **First**                          | ** ** | **Second** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **     | ** ** | **(in thousands)**            | ** ** | ** ** | ** ** | ** ** | ** ** |
| Total revenues |       | $                                  | 302,945    |       | $          | 197,766    |       |   |   |   |   |
| Net income     |       | 141,008                            |       | 81,151     |       |       |       |   |   |
|                |            |                                    |            |            |            |            |            |  |  |  |  |

 

 

| ** **        | ** ** | **2006 fiscal quarters** | ** ** |
|-------------------|------------|------------------------------------|------------|
| ** **        | ** ** | **First**                          | ** ** | **Second** | ** ** | **Third** | ** ** | **Fourth** | ** ** |
| ** **        | ** ** | **(in thousands)**            | ** ** |
| Total revenues    |       | $                                  | 36,300     |   | $ | 232,130 |   | $ | 150,543 |   | $ | 150,062 |   |
| Net income (loss) |       | (5,442                             | )          | 111,361 |   | 59,222 |   | 70,819 |   |
|                   |            |                                    |            |  |  |  |  |  |  |  |  |  |  |

 

***Application of Critical Accounting Policies andEstimates***

Our consolidated financial statements have beenprepared in accordance with GAAP. The preparation of these financial statementsrequires us to make estimates, assumptions and judgments that affect thereported amounts of assets and liabilities and the reported amounts of incomeand expenses during the reporting periods. We base our estimates, assumptionsand judgments on historical experience and on various other factors that webelieve are reasonable under the circumstances. Actual results may differ fromthese estimates 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 ended June 30,2006, which are included in our Annual Report on Form 10-K filedwith the Securities and Exchange Commission on September 12, 2006. On anongoing 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 “criticalaccounting estimate” where:

·       thenature of the estimate or assumption is material due to the level ofsubjectivity and judgment necessary to account for highly uncertain matters orthe susceptibility of such matters to change; and

·       theimpact of the estimates and assumptions on our financial condition or operatingperformance is material.

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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.

*Service Revenue and Receivables*

For a discussion of ourrevenue recognition policies, see “—Recognition and Valuation of ServiceRevenue.”

Becausethere are no quoted market prices for our additional structural advisory feesor residuals receivable, we use discounted cash flow modeling techniques andthe following key assumptions to estimate their values:

·       thediscount rate, which we use to calculate the fair value of our additionalstructural advisory fees and residuals;

·       theannual rate of student loan prepayments;

·       thetrend of interest rates over the life of the loan pool, including the forwardLIBOR curve, and the spread between LIBOR and auction rates; and

·       expectedloan defaults, net of recoveries.

We base these estimates onour proprietary historical data, third-party data and our industry experience,adjusting for specific program and borrower characteristics such as loan typeand borrower creditworthiness. We also monitor trends in loan performance overtime and make adjustments we believe are necessary to value properly ourreceivables balances at each balance sheet date.

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

| ** **                 | ** ** | ** **     | ** ** | **Percentage rate** | ** ** | **Percentage discount rate** | ** ** |
|----------------------------|------------|----------------|------------|--------------------------|------------|----------------------------------------|------------|
| **Trust**                  | ** ** | ** **     | ** ** | **Loan type**       | ** ** | **Default**                            | ** ** | **Recovery** | ** ** | **Prepayments** | ** ** | **Structural  advisory fees** | ** ** | **Residuals** | ** ** |
| Private label  loan trusts |       | Private  label |       |                     | 9.29       | %                                      |       |   | 40 | % |   |   | 7 | % |   |   | 6.70 | % |   |   | 12 | % |   |
| NCT trusts                 |       | GATE/Other     |       |                     | 17.87      |                                   |       |   | 48 |   |   |   | 5 |   |   |   | 6.70 |   |   |   | 12 |   |   |
|                            |            |                |            |                          |            |                                        |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

To our knowledge, therehave been no public market transactions involving the sale of residualsgenerated by a pool of securitized student loans. In determining an appropriatediscount rate for valuing our residuals, we review the rates used by studentloan securitizers as well as rates used in the much broader asset-backedsecurities, or ABS, market. We believe that the 12% discount rate we use forsecuritization trusts facilitated prior to fiscal 2007 is appropriate given theexpected timing of cash flows and the maximum 24-year life of the trustassets and residuals. The securitization trusts we facilitated in September 2006and December 2006 issued BBB rated securities, the only such issuances byany of our securitization trusts. The issuance of BBB rated securities createdan additional class of debtholders with an interest senior to our residualinterest in the trust. As a result, we expect cash flows derived from our residualinterest in these trusts to take longer, and be subject to greater risk,compared to cash flows derived from our residual interests in earliersecuritization trusts. As a result, we believe that a 13% discount rate isappropriate for these securitization trusts.

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 beappropriate loan performance assumptions based on those tiers.

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Our private label loan programs, under whichapproximately 80% of the borrowers have creditworthy co-borrowers, typically afamily member, have an extensive credit underwriting process. GATE programs hada borrower approval rate of approximately 83% in fiscal 2006 as a result of thecredit support provided by the participating schools. Accordingly, we believethat borrowers in our private label programs will prepay at a higher rate anddefault at a lower rate than borrowers in our GATE programs.

At December 31, 2006, we used a 6.70% discountrate for valuing additional structural advisory fees, as compared to a 7.16%discount rate at June 30, 2006, a 6.36% discount rate at December 31,2005 and a 5.96% discount rate at June 30, 2005. Based on the prioritypayment status of additional structural advisory fees in the flow of funds outof the securitization trust, we believe these fees are comparable to 10-yearspreads on BBB rated structured finance and corporate debt securities. Based onmarket quotes for such securities, we believe a spread over comparable maturityU.S. Treasury Notes of 200 basis points is an appropriate discount rate invaluing these projected cash flows.

Two private label loan trusts have issuedpredominately senior auction rate notes to finance the purchase of studentloans. Interest rates for the auction rate notes are determined from time totime at auction. At December 31, 2006, we used a 10 basis point spreadover LIBOR to project the future cost of funding of the senior auction ratenotes in the trusts. Since inception of the first trust, the average spreadover LIBOR for the senior auction rate notes of that trust has been 6.4basis points. Since the inception of the second trust, the average spreadover LIBOR for the senior auction rate notes of that trust has been 6.5 basispoints.

Except for the change tothe discount rate applied to additional structural advisory fees to account forthe change in the market rate of 10-year U.S. Treasury Notes, we did notchange any loan performance assumptions regarding default rates, recovery ratesor discount rates in valuing projected trust cash flows during the first sixmonths of fiscal 2007 or fiscal 2006. During the fourth quarter of fiscal 2006and the first six months of fiscal 2007, loans in the securitization trustsexperienced higher prepayment rates than we had estimated would occur duringthese periods of time, which partially offset the positive net accretion thatcomes from updating the carrying value of our structural advisory fees andresiduals receivables for the passage of time. We do not believe it isnecessary at this time to alter our assumptions regarding future prepaymentsthat we use to estimate the fair value of these receivables. We continue tomonitor the performance of trust assets against our expectations, and will makesuch adjustments to our estimates as we believe are necessary to value properlyour receivables balances at each balance sheet date.

*SensitivityAnalysis*

Increases in our estimatesof defaults, prepayments and discount rates, increases in the spread betweenLIBOR and auction rates indices, as well as decreases in default recovery ratesand the multi-year forward estimates of LIBOR, would have a negative effect onthe value of our additional structural advisory fees and residuals. Studentloan prepayments include either full or partial payments by a borrower inadvance of the maturity schedule specified in the note, including payments as aresult of loan consolidation activity. Because most credit defaults arereimbursable by third parties, increases in defaults generally have the sameeffect as increases in prepayments. If defaults increase beyond the level ofexpected third-party reimbursement, then these changes will have an additionalnegative effect on the value of our additional structural advisory fees andresiduals. For purposes of this sensitivity analysis, we have assumed noamounts in excess of the pledged fund established at the time of eachsecuritization of private label loans are available to reimburse the trust fordefaults. LIBOR is the reference rate for a substantial majority of the loanassets and, we believe, a reasonable index for borrowings of the trusts.Because the trusts’ student loan assets earn interest based on LIBOR and sometrusts have outstanding securities that pay interest based on the results ofauction rates, changes in the spread between LIBOR and the auction rate canaffect the performance of the trusts which have issued auction rate notes.

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Thefollowing table shows the estimated change in our structural advisory fees andresiduals receivable balances at December 31, 2006 based on changes in ourloan performance assumptions. The effect on the fair value of the structuraladvisory fees and residuals receivables are based on variations of 10% or 20%,except for the forward LIBOR rates, which are based on variations of 1% and 2%from the forward LIBOR rates at December 31, 2006, and changes in theassumed spread between 1-month LIBOR rates and auction rates, which arebased on .05% and .10% changes, from the assumed levels for each keyassumption:

| ** **                             | ** ** | **Percentage change**           | ** ** | ** **        | ** ** | **Percentage change** | ** ** |
|----------------------------------------|------------|--------------------------------------|------------|-------------------|------------|----------------------------|------------|
| ** **                             | ** ** | **in assumptions**              | ** ** | **Receivables**   | ** ** | **in assumptions**    | ** ** |
| **Structural advisory fees** | ** ** | ** **                           | ** ** | **Down 20%** | ** ** | **Down 10%**          | ** ** | **balance** | ** ** | **Up 10%** | ** ** | **Up 20%** | ** ** |
| ** **                             | ** ** | **(dollars in thousands)** | ** ** |
| Default rate:                          |       |                                 |       |              |       |                       |       |   |   |   |   |   |   |
| Total structural advisory fees         |       | $                                    | 117,716    |              | $          | 117,176                    |       |   | $ | 116,637 |   |   | $ | 116,097 |   | $ | 115,555 |   |
| Change in receivables balance          |       | 0.93                                 | %          | 0.46              | %          |                       |       |   |   | (0.46 | )% | (0.93 | )% |
| Default recovery rate:                 |       |                                 |       |              |       |                       |       |   |   |   |   |   |   |
| Total structural advisory fees         |       | $                                    | 116,460    |              | $          | 116,548                    |       |   | $ | 116,637 |   |   | $ | 116,733 |   | $ | 116,830 |   |
| Change in receivables balance          |       | (0.15                                | )%         | (0.08             | )%         |                       |       |   |   | 0.08 | % | 0.17 | % |
| Annual prepayment rate:                |       |                                 |       |              |       |                       |       |   |   |   |   |   |   |
| Total structural advisory fees         |       | $                                    | 122,119    |              | $          | 119,310                    |       |   | $ | 116,637 |   |   | $ | 114,088 |   | $ | 111,658 |   |
| Change in receivables balance          |       | 4.70                                 | %          | 2.29              | %          |                       |       |   |   | (2.19 | )% | (4.27 | )% |
| Discount rate:                         |       |                                 |       |              |       |                       |       |   |   |   |   |   |   |
| Total structural advisory fees         |       | $                                    | 125,677    |              | $          | 120,971                    |       |   | $ | 116,637 |   |   | $ | 112,247 |   | $ | 108,192 |   |
| Change in  receivables balance         |       | 7.75                                 | %          | 3.72              | %          |                       |       |   |   | (3.76 | )% | (7.24 | )% |
|                                        |            |                                      |            |                   |            |                            |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

| ** **                     | ** ** | **Change in assumption**   | ** ** | ** **            | ** ** | **Change in assumption** | ** ** |
|--------------------------------|------------|--------------------------------------|------------|-----------------------|------------|------------------------------------|------------|
| ** **                     | ** ** | **Down 200**                    | ** ** | **Down 100**     | ** ** | **Receivables**                    | ** ** | **Up 100** | ** ** | **Up 200** | ** ** |
| ** **                     | ** ** | **basis points**                | ** ** | **basis points** | ** ** | **balance**                        | ** ** | **basis points** | ** ** | **basis points** | ** ** |
| ** **                     | ** ** | **(dollars in thousands)** | ** ** |
| Forward LIBOR rates:           |       |                                 |       |                  |       |                               |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total structural advisory fees |       |                                 | $          | 109,100               |       |                               |       | $ | 112,737 |   |   |   | $ | 116,637 |   |   |   | $ | 120,332 |   |   |   | $ | 124,339 |   |   |
| Change in  receivables balance |       |                                 | (6.46      | )%                    |       |                               | (3.34      | )% |   |   |   |   |   |   | 3.17 | % |   |   | 6.60 | % |   |
|                                |            |                                      |            |                       |            |                                    |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

| ** **                     | ** ** | **Percentage change**           | ** ** | ** **        | ** ** | **Percentage change** | ** ** |
|--------------------------------|------------|--------------------------------------|------------|-------------------|------------|----------------------------|------------|
| ** **                     | ** ** | **in assumptions**              | ** ** | **Receivables**   | ** ** | **in assumptions**    | ** ** |
| **Residuals**                  | ** ** | ** **                           | ** ** | **Down 20%** | ** ** | **Down 10%**          | ** ** | **balance** | ** ** | **Up 10%** | ** ** | **Up 20%** | ** ** |
| ** **                     | ** ** | **(dollars in thousands)** | ** ** |
| Default rate:                  |       |                                 |       |              |       |                       |       |   |   |   |   |   |   |
| Total residual fees            |       | $                                    | 594,791    |              | $          | 589,229                    |       |   | $ | 583,666 |   |   | $ | 578,102 |   | $ | 572,546 |   |
| Change in receivables balance  |       | 1.91                                 | %          | 0.95              | %          |                       |       |   |   | (0.95 | )% | (1.91 | )% |
| Default recovery rate:         |       |                                 |       |              |       |                       |       |   |   |   |   |   |   |
| Total residual fees            |       | $                                    | 581,949    |              | $          | 582,792                    |       |   | $ | 583,666 |   |   | $ | 584,549 |   | $ | 585,428 |   |
| Change in receivables balance  |       | (0.29                                | )%         | (0.15             | )%         |                       |       |   |   | 0.15 | % | 0.30 | % |
| Annual prepayment rate:        |       |                                 |       |              |       |                       |       |   |   |   |   |   |   |
| Total residual fees            |       | $                                    | 638,026    |              | $          | 610,216                    |       |   | $ | 583,666 |   |   | $ | 558,281 |   | $ | 533,995 |   |
| Change in receivables balance  |       | 9.31                                 | %          | 4.55              | %          |                       |       |   |   | (4.35 | )% | (8.51 | )% |
| Discount rate:                 |       |                                 |       |              |       |                       |       |   |   |   |   |   |   |
| Total residual fees            |       | $                                    | 703,398    |              | $          | 640,130                    |       |   | $ | 583,666 |   |   | $ | 533,076 |   | $ | 487,855 |   |
| Change in  receivables balance |       | 20.51                                | %          | 9.67              | %          |                       |       |   |   | (8.67 | )% | (16.42 | )% |
|                                |            |                                      |            |                   |            |                            |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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| ** **                     | ** ** | **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:           |       |                                       |       |                                       |       |                               |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total residual fees            |       |                                       | $          | 561,749                                    |       |                               |       | $ | 572,977 |   |   |   | $ | 583,666 |   |   |   | $ | 591,658 |   |   |   | $ | 598,022 |   |   |
| Change in  receivables balance |       |                                       | (3.76      | )%                                         |       |                               | (1.83      | )% |   |   |   |   |   |   | 1.37 | % |   |   | 2.46 | % |   |
|                                |            |                                            |            |                                            |            |                                    |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

| ** **                                                             | ** ** | **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: |       |                                   |       |                                  |       |                               |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total residual fees                                                    |       |                                   | $          | 588,720                               |       |                               |       | $ | 586,191 |   |   |   | $ | 583,666 |   |   |   | $ | 581,141 |   |   |   | $ | 578,621 |   |   |
| Change in  receivables balance                                         |       |                                   | 0.87       | %                                     |       |                               | 0.43       | % |   |   |   |   |   |   | (0.43 | )% |   |   | (0.86 | )% |   |
|                                                                        |            |                                        |            |                                       |            |                                    |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

These sensitivities arehypothetical and should be used with caution. The effect of each change inassumption must be calculated independently, holding all other assumptionsconstant. Because the key assumptions may not in fact be independent, thenet effect of simultaneous adverse changes in key assumptions may differmaterially from the sum of the individual effects calculated above.

*Consolidation*

Our consolidatedfinancial 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:

·       wedid not have unilateral decision-making abilities related to significantmatters affecting the securitization trusts, such as asset acquisition, prepaymentof debt, placement of debt obligations and modification of trust documents;

·       wedid not have substantially all the risks and rewards of ownership, as TERI, andthe respective colleges in the case of the GATE programs, provide substantiallyall of the student loan guarantees;

·       wewere a facilitator of securitization transactions, for which we receivemarket-based fees, and we were not the transferor of assets to thesecuritization trusts; and

·       ourcontinuing involvement in the trusts is limited to a passive residual interestand our role as an administrator for the trust for which we receivemarket-based fees.

Beginning July 1, 2003, and for securitizationtrusts created after January 31, 2003, we applied Financial AccountingStandards Board, or FASB, Interpretation No. 46, “Consolidation ofVariable Interest Entities, an interpretation of ARB No. 51,” or FIN No. 46,in assessing consolidation. FIN No. 46 provided a new framework foridentifying variable interest entities and determining when a company shouldinclude the assets, liabilities, non-controlling interests and results ofactivities of a variable interest entity in its consolidated financialstatements.

On December 24, 2003, the FASB issued FIN No. 46(revised December 2003), “Consolidation of Variable Interest Entities,” orFIN No. 46R, which addressed how a business enterprise should evaluatewhether it has a controlling interest in an entity through means other thanvoting rights and accordingly 

26

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should consolidate theentity. FIN No. 46R has replaced FIN No. 46. At December 31,2006, each securitization trust created after January 31, 2003 has met thecriteria to be a qualified special-purpose entity, or QSPE, as defined inparagraph 35 of FASB Statement No. 140, “Accounting for the Transfersand Servicing of Financial Assets and Extinguishments of Liabilities.”Accordingly, we did not consolidate these existing securitization trusts in ourfinancial statements. In addition, the securitization trusts created prior to January 31,2003 in which we hold a variable interest that could result in us beingconsidered the primary beneficiary of such trust, have been amended in orderfor them to be considered QSPEs. The adoption of FIN No. 46R, which webegan to apply in December 2003, did not have a material impact on ourconsolidated financial condition, results of operations, earnings per share orcash flows.

The FASB has issued anexposure draft that would amend FASB Statement No. 140. The proposedamendment would, among other things, change the requirements that an entitymust meet to be considered a QSPE. We are monitoring the status of the exposuredraft to assess its impact, if any, on our financial statements.

**Results ofOperations**

***Three and six months ended December 31, 2006 and2005***

***Revenue Related to Securitization Transactions***

The following tablesets forth for the first six months of fiscal 2007 and fiscal 2006:

·       thetotal principal and accrued interest balance of private label loanssecuritized;

·       thesecuritization-related service revenue components, other than administrativeand other fees, by dollar amount and as a percentage of the total principal andaccrued interest balance of loans securitized; and

·       updates to reflect any fairvalue adjustment to additional structural advisory fees and residuals for priortrusts.

| **First six 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)**                 | ** ** | ** **                               | ** ** |
| 2007                                                     |       |                                                 |       |                                     |       |       |       |                                       |       |       |       |                                  |       |          |       |       |       |   |   |   |   |
| Private label  loans                                     |       |                                                 | $          | 2,109,684                                |       |       | $          | 261,926                                    |       | 12.4       | %          |                                  | $          | 25,447        |       |       | 1.2        | % | $ | 287,373 |   | $ | 105,070 |   | 5.0 | % |
| Trust updates(2)                                         |       |                                                 | —     |                                     |       | —     |       |                                       |       |       | 2,893      |                                  |       |          |       | 2,893      |       | 25,773 |   |   |   |
| Other(3)                                                 |       |                                                 | —     |                                     |       | 2          |       |                                       |       |       | —     |                                  |       |          |       | 2          |       | — |   |   |   |
| Total                                                    |       |                                                 | $          | 2,109,684                                |       |       | $          | 261,928                                    |       |       |       |                                  | $          | 28,340        |       |       |       |   | $ | 290,268 |   | $ | 130,843 |   |   |   |
| 2006                                                     |       |                                                 |       |                                     |       |       |       |                                       |       |       |       |                                  |       |          |       |       |       |   |   |   |   |
| Private label  loans                                     |       |                                                 | $          | 1,265,387                                |       |       | $          | 95,652                                     |       | 7.5        | %          |                                  | $          | 14,778        |       |       | 1.2        | % | $ | 110,430 |   | $ | 78,216 |   | 6.2 | % |
| Trust updates(2)                                         |       |                                                 | —     |                                     |       | —     |       |                                       |       |       | 1,440      |                                  |       |          |       | 1,440      |       | 19,973 |   |   |   |
| Other(3)                                                 |       |                                                 |       |                                     |       | 518        |       |                                       |       |       | —     |                                  |       |          |       | 518        |       |   |   |   |   |
| Total                                                    |       |                                                 | $          | 1,265,387                                |       |       | $          | 96,170                                     |       |       |       |                                  | $          | 16,218        |       |       |       |   | $ | 112,388 |   | $ | 98,189 |   |   |   |

----

(1)             Represents total principal and accrued interest.

(2)             Trust updates reflect changes resulting from thepassage of time, which results in accretion of the discounting inherent in thefair value estimates of additional structural advisory fees and residuals, aswell as any changes in the estimates and assumptions, we make in calculatingthe fair value of these service revenue components.

(3)             Represents the receipt of funds from various trusts’cost of issuance accounts once it was determined that the trust no longerneeded such cost of issuance funds.

27

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Ourprivate label loan products are marketed through two marketing channels: (a) directto consumer, which generally refers to programs that lenders, education loanmarketers, businesses, affinity groups or other organizations market directlyto prospective borrowers, and (b) school channel, which refers to programsthat lenders or third parties market indirectly through educationalinstitutions. Private label loans do not include GATE loans. Our estimates ofthe allocation by marketing channel of our securitization revenues for thefirst six months of fiscal 2007, expressed as a percentage of the totalprincipal and accrued interest of private label loans securitized in eachchannel, are as follows:

|                                                                          | ** ** | ** **          | ** ** | ** **                      | ** ** | ** **                             | ** ** | **Percentage yield**                    | ** ** |
|--------------------------------------------------------------------------|------------|---------------------|------------|---------------------------------|------------|----------------------------------------|------------|----------------------------------------------|------------|
| **Month and year  of private  label securitization** | ** ** | ** **          | ** ** | **Marketing  channel**          | ** ** | **Volume of  loans  securitized** | ** ** | **Up-front  structural  advisory fees** | ** ** | **Additional  structural  advisory fees** | ** ** | **Residuals** | ** ** | **Total(2)** | ** ** |
| ** **                                                               | ** ** | ** **          | ** ** | **(dollars in  millions)** | ** ** | ** **                             | ** ** | ** **                                   | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Fiscal 2007**                                                          | ** ** | ** **          | ** ** | ** **                      | ** ** | ** **                             | ** ** |                                         | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| December 2006                                                       |       | Direct  to consumer |       | $                               | 676        |                                   | 93         | %                                            |       | 12.6 | % |   |   | 1.2 | % |   |   | 7.0 | % |   |   | 20.8 | % |   |
|                                                                     |       | School  channel     |       | 48                              |       | 7                                      |       |                                         | 7.3        |   |   |   | 1.2 |   |   |   | 2.1 |   |   |   | 10.6 |   |   |
|                                                                     |       | Total               |       | $                               | 724        |                                   |       |                                         |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
|                                                                     |       | Blended  yield(1)   |       |                            |       |                                   |       |                                         | 12.2       |   |   |   | 1.2 |   |   |   | 6.7 |   |   |   | 20.1 |   |   |
| September 2006                                                      |       | Direct to consumer  |       | $                               | 973        |                                   | 70         |                                         |       | 14.7 |   |   |   | 1.2 |   |   |   | 5.1 |   |   |   | 21.0 |   |   |
|                                                                          |       | School  channel     |       | 413                             |       | 30                                     |       |                                         | 7.3        |   |   |   | 1.2 |   |   |   | 1.7 |   |   |   | 10.2 |   |   |
|                                                                          |       | Total               |       | $                               | 1,386      |                                   |       |                                         |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
|                                                                          |       | Blended  yield(1)   |       |                            |       |                                   |       |                                         | 12.5       |   |   |   | 1.2 |   |   |   | 4.1 |   |   |   | 17.8 |   |   |
| Total for first  six months of fiscal 2007                          |       |                |       | 2,110                           |       |                                   |       |                                         | 12.4       |   |   |   | 1.2 |   |   |   | 5.0 |   |   |   | 18.6 |   |   |
| **Fiscal 2006**                                                          | ** ** | ** **          | ** ** | ** **                      | ** ** | ** **                             | ** ** |                                         | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| October 2005                                                        |       | Direct  to consumer |       | $                               | 921        |                                   | 73         | %                                            |       | 8.8 | % |   |   | 1.2 | % |   |   | 7.5 | % |   |   | 17.5 | % |   |
|                                                                     |       | School  channel     |       | 344                             |       | 27                                     |       |                                         | 4.1        |   |   |   | 1.2 |   |   |   | 2.6 |   |   |   | 7.8 |   |   |
|                                                                     |       | Total               |       | $                               | 1,265      |                                   |       |                                         |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
|                                                                     |       | Blended  yield(1)   |       |                            |       |                                   |       |                                         | 7.5        |   |   |   | 1.2 |   |   |   | 6.2 |   |   |   | 14.9 |   |   |
| Total for first six months  of fiscal 2006                               |       |                |       | $                               | 1,265      |                                   |       |                                         |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
|                                                                     |       | Blended  yield(1)   |       |                            |       |                                   |       |                                         | 7.5        |   |   |   | 1.2 |   |   |   | 6.2 |   |   |   | 14.9 |   |   |
|                                                                          |            |                     |            |                                 |            |                                        |            |                                              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

----

(1)          Blended yield representssecuritization revenues as a percentage of the total principal and accruedinterest balance of the loans securitized from all marketing channels at thedate of securitization.

(2)          Due to rounding and thecomplex nature of these calculations, which involve allocating the totalrevenue for a securitization across the different marketing channels based onthe aggregate profitability of each marketing channel, the total yield bymarketing channel and securitization may not represent the sum of theindividual yields by revenue source.

Theseyields by marketing channel represent an approximate allocation of revenues andcosts based on various estimates and assumptions regarding the relativeprofitability of these loans, and should be read with caution. Furthermore,these yields are dependent on a number of factors, including the mix of loansbetween marketing channels that are included in a particular securitization,the average life of loans, which can be impacted by prepayments, the time ofyear that the loans are securitized and the relative mix of loans from studentswith various expected terms to graduation, the structure of, and prevailingmarket conditions at the time of, a securitization, the marketing fees whichour clients earn on loans we securitize 

28

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for them, along with a number of other factors. Therefore,readers are cautioned that the approximated blended yields and yields bymarketing channel above may not be indicative of yields that we may be able toachieve in future securitizations.

*Up-front structuraladvisory fees*

The up-front component of structural advisory feesincreased to $261.9 million for the first six months of fiscal 2007 from $96.2million for the first six months of fiscal 2006. Up-front structural advisoryfees decreased to $88.6 million for the second quarter of fiscal 2007 from$96.2 million for the second quarter of fiscal 2006. The increase in up-frontstructural advisory fees for the first six months of fiscal 2007 compared tothe first six months of fiscal 2006 was primarily due to an increase in loanfacilitation volume, which enabled us to securitize a greater amount of loans,and an increase in up-front structural advisory fees as a percentage of theprivate label loan volume securitized, or up-front structural advisory feeyield. The securitization trusts we facilitated in the first and secondquarters of fiscal 2007 issued BBB rated securities, the only such issuances byany of our securitization trusts. The issuance of BBB rated securities enabledus to increase the up-front structural advisory fee yield, with a decrease inthe amount of residuals we expect to receive, from these securitizationtransactions.

The decrease in the up-front structural advisory feesfor the second quarter of fiscal 2007 compared to the second quarter of fiscal2006 was due primarily to a difference in the total number of securitizationtransactions completed by us during the first six months of the respectivefiscal years. We completed securitizations in each quarter of the first half offiscal 2007. In contrast, we did not complete a securitization transaction inthe first quarter of fiscal 2006. As a result, the securitization transactioncompleted during the second quarter of fiscal 2006 was larger relative to thesecuritization transaction completed in the second quarter of fiscal 2007. Thiscaused up-front structural advisory fees to be greater in the second quarter offiscal 2006 than the second quarter of fiscal 2007. The decrease in up-frontstructural advisory fees, however, was partially offset by an increase inup-front structural advisory fee yield, which improved from 7.5% in the secondquarter of fiscal 2006 to 12.2% in the second quarter of fiscal 2007. We expectour up-front structural advisory fee yield for future securitizations tofluctuate as a result of market conditions at the time of securitization andthe transaction structure in light of the loan assets being securitized.

Thefollowing table reflects the changes in up-front structural advisory feesattributable to the changes in securitization volume and the fee yield and loanmix for the six and three months ended December 31, 2006 and 2005:

| ** **                                                                                     | ** ** | **Up-front structural advisory fees** | ** ** |
|------------------------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                                                     | ** ** | **Total  volume  of loans  securitized**        | ** ** | **Change  attributable to  increased  (decreased)  securitization  volume** | ** ** | **Change  attributable to  change in  fee yield and  loan mix** | ** ** | **Total change** | ** ** |
| ** **                                                                                     | ** ** | **(in thousands)**                              | ** ** |
| Six months ended  December 31, 2006 vs. six months ended December 31, 2005           |       | $                                                    | 2,109,684  |   |   | $ | 63,807 |   |   |   | $ | 101,951 |   |   |   | $ | 165,758 |   |   |
| Three months  ended December 31, 2006 vs. three months ended December 31,  2005 |       | $                                                    | 723,551    |   |   | $ | (41,476 | ) |   |   | $ | 33,924 |   |   |   | $ | (7,552 | ) |   |

 

29

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*Additionalstructural advisory fees*

Theadditional component of structural advisory fees increased to $28.3 million forthe first six months of fiscal 2007 from $16.2 million for the first six monthsof fiscal 2006. Additional structural advisory fees decreased to $9.8 millionfor the second quarter of fiscal 2007 from $16.0 million for the second quarterof fiscal 2006. The increase in additional structural advisory fees between thesix-month periods was primarily a result of increases in aggregate securitizationvolume. The decrease in additional structural advisory fees between thethree-month periods was primarily the result of the relative sizes of thesecuritization transactions closed in the second quarters of fiscal 2007 andfiscal 2006.The following table summarizes the changes in our estimate of thefair value of the structural advisory fees receivable for the six and threemonths ended December 31, 2006 and 2005:

| ** **                             | ** ** | **Six months ended  December 31,** | ** ** |
|----------------------------------------|------------|---------------------------------------------------|------------|
| ** **                             | ** ** | **2006**                                          | ** ** | **2005** | ** ** |
| ** **                             | ** ** | **(in thousands)**                           | ** ** |
| Fair value at  beginning of period     |       | $                                                 | 88,297     |   | $ | 53,371 |   |
| Additions from new securitizations     |       | 25,447                                            |       | 14,778 |   |
| Trust updates                          |       |                                              |       |   |   |
| Passage of time (fair value accretion) |       | 3,411                                             |       | 1,804 |   |
| Other factors                          |       | (518                                              | )          | (364 | ) |
| Total fair value adjustments           |       | 2,893                                             |       | 1,440 |   |
| Fair value at end of  period           |       | $                                                 | 116,637    |   | $ | 69,589 |   |

 

| ** **                             | ** ** | **Three months ended  December 31,** | ** ** |
|----------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                             | ** ** | **2006**                                            | ** ** | **2005** | ** ** |
| ** **                             | ** ** | **(in thousands)**                             | ** ** |
| Fair value at  beginning of period     |       | $                                                   | 106,848    |   | $ | 53,570 |   |
| Additions from new securitizations     |       | 8,861                                               |       | 14,778 |   |
| Trust updates                          |       |                                                |       |   |   |
| Passage of time (fair value accretion) |       | 1,821                                               |       | 1,009 |   |
| Other factors                          |       | (893                                                | )          | 232 |   |
| Total fair value adjustments           |       | 928                                                 |       | 1,241 |   |
| Fair value at end of  period           |       | $                                                   | 116,637    |   | $ | 69,589 |   |

 

During the first six months of fiscal 2007, ourestimates of the fair value of our additional structural advisory fees resultedin an increase in their carrying value of approximately $2.9 million. Thisincrease was primarily due to the accretion of the discounting inherent in thefair value estimates and the impact of a decrease in the 10-year U.S.Treasury note rate, offset in part by the effect of higher prepayment ratesthan we had estimated would occur during the period. During the first sixmonths of fiscal 2006, our estimates of the fair value of our additionalstructural advisory fees resulted in an increase in their carrying value ofapproximately $1.4 million. This increase was primarily due to the accretion ofdiscounting inherent in the fair value estimates and the impact of an increasein the implied forward LIBOR curve during the period, offset by an increase inthe discount rate. During the second quarter of fiscal 2007, our estimate ofthe fair value of our additional structural advisory fees resulted in anincrease in their carrying value of approximately $0.9 million. During thesecond quarter of fiscal 2006, our estimate of the fair value of our additionalstructural advisory fees resulted in an increase of approximately $1.2 million.These increases were due primarily to the discounting inherent in the fairvalue estimates, offset in part in the second quarter of fiscal 2007 by theperformance of the trust assets.

On a quarterly basis, we update our estimate of thefair value of our additional structural advisory fees, which we expect to beginto receive approximately five to seven years after the date of a particular 

30

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securitizationtransaction. In doing so, we give effect to the passage of time, which resultsin the accretion of the discounting inherent in the fair value estimates, andwe also adjust for any change in the discount rate and other assumptions thatwe use in estimating the fair value of these receivables. We monitor theperformance of trust assets, including default, recovery, prepayment andforward LIBOR rate experience, which we also consider in our estimates. We usean implied forward LIBOR curve to estimate trust cash flows. For a discussionof the assumptions we make in estimating our additional structural advisoryfees, see “—Executive Summary—Application of Critical Accounting Policies andEstimates—Service Revenue and Receivables.”

We base the discount rate that we use to calculate thefair value of our additional structural advisory fees on the 10-year U.S.Treasury note rate plus 200 basis points. During the first six months of fiscal2007 and fiscal 2006, the 10-year U.S. Treasury note rate decreased 46basis points and increased 40 basis points, respectively. We applied a discountrate of 6.70% at December 31, 2006, 7.16% at June 30, 2006, 6.36% at December 31,2005 and 5.96% at June 30, 2005. A decrease in the 10-year U.S.Treasury note rate has the effect of increasing the estimated fair value of ourstructural advisory fees receivable, while an increase in the rate has theopposite effect on our estimate of their fair value.

We made no changes in ourassumptions regarding default rates or recovery rates for the private labelloan trusts or NCT trusts during either the first six months of fiscal 2007 orthe first six months of fiscal 2006. We also made no changes to our assumptionregarding prepayments during the first six months of fiscal 2007. During thesecond quarter of fiscal 2006, we completed an analysis of historicalprepayments of certain loans included in our proprietary private student loanperformance database. The analysis indicated that the average prepayment ratethroughout the life of the loan was not materially different from our previousestimate. At the same time, the analysis enabled us to refine our valuationapproach to incorporate prepayment assumptions specific to particular points oftime in the life of the student loans. We began using these refined prepaymentassumptions to estimate the fair value of our residuals and structural advisoryfees receivables during the second quarter of fiscal 2006.

*Residuals*

Service revenues from residuals increased to $130.8million for the first six months of fiscal 2007 from $98.2 million for thefirst six months of fiscal 2006, and decreased to $62.2 million for the secondquarter of fiscal 2007, compared to $90.7 million for the second quarter offiscal 2006. The increase in service revenues from residuals in the first sixmonths of fiscal 2007 compared to the first six months of fiscal 2006 wasprimarily a result of an increase in securitization volume. The decrease inservice revenues from residuals for the second quarter of fiscal 2007 comparedto the second quarter of fiscal 2006 was due primarily to the relative sizes ofthe securitization transactions closed in the second quarters of fiscal 2007and fiscal 2006. We completed securitizations in each quarter of the first halfof 2007. In contrast, we did not complete a securitization transaction in thefirst quarter of fiscal 2006. As a result, the securitization transactioncompleted during the second quarter of fiscal 2006 was larger relative to thesecuritization transaction completed in the second quarter of fiscal 2007. Thiscaused service revenues from residuals to be greater in the second quarter offiscal 2006 than the second quarter of 2007. In addition, the issuance of BBBrated securities in the securitizations completed during the fiscal 2007periods decreased the amount of residuals we expect to receive from thesesecuritizations.

31

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The following tablereflects the changes in residuals attributable to the changes in securitizationvolume and the updates to prior trusts:

| ** **                                                                                | ** ** | **Residuals**           | ** ** |
|-------------------------------------------------------------------------------------------|------------|-------------------------|------------|
| **Fiscal year**                                                                      | ** ** | ** **              | ** ** | **Total  volume  of loans  securitized** | ** ** | **Change  attributable to  increased  (decreased)  securitization  volume and  change in loan mix** | ** ** | **Change  attributable to  trust updates(1)** | ** ** | **Total change** | ** ** |
| ** **                                                                                | ** ** | **(in thousands)** | ** ** |
| Six months ended  December 31, 2006 vs. six months ended December 31, 2005 |       | $                       | 2,109,684  |   |   | $ | 26,854 |   |   |   | $ | 5,800 |   |   |   | $ | 32,654 |   |   |
| Three months ended  December 31, 2006 vs. three months ended December 31, 2005  |       | $                       | 723,551    |   |   | $ | (29,901 | ) |   |   | $ | 1,374 |   |   |   | $ | (28,527 | ) |   |
|                                                                                           |            |                         |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

----

(1)          The change attributableto trust updates in fiscal 2007 and 2006 was primarily the result of thepassage of time and the resulting accretion of the discounting inherent inthese fair value estimates of residuals and an increase in the underlyingreceivable balance as a result of additional securitizations, rather thanchanges in our assumptions.

Thefollowing table summarizes the changes in our estimate of the fair value of theresiduals receivable for the six and three months ended December 31, 2006and 2005:

| ** **                             | ** ** | **Six months ended  December 31,** | ** ** |
|----------------------------------------|------------|---------------------------------------------------|------------|
| ** **                             | ** ** | **2006**                                          | ** ** | **2005** | ** ** |
| ** **                             | ** ** | **(in thousands)**                           | ** ** |
| Fair value at  beginning of period     |       | $                                                 | 452,823    |   | $ | 247,275 |   |
| Additions from new securitizations     |       | 105,070                                           |       | 78,216 |   |
| Trust updates                          |       |                                              |       |   |   |
| Passage of time (fair value accretion) |       | 30,140                                            |       | 16,661 |   |
| Other factors                          |       | (4,367                                            | )          | 3,312 |   |
| Total fair value adjustments           |       | 25,773                                            |       | 19,973 |   |
| Fair value at end of  period           |       | $                                                 | 583,666    |   | $ | 345,464 |   |

 

| ** **                             | ** ** | **Three months ended  December 31,** | ** ** |
|----------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                             | ** ** | **2006**                                            | ** ** | **2005** | ** ** |
| ** **                             | ** ** | **(in thousands)**                             | ** ** |
| Fair value at  beginning of period     |       | $                                                   | 521,486    |   | $ | 254,757 |   |
| Additions from new securitizations     |       | 48,315                                              |       | 78,216 |   |
| Trust updates                          |       |                                                |       |   |   |
| Passage of time (fair value accretion) |       | 16,430                                              |       | 9,243 |   |
| Other factors                          |       | (2,565                                              | )          | 3,248 |   |
| Total fair value adjustments           |       | 13,865                                              |       | 12,491 |   |
| Fair value at end of  period           |       | $                                                   | 583,666    |   | $ | 345,464 |   |

 

Our estimates of the fair value of our residualsreceivable resulted in an increase in their aggregate carrying value ofapproximately $25.8 million during the first six months of fiscal 2007 and$20.0 million during the first six months of fiscal 2006, due primarily to thepassage of time. In addition, during the first quarter of fiscal 2007, werenegotiated the fees that the securitization trusts are required to pay to theloan servicer that services a majority of the loans in each trust. Thereduction in these expected trust expenses had a positive effect on ourestimate of the fair value of our residuals receivable during the first sixmonths 

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of fiscal 2007. Ourestimates of the fair value of our residuals receivable resulted in an increasein their aggregate carrying value of approximately $13.9 million during thesecond quarter of fiscal 2007 and $12.5 million during the second quarter offiscal 2006, due primarily to the passage of time. The amount of the fair valueadjustments also increased between periods as the underlying receivablebalances increased. As we conduct more securitization transactions, we expectthat adjustments for the passage of time will continue to increase and therebyadd to the residual revenues that we discount to fair value.

As we do with our additional structural advisory fees,on a quarterly basis, we update our estimate of the fair value of ourresiduals. In doing so, we give effect to the passage of time, which results inthe accretion of the discounting inherent in these fair value estimates, and wealso adjust for any change in the discount rate that we use in estimating thefair value of these receivables. We used a 12% discount rate during the firstsix months of fiscal 2007 and throughout fiscal 2006 in valuing residuals forsecuritizations completed prior to fiscal 2007. As a result of our BBBfinancing structure, we used a 13% discount rate in valuing residuals for thesecuritizations completed in the first six months of fiscal 2007. We alsomonitor the performance of trust assets, including default, recovery,prepayment and forward LIBOR rates 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 residuals, see “—ExecutiveSummary—Application of Critical Accounting Policies and Estimates—ServiceRevenue and Receivables.” During the fourth quarter of fiscal 2006 and thefirst six months of fiscal 2007, loans in the securitization trusts experiencedhigher prepayment rates than we had estimated would occur during these periodsof time, which partially offset the positive net accretion that comes fromupdating the carrying value of our structural advisory fees and residualsreceivables for the passage of time. The negative effects of the higherprepayment rates were partially offset during the first six months of fiscal2007 by the positive impact of expected reductions in servicing-related fees tobe paid by the securitization trusts as a result of a new contract executedduring the first quarter of fiscal 2007. We do not believe it is necessary atthis time to alter our assumptions regarding future prepayments that we use toestimate the fair value of our receivables. We continue to monitor theperformance of trust assets against our expectations, and will make suchadjustments to our estimates as we believe are necessary to value properly ourreceivables balance at each balance sheet date.

In determining anappropriate discount rate for valuing residuals, we review the rates used bystudent loan securitizers, as well as rates used in the much broader ABSmarket. We believe that the 12% discount rate we use for securitization trustscreated prior to fiscal 2007 is appropriate given the maximum 24-yearlife of the trust assets and residuals. The securitization trusts wefacilitated in the first and second quarters of fiscal 2007 issued BBB ratedsecurities, the only such issuances by any of our securitization trusts. Theissuance of BBB rated securities changed the timing and amount of cash flowsexpected to be derived from our residual interest in these trusts and increasedthe risk associated with the residual cash flows from these trusts. As aresult, we have discounted the cash flows expected from the residual interestin these trusts by 13%.

*Processing feesfrom TERI*

Processing fees from TERIincreased to $66.7 million for the first six months of fiscal 2007 from$51.2 million for the first six months of fiscal 2006 and increased to$29.6 million for the second quarter of fiscal 2007 from $25.3 million for thesecond quarter of fiscal 2006. The increase was primarily due to increasedreimbursed expenses required to process the increased volume of private labelloans that we facilitated during the fiscal 2007 periods. The volume of privatelabel loans we facilitated increased to $2.38 billion for the first six monthsof fiscal 2007 from $1.83 billion for the first six months of fiscal 2006 andto $743 million for the second quarter of fiscal 2007 from $618 million for thesecond quarter of fiscal 2006.

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*Administrative andother fees*

Administrative and otherfees increased to $9.0 million for the first six months of fiscal 2007 from$3.8 million for the first six months of fiscal 2006 and increased to $4.7million for the second quarter of fiscal 2007 from $2.3 million for the secondquarter of fiscal 2006. The increases were primarily due to increasedreimbursed expenses that we generated between periods from marketingcoordination services provided to some of our clients. To a lesser extent, theincrease was due to increasing student loan balances in the securitizationtrusts during the fiscal 2007 periods compared to the fiscal 2006 periods. Wegenerated approximately $6.2 million in reimbursable expenses from marketingcoordination services during the first six months of fiscal 2007, compared toapproximately $1.3 million in reimbursable expenses from marketing coordinationservices during the first six months of fiscal 2006. We generated approximately$3.3 million in reimbursable expenses from marketing coordination servicesduring the second quarter of fiscal 2007, compared to approximately $1.3million in reimbursable expenses from marketing coordination services duringthe second quarter of fiscal 2006. We earned administrative fees for the dailymanagement of the securitization trusts of approximately $2.7 million duringthe first six months of fiscal 2007 and $2.0 million during the first sixmonths of fiscal 2006. We earned administrative fees for the daily managementof the securitization trusts of approximately $1.4 million during the secondquarter of fiscal 2007 and $1.0 million during the second quarter of fiscal2006.

***Net Interest Income***

Net interest incomeincreased to $4.0 million for the first six months of fiscal 2007 from$2.9 million for the first six months of fiscal 2006. Net interest incomeincreased to $2.8 million for the second quarter of fiscal 2007 from $1.6million for the second quarter of fiscal 2006. The increases in the currentyear periods were due primarily to higher average cash balances available forinvestment, partially offset by the impact of our strategy of allocating aportion of our investments in tax exempt instruments which normally carry loweraverage yields.

***Non-interest Expenses***

Total non-interest expenses increased to $124.6million for the first six months of fiscal 2007 from $89.7 million for thefirst six months of fiscal 2006 and increased to $59.0 million for the secondquarter of fiscal 2007 from $44.1 million for the second quarter of fiscal2006. Compensation and benefits increased to $57.5 million for the first sixmonths of fiscal 2007 from $40.9 million for the first six months of fiscal2006 and increased to $25.9 million for the second quarter of fiscal 2007 from$21.2 million for the second quarter of fiscal 2006. General and administrativeexpenses increased to $67.1 million for the first six months of fiscal 2007from $48.8 million for the first six months of fiscal 2006, and increased to$33.1 million for the second quarter of fiscal 2007 from $22.9 million forthe second quarter of fiscal 2006.

Compensation and benefits expense increased primarilydue to an increase in accruals related to our employee incentive compensationplans, primarily as a result of our positive financial results during the firstsix months of fiscal 2007. The increase in compensation and benefits expense isalso the result of an increase in personnel. Our average total number ofemployees was 6% higher during the first six months of fiscal 2007 than duringthe corresponding prior year period. Our average total number of employees wasalso 6% higher during the second quarter of fiscal 2007 than during the secondquarter of fiscal 2006. We hired additional personnel to meet the operating andinformation systems requirements from our growing loan processing andsecuritization activities. During the current year periods, we outsourced somecustomer service, loan facilitation and operations functions, resulting in areduction in headcount for those areas. This reduction was more than offset byan increase in headcount in information technology, legal, audit and compliancefunctions. The increase in the number of information technology, legal, auditand compliance personnel employees contributed to an overall increase incompensation and benefits expense in the current year periods.

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General and administrative expenses increased duringthe first six months of fiscal 2007 as compared to the first six months of 2006as a result of increases in several subcategories of expenses. Marketingcoordination expenses increased from $5.9 million for the first six months offiscal 2006 to $15.2 million for the first six months of fiscal 2007. The increasein marketing coordination expense was primarily due to the expansion of ourmarketing coordination services to a larger client base. Depreciation andamortization expense increased from $6.9 million for the first six months offiscal 2006 to $7.9 million for the first six months of fiscal 2007. Theincrease in depreciation and amortization expense is due to the expansion ofour loan processing operations which resulted in additional purchases of fixedassets. External call center costs increased from $5.9 million for the firstsix months of fiscal 2006 to $11.3 million for the first six months of fiscal2007. The increase in external call center costs was primarily due to increasesin personnel necessary to process the volume of loans facilitated during thefiscal 2007 period.

General and administrative expenses increased duringthe second quarter of fiscal 2007 as compared to the second quarter of 2006 asa result of increases in several subcategories of expenses. Marketingcoordination expenses increased from $3.1 million for the second quarter offiscal 2006 to $9.0 million for the second quarter of fiscal 2007. The increasein marketing coordination expense was primarily due to the expansion of ourmarketing coordination services to a larger client base. External call centercosts increased from $2.1 million for the second quarter of fiscal 2006 to $4.4million for the second quarter of fiscal 2007. The increase in external callcenter costs is primarily due to an increase in the number of customer servicepersonnel necessary to process the increased volume of loans facilitated duringthe fiscal 2007 period.

Weexpect that our operating expenses will continue to increase as we devoteadditional resources to marketing coordination services and the expectedincreasing loan volumes facilitated for our existing and new clients. Thefollowing table summarizes the components of operating expenses, both thosereimbursed and not reimbursed by TERI under our master servicing agreement.

| ** **                                | ** ** | **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  December 31,** | ** ** |                                           | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| 2006                                      |       |                                           | $          | 13,669 | ** ** |   |   | $ | 15,922 | ** ** |   |   | $ | 29,591 | ** ** |   |   | $ | 12,226 | ** ** |   |   | $ | 17,166 | ** ** |   |   | $ | 29,392 | ** ** |   |   | $ | 58,983 | ** ** |   |
| 2005                                      |       |                                           | 13,079     | ** ** |   |   | 12,055 | ** ** |   |   | 25,134 | ** ** |   |   | 8,081 | ** ** |   |   | 10,836 | ** ** |   |   | 18,917 | ** ** |   |   | 44,051 | ** ** |   |
| **Six  months ended December 31,**   | ** ** |                                           | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| 2006                                      |       |                                           | $          | 30,699 | ** ** |   |   | $ | 35,922 | ** ** |   |   | $ | 66,621 | ** ** |   |   | $ | 26,804 | ** ** |   |   | $ | 31,157 | ** ** |   |   | $ | 57,961 | ** ** |   |   | $ | 124,582 | ** ** |   |
| 2005                                      |       |                                           | 25,930     | ** ** |   |   | 25,001 | ** ** |   |   | 50,931 | ** ** |   |   | 14,972 | ** ** |   |   | 23,815 | ** ** |   |   | 38,787 | ** ** |   |   | 89,718 | ** ** |   |

 

***Income Tax Expense***

Income tax expense increased to $154.0 million for thefirst six months of fiscal 2007 from $75.3 million for the first sixmonths of fiscal 2006. The increase in income tax expense was primarily theresult of an increase in the amount of income before income tax expense betweenperiods. During the first six months of fiscal 2007 our effective tax rate, orthe income tax expense as a percentage of income before tax expense, increasedto approximately 40.9% from an effective tax rate of 38.5% for all of fiscal2006. The increase in our effective tax rate was primarily due to the change inthe relative sources of total revenues as our up-front structural advisory feesincreased and our residual revenues decreased during the first six months offiscal 2007 as compared to all of fiscal 2006. Our effective tax rateapplicable to up-front structural advisory fees is greater than our effectivetax rate applicable to residual revenues.

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Income tax expensedecreased to $57.6 million for the second quarter of fiscal 2007 from $79.2million for the second quarter of fiscal 2006. The decrease in income taxexpense in the second quarter of fiscal 2007 as compared to the secondquarter of fiscal 2006 was due to the decrease in income before taxes betweenthe periods as a result of the relative sizes of the securitizationtransactions completed during the second quarters of fiscal 2006 and fiscal2007.

**FinancialCondition, Liquidity and Capital Resources**

Our liquidity requirementshave historically consisted, and we expect that they will continue to consistof, capital expenditures, working capital, business development expenses,general corporate expenses, repurchases of our common stock, quarterly cashdividends and potential acquisitions.

***Short-term Funding Requirements***

We expect to fund ourshort-term liquidity requirements through cash flow from operations. Webelieve, based on our current operating plan, that our current cash and cashequivalents will be sufficient to fund our operations through at least fiscal2008.

***Long-term Funding Requirements***

We expect to fund the growth of our business throughcash flow from operations and through issuances of common stock, promissorynotes or other securities. We expect to assess our financing alternativesperiodically and access the capital markets opportunistically. If our existingresources are insufficient to satisfy our liquidity requirements, or if weenter into an acquisition or strategic arrangement with another company, we mayneed to sell additional equity or debt securities. Any sale of additionalequity or convertible debt securities may result in additional dilution to ourstockholders, and we cannot be certain that additional public or privatefinancing will be available in amounts or on terms acceptable to us, if at all.If we are unable to obtain this additional financing, we may be required todelay, reduce the scope of, or eliminate one or more aspects of our businessdevelopment activities, which could harm the growth of our business, or we maybe required to reduce or eliminate our quarterly cash dividends to ourstockholders.

Our actualliquidity and capital funding requirements may depend on a number of factors,including:

·       thetiming, size and structure of the securitization transactions that westructure, as well as the composition of the loan pool being securitized;

·       theamount and timing of receipt of additional structural advisory fees andresiduals;

·       ouroperating and information systems needs;

·       theextent to which our services gain increased market acceptance and remaincompetitive;

·       theextent to which we repurchase shares of our common stock or pay cash dividendsto our stockholders;

·       regulatorycapital requirements applicable to Union Federal;

·       thetiming and magnitude of income tax payments; and

·       the costs and timing ofacquisitions of complementary businesses.

***Treasury Stock***

We had treasury stock of$135.5 million at December 31, 2006 and $121.5 million at June 30, 2006.Our treasury stock balance was derived from the repurchases of our common stockin open market 

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transactions.Our board of directors approved the repurchase of 2,250,000 shares of ourcommon stock in the fourth quarter of fiscal 2005 and approved the repurchaseof an additional 7,500,000 shares of our common stock in the first quarter offiscal 2006. As of December 31, 2006, we had repurchased an aggregate of6,206,700 shares at an average price, excluding commissions, of $21.81 pershare. During July 2006, werepurchased 436,500 shares of common stock at an average purchase price pershare, excluding commissions, of $31.88.

***Cash, Cash Equivalents and Investments***

At December 31, 2006,we had $256.6 million in cash, cash equivalents and investments. At June 30,2006, we had $143.0 million in cash, cash equivalents and investments. Theincrease in cash, cash equivalents and investments is primarily due to cashgenerated from our September 2006 and December 2006 securitizationtransactions, offset by cash used to fund cash dividends and repurchases of ourcommon stock during the first six months of fiscal 2007. Cash, cash equivalentsand investments at December 31, 2006 primarily included investments invariable rate demand notes, mortgage backed securities, Federal Home Loan Bankbonds and funds deposited in a money market fund that invests in short-termobligations of the U.S. Treasury and repurchase agreements fully collateralizedby obligations of the U.S. Treasury.

***Loans Held for Sale***

At December 31, 2006,we had loans held for sale of $14.9 million as compared to no loans at June 30,2006. The increase in loans held for sale resulted from our acquisition ofUnion Federal on November 30, 2006. Our loans held for sale at December 31,2006 were comprised entirely of mortgage loans.

***Service Receivables***

Our service receivablesincreased to $711.6 million at December 31, 2006 from $551.6 millionat June 30, 2006, primarily as a result of the structural advisory feesand residuals generated from the September 2006 and December 2006securitization transactions. The increase in service receivables was also dueto a net increase in our estimate of the fair value of our residuals receivableof $25.8 million during the first six months of fiscal 2007, primarily as a resultof the accretion of the discounting inherent in the fair value estimates due tothe passage of time.

***Property and Equipment, net***

During the first sixmonths of fiscal 2007, our property and equipment, net increased by $0.3million, as $7.6 million of depreciation expense recorded during the period wasmore than offset by $7.8 million we spent on the expansion and improvementof our loan processing facilities and systems. During the first six months offiscal 2007, we financed the acquisition of $0.1 million in equipment throughcapital leases.

***Prepaid Income Taxes***

We had no prepaid incometaxes at December 31, 2006 as compared to $11.6 million at June 30,2006. At June 30, 2006, this balance was primarily derived from the incometax benefit of employee stock option exercises and tax allocation strategiesimplemented in the fourth quarter of fiscal 2006.

***Other Prepaid Expenses***

Other prepaid expensesdecreased to $14.1 million at December 31, 2006 from $17.3 million at June 30,2006, primarily due to a decrease in prepaid marketing expenses ofapproximately $2.2 million.

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***Other Assets***

Other assets decreased to$4.9 million at December 31, 2006 from $5.1 million at June 30, 2006.

***Deposits***

At December 31, 2006,we had deposits of $36.5 million as compared to no deposits at June 30,2006. The increase in deposits resulted from our acquisition of Union Federalon November 30, 2006.

***Accounts Payable and Accrued Expenses***

Accounts payable andaccrued expenses increased to $37.1 million at December 31, 2006 from $34.4 millionat June 30, 2006. Our accrued bonuses were approximately $1.0 millionhigher at December 31, 2006 as compared to June 30, 2006 due to anincrease in accruals related to our employee incentive compensation plans,primarily as a result of our positive financial results during the first sixmonths of fiscal 2007. Our accounts payable were $2.0 million higher at December 31,2006, as compared to June 30, 2006, primarily due to the timing of thereceipt and processing of invoices.

***Income Taxes Payable***

We had income taxespayable of $5.4 million at December 31, 2006 as compared to no incometaxes payable at June 30, 2006. Our income taxes payable increased as aresult of the earnings generated during the first six months of fiscal 2007.

***Net Deferred Income Tax Liability***

We have a net deferredincome tax liability primarily because, under GAAP, we recognize residuals infinancial statement income earlier than they are recognized for income taxpurposes. Our net deferred income tax liability increased primarily as a resultof the increase in residual revenue recognized during the first six months offiscal 2007, which more than offset the recognition of our share of taxableincome from the securitization trusts.

***Capital Lease Obligations***

Capital lease obligationsdecreased to $6.9 million at December 31, 2006 from $8.8 million at June 30,2006, primarily due to scheduled principal payments made during the first sixmonths of fiscal 2007.

***Notes Payable to TERI***

Notes payable to TERIdecreased to $4.1 million at December 31, 2006 from $4.5 million at June 30,2006. The balance relates to two acquisition notes we issued to acquire TERI’sloan processing operations in 2001. The decrease in notes payable to TERI wasdue to the scheduled principal payments made during the first six months offiscal 2007.

***Other Liabilities***

Other liabilitiesincreased to $2.3 million at December 31, 2006 from $2.2 million at June 30,2006. The balance at both period ends related primarily to deferred rentrelated to several operating leases for office space.

***Contractual Obligations***

As of December 31,2006, our contractual obligations had not changed materially from thosedescribed under the caption “Item 7. Management’s Discussion and Analysis ofFinancial Condition and 

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Resultsof Operations-Financial Condition, Liquidity and Capital Resources-ContractualObligations” in our annual report on Form 10-K for the fiscal yearended June 30, 2006.

***Cash Flows***

Our net cash provided byoperating activities increased to $135.2 million for the first six months offiscal 2007, compared to cash provided by operating activities of $46.4 millionfor the first six months of 2006. The increase in cash provided by operationsresulted primarily from increases in net income and deferred income tax expenseoffset in part by increases in residual receivables and structural advisory feereceivables.

Our cash used in investingactivities increased to $21.3 million during the first six months of fiscal 2007,compared to $7.2 million used in investing activities during the first sixmonths of fiscal 2006. Net cash used in investing activities increased duringthe first six months of fiscal 2007 primarily as a result of net purchases ofinvestments and, to a lesser extent, capital expenditures related to the expansionand improvement of our loan processing facilities and systems.

Net cash used in financingactivities decreased to $29.2 million during the first six months of fiscal 2007,compared to $80.5 million during the first six months of fiscal 2006. Anincrease in use of cash for cash dividends during the first six months offiscal 2007 compared to the first six months of fiscal 2006 was more thanoffset by a decrease in use of cash for repurchases of common stock during thefiscal 2007 period compared to the fiscal 2006 period.

We expect that our capitalexpenditure requirements for the final two quarters of fiscal 2007 will beapproximately $23.0 million. We expect to use these funds primarily for theexpansion of our loan processing operations and the purchase of computer andoffice equipment.

***Borrowings***

In June 2001, weissued two acquisition notes to TERI totaling $7.9 million to acquire TERI’sloan processing operations as well as its workforce-in-place. Principal andinterest at an annual rate of 6% is payable on these notes in 120 monthlypayments of $87,706 commencing on July 20, 2001 and ending on June 20,2011. At December 31, 2006, outstanding principal on these notes totaled$4.1 million as compared to $4.5 million at June 30, 2006.

**Off-Balance Sheet Transactions**

We offer outsourcing services in connection with thelifecycle of a private student loan, from program design and marketing coordinationthrough loan administration and, ultimately, to the sale and securitization ofthe loans. We also structure and facilitate the securitization of student loansfor our clients through a series of bankruptcy remote, qualified specialpurpose trusts.

We do not utilize these trusts as a means to transferassets or liabilities from our balance sheet to those of the trusts because weare not the originator of the securitized student loans or the issuer of therelated debt. We do not serve as lender, guarantor or loan servicer for studentloans. Specifically, these trusts purchase such student loans from third-party financialinstitutions, the financing of which is provided through the issuance ofasset-backed securities.

The principal usesof these trusts are to:

·       generatesources of liquidity for our clients’ assets sold into such trusts and toreduce their credit risk;

·       makeavailable more funds to students and colleges; and

·       leveragethe capital markets to reduce borrowing costs to students.

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See “—Executive Summary—Applicationof Critical Accounting Policies and Estimates—Consolidation” for a discussionof our determination to not consolidate these securitization trusts.

**Inflation**

Inflation was not amaterial factor in either revenue or operating expenses during the periodspresented.

**Factors That May AffectFuture Results**

This quarterly reportincludes forward-looking statements within the meaning of Section 21E ofthe Securities Exchange Act of 1934, as amended, or the Exchange Act, and Section 27Aof the Securities Act of 1933, as amended. For this purpose, any statementscontained herein regarding our strategy, future operations, financial position,future revenues, projected costs, prospects, plans and objectives ofmanagement, other than statements of historical facts, are forward-lookingstatements. The words “anticipates,” “believes,” “estimates,” “expects,” “intends,”“may,” “plans,” “projects,” “will,” “would” and similar expressions areintended to identify forward-looking statements, although not allforward-looking statements contain these identifying words. We cannot guaranteethat we actually will achieve the plans, intentions or expectations expressedor implied in our forward-looking statements. There are a number of importantfactors that could cause actual results, levels of activity, performance orevents to differ materially from those expressed or implied in theforward-looking statements we make. These important factors include our “criticalaccounting estimates” set forth above under “—Application of CriticalAccounting Policies and Estimates” and the risk factors set forth below underItem 1A of Part II. Although we may elect to update forward-lookingstatements in the future, we specifically disclaim any obligation to do so,even if our estimates change, and readers should not rely on thoseforward-looking statements as representing our views as of any date subsequentto February 8, 2007.

**Item 3—Quantitativeand Qualitative Disclosures about Market Risk**

***General***

Market risk is the risk ofchange in fair value of a financial instrument due to changes in interestrates, equity prices, creditworthiness, foreign exchange rates or otherfactors. At June 30, 2006 and December 31, 2006, our primary market riskexposure related to changes in interest rates applicable to our cash, cashequivalents and investments. At December 31, 2006, as a result of ouracquisition of Union Federal, our exposure to market risk also included loansheld for sale and deposits. Our overall market risk as of December 31, 2006,however, had not changed materially as a result of the acquisition or otherwise.

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

Because there are noquoted market prices for our additional structural advisory fees and residualsreceivables, we use discounted cash flow modeling techniques and variousassumptions 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 themulti-year forward estimates of the LIBOR rate, which is the reference rate fornearly all of the loan assets and all of the borrowings of the securitizationtrusts, would have a negative effect on the value of our additional structuraladvisory fees and residuals. For an analysis of the estimated change in ourstructural advisory fees and residuals receivables balance at December 31,2006 based on changes in these loan performance assumptions, see “Management’sDiscussion and Analysis of Financial Conditions and 

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Resultsof Operations—Executive Summary—Application of Critical Accounting Policies andEstimates—Sensitivity Analysis.”

**Item 4—Controls andProcedures**

Our management, with the participation of our chiefexecutive officer and chief financial officer, evaluated the effectiveness ofour disclosure controls and procedures as of December 31, 2006. The term “disclosurecontrols and procedures,” 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 management necessarilyapplies its judgment in evaluating the cost-benefit relationship of possiblecontrols and procedures. Based on the evaluation of our disclosure controls andprocedures as of December 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.

No change in our internal control over financialreporting, as defined in Rules 13a-15(f) and 15d-15(f) underthe Exchange Act, occurred during the fiscal quarter ended December 31,2006 that has materially affected, or is reasonably likely to materiallyaffect, our internal control over financial reporting.

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**Part II.   OtherInformation**

**Item 1A.**   RiskFactors

Investing in our common stock involves a high degreeof risk. You should carefully consider the risks and uncertainties describedbelow in addition to the other information included in this quarterly report.If any of the following risks actually occurs, our business, financialcondition or results of operations would likely suffer. In that case, thetrading price of our common stock could fall.

Other than updatingfinancial and information for the most recently completed fiscal quarter, wehave not made any material changes to the risk factors previously disclosed inour quarterly report on Form 10-Q for the quarter ended September 30,2006, other than:

·       inlight of the closing of our acquisition of Union Federal, we deleted the riskfactor previously entitled, “We may not receive approval from the Office ofThrift Supervision to acquire Union Federal Savings Bank,” and we updated thefollowing risk factors:

·        “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.”

·        “we could also becomesubject to registration or licensing and other regulatory requirements inMassachusetts and other states by expanding the scope or extent of ourservices.”

***We derive asignificant portion of our revenue and substantially all of our income fromstructuring securitization transactions; our financial results and futuregrowth would be adversely affected if we are unable to structuresecuritizations.***

Securitization refers tothe 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 33 loan securitizationssince our formation in 1991. In connection with securitizations, we receivecompensation in the form of structural advisory fees, residuals andadministrative fees for management of the trusts. The amount and timing of thefees we recognize are affected, in part, by the size and structure of thesecuritization transactions, as well as the composition of loan pools to besecuritized, the return expectations of investors and assumptions we makeregarding loan portfolio performance, including defaults, recoveries,prepayments and the cost of funding. Revenue from new securitizationsconstituted 78% of our total revenue for the first six months of fiscal 2007, 74%of our total revenue for fiscal 2006 and 75% of our total revenue for fiscal2005. Substantially all of our net income in those fiscal periods wasattributable to securitization-related revenue.

***A number offactors, some of which are beyond our control, may adversely affect oursecuritization activities and thereby adversely affect our results ofoperations.***

Our financialperformance and future growth depend in part on our continued success instructuring securitizations. Several factors may affect both our abilityto structure securitizations and the revenue we generate for providing our structuraladvisory and other services, including the following:

·       degradationof the credit quality or performance of the loan portfolios of the trusts westructure, which could reduce or eliminate investor demand for futuresecuritizations that we facilitate;

·       prolongedvolatility in the capital markets generally or in the student loan asset-backedsecurities sector specifically, which could restrict or delay our access to thecapital markets;

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·       adverseperformance of, or other problems with, student loan-backed securitizationsthat other parties facilitate could impact pricing or demand for oursecuritizations;

·       challengesto the enforceability of student loans based on violations of federal or stateconsumer protection laws and related regulations, or imposition of penalties orliability on assignees of student loans for violation of such laws andregulations;

·       anymaterial downgrading or withdrawal of ratings given to securities previouslyissued in securitizations that we structured, or any occurrence of an event ofdefault with respect to such securities, which could reduce demand foradditional securitizations that we structure; and

·       unwillingnessof financial guarantee providers to offer credit insurance in thesecuritizations that we structure or in student loan-backed securitizationsgenerally.

A portion of the securities issued since 1998 insecuritization transactions that we structured were sold to asset-backedcommercial paper conduits. If these or similar asset-backed conduits cease topurchase securities in the securitizations that we structure, wemay experience a delay in the timing of our securitizations as we seek tofind alternate channels of distribution.

Under the terms of some ofour contracts with key lender clients, we have an obligation to securitizeloans originated by those lenders periodically. We may agree with otherlenders to securitize more frequently in the future. If we do not honor theseobligations, we may be required to pay liquidated or other damages, whichcould adversely affect our results of operations.

***In connection withour recognition of revenue from securitization transactions, if the estimateswe make, or the assumptions on which we rely, in preparing our financialstatements prove inaccurate, our actual results may vary materially fromthose reflected in our financial statements.***

We receive structural advisory fees for our servicesin connection with securitization transactions. We receive an up-front portionof these structural advisory fees when the securitization trust purchases theloans or soon thereafter. We receive an additional portion of these structuraladvisory fees over time, based on the amount of loans outstanding in the trustfrom time to time over the life of the trust. We also have the right to receivea portion of any residual interests that the trust creates. As required underaccounting principles generally accepted in the United States of America, orGAAP, we recognize as revenue an estimate of the fair value of the additionalportion of the structural advisory fees and residuals at the time thesecuritization trust purchases the loans because these revenues are deemed tobe earned before they are actually paid to us. We record additional structuraladvisory fees and residuals as receivables on our balance sheet at our estimateof their fair value. Accounting rules require that these receivables berecorded at fair value and we use discounted cash flow modeling techniques andcertain assumptions to estimate fair value because there are no quoted marketprices for our additional structural advisory fees or residuals receivable. Weestimate the fair value both initially and in each subsequent quarter andreflect the change in our estimate of fair value in earnings for that period.Our key assumptions to estimate the fair value include prepayment and discountrates, interest rate trends, the spread between LIBOR and the auction rates onour senior auction rate notes, the expected credit losses from the underlyingsecuritized loan portfolio, net of recoveries, and the expected timing of cashflows from the trusts’ underlying student loan assets. If the actualperformance of some or all of the securitization trusts varies from the keyassumptions we use, the actual additional structural advisory fees and residualsthat we receive from the trusts could be significantly less than reflected inour current financial statements, and we may incur a material negativeadjustment to our earnings in the period in which our assumptions change. For adiscussion of the sensitivity of the additional structural advisory fees andresiduals to variations in our assumptions and estimates, see “Management’sDiscussion and Analysis of Financial Condition and Results of Operations—ExecutiveSummary—Application of Critical Accounting Policies and Estimates—ServiceRevenue and Receivables—Sensitivity Analysis.” In 

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particular, economic,regulatory, competitive and other factors affecting prepayment, default andrecovery rates on the underlying securitized loan portfolio, including full orpartial prepayments and prepayments as a result of loan consolidation activity,could cause or contribute to differences between the actual performance of thesecuritization trusts and our key assumptions.

Our residuals andadditional structural advisory fees in each securitization we have facilitatedare subordinate to securities issued to investors in such securitizations andmay fail to generate any cash flow for us if the securitized assets onlygenerate enough cash flow to pay the debt holders.

***Our financialresults could be adversely affected if we were required to consolidate thefinancial results of the entities that we use for securitizations that wefacilitate.***

We provide structuraladvisory and other services for loan securitizations undertaken throughstatutory trusts. We do not consolidate the financial results of the trustswith our own financial results. For a discussion of our decision not toconsolidate, see “Management’s Discussion and Analysis of Financial Conditionand Results of Operations—Executive Summary—Application of Critical AccountingPolicies and Estimates—Consolidation” included in this quarterly report. Someof the accounting rules relevant to this issue are in the process of beingamended. If we were required to consolidate the financial results of one ormore trusts with our own financial results as a result of amendments or changesin accounting rules, or if the SEC or other accounting authorities do not agreewith our current approach, our financial results could be adversely affected,particularly in the early years of a trust when the trust typically experienceslosses.

***If our relationships with key clients terminate, ourrevenue and results of operations would be adversely affected.***

We structure and support private student loan programsfor commercial banks, including JPMorgan Chase Bank and Bank of America.Structural advisory fees and residuals from securitization of JPMorgan ChaseBank loans represented approximately 26% of our total revenue for fiscal 2006and approximately 30% of our total revenue for fiscal 2005. Structural advisoryfees and residuals from securitization of Bank of America loans representedapproximately 16% of total revenue for fiscal 2006 and approximately 18% oftotal revenue for fiscal 2005. We also structure and support private studentloan programs for companies that assist lenders such as Charter One Bank, N.A.in marketing their programs to customers. Structural advisory fees andresiduals from securitization of loans marketed by Collegiate Funding Services,or CFS, represented approximately 10% of our total revenue for fiscal 2006 andapproximately 17% of our total revenue for fiscal 2005. JPMorgan Chase Bankacquired CFS in March 2006, and we entered into an agreement with JPMorganChase Bank in May 2006 that terminated our previous agreement with CFS.Under our new agreement, JPMorgan Chase Bank agreed to increase its marketingexpenditures in connection with its Education One loan program in an amountequal to CFS’s marketing commitment under its previous agreement with us,although we cannot assure you that the resulting loan volume will offset theloss of the loan volume derived from CFS.

We have agreements with lenders that govern thepurchase of loans for securitization. Our agreement with JPMorgan Chase Bank isscheduled to terminate in March 2010. Our agreements pursuant to whichCharter One Bank serves as a program lender are generally scheduled toterminate in May 2008. Our agreement with Bank of America governing thepurchase of direct-to-consumer loans expires on May 31, 2008, providedthat either party may terminate this agreement on or after June 1,2007, upon 90 days notice. Our agreement with Bank of America governing thepurchase of school channel loans can be terminated at any time upon 180 daysnotice. Our two agreements with Bank of America that govern the purchase ofGATE loans expire on November 30, 2007, but can be terminated by eitherparty with 90 days notice. In the absence of termination, both agreements willautomatically renew for successive one-year terms. Each client above has theright to terminate its agreement on short notice, generally 30 days orless, if we materially breach our agreement, including our failure toperform at service levels specified in those 

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contracts. In addition,under the terms of our lender clients’ guaranty agreements with TERI, both thelender and TERI may propose modifications to loan program guidelinesduring the first calendar quarter of each year. If the parties are unable toagree on a proposed modification, such as an adjustment of the guarantee fees,the party proposing the modification has the option of terminating the guarantyagreement, effective as of May 1 of that calendar year. Under its masterloan guaranty agreement with us, TERI may not propose a change to programguidelines without our consent. Similarly, under our agreements with lendersthat have multi-year terms, the lender cannot change the program guidelineswithout our consent, which we cannot unreasonably withhold.

A significant decline inservices to JPMorgan Chase Bank, Bank of America, or Charter One Bank, or thetermination of guaranty agreements between those lenders and TERI, could reducethe overall volume of loans we facilitate, which could be difficult to replacethrough arrangements with other lenders. Our revenue, business and financialresults could suffer as a result.

***The outsourcingservices market for education lending is highly competitive and if we are notable to compete effectively, our revenue and results of operations may beadversely affected.***

We assist national and regional financial institutionsand educational institutions, as well as businesses, education loan marketersand other enterprises, in structuring and supporting their private educationloan programs. We receive fees for services we provide primarily in connectionwith the securitization of our clients’ loans. The outsourcing services marketin which we operate includes a large number of service providers, some of whichhave greater financial, technical and marketing resources, larger customerbases, greater name recognition and more established relationships with theirclients than we have. Larger competitors with greater financial resourcesmay be better able than us to respond to the need for technologicalchanges, compete for skilled professionals, build upon efficiencies based on alarger volume of loan transactions, fund internal growth and compete for marketshare generally. We may face competition from our clients if they choose,or acquire the ability, to provide directly the services that we provide. In March 2006,our client JPMorgan Chase Bank completed its acquisition of CFS, a marketer ofeducation loans we facilitate. This acquisition could result in the emergenceof a new competitor with the ability to offer outsourced services, includingsecuritization services, for private student loans. In addition, wemay face competition from third parties who decide to expand theirservices to include the suite of services that we provide. We are aware oftwo principal competitors, SLM Corporation, or Sallie Mae, and Servus FinancialCorporation, an affiliate of Wells Fargo Company, that offer a similar range ofservices to lenders. Our business could also be adversely affected if SallieMae’s program to market private student loans directly to consumers continuesto grow, if Sallie Mae seeks to market more aggressively to third parties thefull range of services for private loan programs that we provide or if SallieMae’s recently announced private loan consolidation product results inincreased consolidation of private student loans held by the securitizationtrusts we have facilitated. We are also aware of smaller privately held venturebacked companies that are developing systems and expertise with plans tocompete directly with us. If we are not able to compete effectively, ourrevenue and results of operations may be adversely affected. In addition, ifthird parties choose to provide the range of services that we provide, pricingfor our services may become more competitive, which could lower ourprofitability.

In addition, there has been significant consolidationwithin the banking industry. For example, in 2004 Charter One Financial, Inc.,the publicly-traded parent company of Charter One Bank was acquired by CitizensFinancial Group, Inc. and Bank One Corporation was acquired by JPMorganChase & Co. In addition, Sallie Mae acquired our client, SouthwestStudent Services Corporation, resulting in termination of our relationship withthat client. The acquisition by JPMorgan Chase Bank of CFS could result in areduction in our business with either or both of them. The merger may alsonegatively affect the volume of Charter One Bank loans that we process andsecuritize, because Charter One Bank no longer serves as a 

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program lender for CFSloan programs that we facilitate. Further consolidation could result in a lossof business if one or more of our clients were acquired by a competitor or alender 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, including in response to legislative initiativesaffecting the availability and profitability of federal loans.

***If our clients do not successfully market and sellstudent loans, our business will 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. Inaddition, if the loans were marketed by our clients in a manner that is unfairor deceptive, or if the marketing, origination or servicing violated anyapplicable law, state unfair and deceptive practices acts could imposeliability on a securitization trust holding the loan or create defenses to theenforceability of the loan. In response to recent legislative initiatives,lenders may increasingly focus on the direct to consumer marketing channel,increasing competition within the channel for private student loans.

***In structuring andfacilitating securitizations of our clients’ loans and as holders of rights toreceive residual cash flows in those trusts, we may incur liabilities toinvestors in the asset-backed securities those trusts issue.***

We have facilitated and structured a number ofdifferent special purpose trusts that have been used in securitizations tofinance student loans that our clients originate. Under applicable state andfederal securities laws, if investors incur losses as a result of purchasingasset-backed securities that those trusts issue, we could be deemed responsibleand could be liable to those investors for damages. If we failed to cause thetrusts to disclose adequately all material information regarding an investmentin the asset-backed securities or if the trust made statements that were misleadingin any material respect in information delivered to investors, it is possiblethat we could be held responsible for that information or omission. Inaddition, under various agreements entered into with underwriters or financialguarantee insurers of those asset-backed securities, we are contractually boundto indemnify those persons if investors are successful in seeking to recoverlosses from those parties and the trusts are found to have made materiallymisleading statements or to have omitted material 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.

***If our relationship with TERI terminates, our businesscould be adversely affected.***

In June 2001,we purchased the loan processing operations of TERI and entered into a seriesof agreements 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 $66.7 million, or 13% of total revenue,for the first six months of fiscal 2007, and $51.2 million or 19% of totalrevenue, for the first six months of fiscal 2006. In addition, we have agreedto 

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undertakeon a best-efforts basis to arrange or facilitate securitizations for a limitedcategory of TERI-guaranteed loans and have the right to receive structural advisoryand other fees in connection with these securitizations. We also have enteredinto an agreement to receive from TERI updated information about theperformance of the student loans it has guaranteed, to allow us to supplementour database. Each of these agreements with TERI had an initial term through June 2006.In October 2004, we exercised our option to renew each agreement for anadditional five-year term, through June 2011. If our agreements with TERIterminate for any reason, or if TERI fails to comply with its obligations, ourbusiness would be adversely affected and the value of our intangible assetscould be impaired for the following reasons:

·       wemay not be able to offer our clients guarantee services from another guarantorand, accordingly, our access to loans and our opportunities to structuresecuritization transactions may diminish significantly;

·       wemay not be successful in establishing an arrangement with a third-party toprovide the warranties that TERI currently provides to lenders related toorigination services. In such case, we may be required to provide suchwarranties; and

·       ifTERI is unable to provide guarantee services for loans, any financial guaranteeinsurance coverage we obtain in securitization transactions could be costly, ifavailable at all.

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

***Our business couldbe 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 December 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, our clients may not wish to enter into guarantee arrangements withTERI. In addition, we may receive lower structural advisory fees because itcould be necessary to obtain financial guarantee insurance for the asset-backedsecuritizations that we structure. Finally, the inability of TERI as studentloan guarantor to meet its guaranty obligations could reduce the amount ofprincipal or interest paid to the holders of asset-backed securities, whichcould adversely affect our residual interests in securitization trusts or harmour ability to structure securitizations in the future. In each such case, ourbusiness would be adversely affected.

***Our business couldbe adversely affected if PHEAA fails to provide adequate or timely services orif our relationship with PHEAA terminates.***

As of December 31,2006, PHEAA serviced a majority of loans whose origination we support. Thisarrangement allows us to increase the volume of loans in our clients’ loanprograms without incurring the overhead investment in servicing operations. Ourreliance on an external service provider for loan servicing subjects us torisks associated with inadequate or untimely services, such as inadequatenotice of developments in prepayments, delinquencies and defaults. Asubstantial increase in these rates could adversely affect our ability toaccess profitably the securitization markets for our clients’ loans and thevalue of our additional structural advisory fees and residuals receivable. Inaddition, if our relationship with PHEAA terminates, we would either need toexpand or develop a relationship with another TERI-approved loanservicer, which could be time consuming and costly. In such event, our businesscould be adversely affected. Although we periodically review the costsassociated with establishing servicing operations to service loans, we have noplans to establish and perform servicing operations at this time.

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***The growth of ourbusiness could be adversely affected by changes in federal student loanprograms or expansions in the population of students eligible for loans underfederal 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 and terms of loans that the federal government originates orguarantees affects the demand for private student loans because students andtheir families often rely on private loans to bridge a gap between availablefunds, including family savings, grants and federal and state loans, and thecosts of post-secondary education. The federal government currently places bothannual and aggregate limitations on the amount of federal loans that anystudent can receive and determines the criteria for student eligibility. Theseguidelines are adjusted in connection with funding authorizations from theUnited States Congress for programs under the Higher Education Act. DuringFebruary 2006, Congress passed, and the President signed, the DeficitReduction Act of 2005. The Deficit Reduction Act of 2005 includes severalchanges to federal student loan programs. Although aggregate borrowing limitsdo not change, the Deficit Reduction Act of 2005 increases amounts that firstand second year college students may borrow and makes Parent Loans forUndergraduate Students, or PLUS, loans available to graduate and professionalstudents. Loans to fund graduate level education represented approximately 11%during the first six months of fiscal 2007, 15% during fiscal 2006 and 13%during fiscal 2005 of our total loan facilitation volume. The loan limitincreases take effect July 1, 2007 while most other provisions took effectJuly 1, 2006. Recent legislation, as well as future legislation, couldweaken the demand for private student loans, which could adversely affect thevolume of private loans and the securitization transactions that we facilitateand structure and, as a result, the growth of our business.

***Access to alternative means of financing the costs ofeducation may reduce demand for private student loans.***

The demand forprivate student loans could weaken if student borrowers use other vehicles tobridge the gap between available funds and costs of post-secondary education.These vehicles include, among others:

·       homeequity loans, under which families borrow money based on the value of theirreal estate;

·       pre-paidtuition plans, which allow students to pay tuition at today’s rates to covertuition costs in the future;

·       529plans, which are state-sponsored investment plans that allow a family to savefunds for education expenses; and

·       educationIRAs, now known as Coverdell Education Savings Accounts, under which a holdercan make annual contributions for education savings.

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

***The timing of oursecuritization activities and size of our securitization transactions willgreatly affect our quarterly financial results.***

Our quarterly revenue,operating results and profitability have varied and may continue to varysignificantly on a quarterly basis. In fiscal 2006, we recognized 6%, 41%, 26%and 27% of our total service revenue in the respective fiscal quarters offiscal 2006. Our quarterly revenue varied primarily because of the timing ofthe securitizations that we structured. In fiscal 2006, we facilitated onesecuritization in the second quarter, one securitization in the third quarter,and two securitizations in the fourth quarter, but none in the first quarter.Unlike in previous fiscal years, we facilitated one securitization in the firstquarter and one securitization in the second quarter of fiscal 2007. Variationsin the size or structure of each securitization transaction, as well as thecomposition of the loan pools being securitized, will continue to 

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resultin variability of our operating results on a quarterly basis. The timing andsize of our planned securitization activities may be affected by theseasonality of student loan applications and loan originations, as well as theother factors that could adversely affect our securitization activities. Originationof student loans is generally subject to seasonal trends, with the volume ofloan applications increasing with the approach of tuition payment dates. Infiscal 2006, we processed 37% of our total loan facilitation volume in thefirst quarter ended September 2005, and 19%, 25% and 19% of our total loanfacilitation volume in the respective successive quarters.

***If competitorsacquire or develop a student loan database or advanced loan informationprocessing 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 on behalfof lenders, determine the terms of securitization transactions and establishthe fair value of the structural advisory fees and residuals that we recognizeas revenue. We also have developed a proprietary loan information processingsystem to enhance our application processing and loan origination capabilities.Our student loan database and loan information processing system provide uswith a competitive advantage in offering our services. Third parties couldcreate or acquire databases and systems such as ours. For example, as lendersand other organizations in the student loan market originate or service loans,they compile over time information for their own student loan performancedatabase. If a third party creates or acquires a student loan database ordevelops a loan information processing system, our competitive positioning,ability to attract new clients and business could be adversely affected.

***Changes in interestrates could affect the value of our additional structural advisory fees andresiduals receivable, as well as demand for private student loans and our 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 defaultrates for outstanding student loans. In addition, higher interest rates, or theperception that interest rates could increase in the future, could cause anincrease in prepayments, including full or partial prepayments or prepaymentsas a result of loan consolidation activity. In particular, prepayments mayincrease during periods in which long-term interest rates, such as interestrates on mortgages, are lower than short-term interest rates, including rateson student loans. If the prepayment or default rates increased for the studentloans held by the securitization trusts, we may experience a decline in thevalue of our additional structural advisory fees and residuals receivable,which could cause a decline in the price of our common stock and could causefuture securitization transactions to be less profitable for us. In addition,most of the student loans that our clients originate carry floating rates ofinterest tied to prevailing short-term interest rates. An increase in interestrates could reduce borrowing for education generally, which, in turn, couldcause the overall demand for our services to decline.

***If we are unable toprotect the confidentiality of our proprietary database and information systemsand processes, the value of our services and technology will be adverselyaffected.***

We rely on trade secret laws and restrictions ondisclosure to protect our proprietary database and information systems andprocesses. We have entered into confidentiality agreements with third partiesand with some of our employees to maintain the confidentiality of our tradesecrets and proprietary information. These methods may neither effectivelyprevent disclosure of our confidential information nor provide meaningfulprotection for our confidential information if there is unauthorized use ordisclosure.

We own no patents and havefiled no patent applications with respect to our proprietary database or loaninformation processing systems. Accordingly, our technology is not covered bypatents that would preclude or inhibit competitors from entering our market.Monitoring unauthorized use of the systems and 

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processesthat we developed is difficult, and we cannot be certain that the steps that wehave taken will prevent unauthorized use of our technology. Furthermore, othersmay independently 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.

***An interruption in or breach of our informationsystems 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. Our systems and operations are potentially vulnerable to damage orinterruption from network failure, hardware failure, software failure, power ortelecommunications failures, computer viruses and worms, penetration of ournetwork by hackers or other unauthorized users and natural disasters. Anyfailure or interruption, or breach in security, of our information systems orthe third-party information systems on which we rely could cause underwritingor other delays and could result in fewer loan applications being received,slower processing of applications and reduced efficiency in loan processing. Afailure, interruption or breach in security could also result in an obligationto notify clients in states such as California that require such notification,with possible civil liability resulting from such failure, interruption orbreach. We cannot assure you that such failures, interruptions or breaches willnot occur, or if they do occur that we or the third parties on whom we relywill adequately address them. The precautionary measures that we haveimplemented to avoid systems outages and to minimize the effects of any data ortelephone systems interruptions may not be adequate, and we may not haveanticipated or addressed all of the potential events that could threaten orundermine our information systems. In addition, we have not institutedredundancy for key systems. The occurrence of any failure, interruption orbreach could significantly impair the reputation of our brand, diminish theattractiveness of our services and harm our business.

***If we experience adata security breach and confidential customer information is disclosed, we maybe subject to penalties imposed by regulators, civil actions for damages andnegative publicity, which could affect our customer relationships and have amaterial adverse effect on our business. In addition, current state and federallegislative proposals, if enacted, may impose additional requirements on us tosafeguard confidential customer information, which may result in increasedcompliance costs. We have devoted significant technological resources toaddress new federal requirements for authentication of Internet customers.***

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 data security breach,or if we or the securitization trusts that we administer otherwise improperlydisclose confidential customer information, such breach or other disclosurecould generate negative publicity about us and could adversely affect ourrelationships with our clients, including the lenders and educationalinstitutions with which we do business. This could have a material adverseeffect on our business. In addition, pending legislative proposals, if adopted,likely would result in substantial penalties for unauthorized disclosure ofconfidential consumer information. New requirements issued by the FederalFinancial Institutions Examination Council regarding authentication ofcustomers accessing account information became effective January 1, 2007.Those requirements have posed technology challenges for us, and we are in theprocess of implementing additional authentication procedures in order to complywith those requirements. Failure to comply with those requirements could resultin regulatory sanctions imposed on our client lenders and loss of business forus.

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***The loanorigination 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 an increasing volume oftransactions is based in large part on the systems and processes we haveimplemented and developed. The loan origination process is becomingincreasingly dependent upon technological advancement such as the ability toprocess loans over the Internet, accept electronic signatures and provideprocess updates instantly. Our future success depends in part on our ability todevelop and implement technology solutions that anticipate and keep pace withthese and other 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 to expendsignificant funds to develop or acquire new technologies. If we cannot offernew 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.

***We have expandedour operations rapidly in recent years, and if we fail to manage effectivelyour growth, our financial results could be adversely affected.***

From our inception to December 31, 2006, ourassets have grown to $1.0 billion. Our revenue increased to $500.7 million forthe first six months of fiscal 2007 from $268.4 million for the first sixmonths of fiscal 2006. Our growth may place a strain on our management, systemsand resources. We must continue to refine and expand our business developmentcapabilities, our systems and processes and our access to financing sources. Aswe grow, we must continue to hire, train, supervise and manage new employees.

We have recently begun to co-source some borrowerservice functions, including some call center operations, in an effort toreduce costs and enhance our ability to process an increasing volume of loans.We have limited experience with our co-sourcing vendor and rely on the vendorto provide a high level of customer service. Our reliance on this externalservice provider subjects us to risks associated with inadequate or untimelyservices, and could result in a lower number of loans than we would experienceif we performed the service function in-house.

We recently completedour acquisition of Union Federal Savings Bank, North Providence, Rhode Island.We may face challenges in integrating our products, services and employees.

We cannot assure you that we will be able to:

·       expandour systems effectively;

·       allocateour human resources optimally;

·       identifyand hire qualified employees or vendors; or

·       incorporateeffectively the components of any business that we may acquire in our effort toachieve growth.

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

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***We may be subjectto state registration or licensing requirements in jurisdictions where we arenot currently registered or licensed. If we determine that we are subject tothe registration or licensing requirements of any jurisdiction, our compliancecosts could increase significantly and other adverse consequences may result.***

Based on the adviceof national counsel and, in some states, additional local counsel opinions andinformal advice from state regulators, we have been operating on the basis thatno registrations or licenses are required of us under laws applicable to loanbrokers, small lenders and loan arrangers, and other similar laws. We willcontinue to review state registration and licensing requirements that maybecome applicable to us in the future, in view of the expansion of the scope ofthe services we provide, our plans for future activities and the time that haselapsed since our prior review. As a result of this continuing review, we may determinethat registration or licensing is required in jurisdictions where we are notcurrently registered or licensed. Even if we are not physically present in astate, its regulators may take the position that registration or licensing isrequired because we provide services by mail, telephone, the Internet or otherremote means. If we identify any states in which registration or licensing isrequired, we will proceed with registration or licensing in the affected state.If any state asserts jurisdiction over our business, we will consider whetherto challenge the assertion or proceed with registration or licensing in theaffected state. Compliance with such requirements could involve additionalcosts, which could have a material adverse effect on our business. Our failureto comply with these laws could lead to, among other things:

·       curtailmentof our ability to continue to conduct business in the relevant jurisdiction,pending processing of registration or a license application;

·       administrativeenforcement actions;

·       classaction lawsuits;

·       theassertion of legal defenses delaying or otherwise affecting the enforcement ofloans; and

·       criminal as well as civilliability. This could have a material adverse effect on our business.

Our new affiliate, Union FederalSavings Bank, may conduct business without regard to such state licensing lawsand requirements, because it is chartered by the federal Office of ThriftSupervision, or OTS. Certain of our advertising and marketing coordinationemployees who focus on our proprietary brand loans have become employees ofUnion Federal, and will support those brands. To the extent that our engagementin marketing related activities becomes part of the business of Union Federal,the likelihood of assertion of state regulatory requirements affecting loanbrokers, small lenders and credits services organizations will be reduced.

***If the regulatory exemptions or rulings that allow usto conduct our business without registration or licensing are modified orrevoked, or the statutory and regulatory requirements change in the future, ourcompliance costs could increase substantially.***

The Massachusetts Division of Banks ruled that ourbusiness with TERI is not subject to licensing because, as a provider, of loanorigination outsourcing services, we do not conduct a lending business withconsumers in our own name and our processing centers are not generally open tothe public. The Massachusetts Small Loan Act requires any person that isengaged, for compensation, in the business of making small loans, or in aidingor assisting the borrower or the lender in procuring or making such loans, toobtain a license. Under the statute, the business of making small loansincludes the making of loans of $6,000 or less with interest rates and expensesof more than 12% per year. The TERI-guaranteed loans that we facilitate, aswell as GATE loans we support, 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 

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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 thesecuritizations that 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.

***We may be exposedto liability for failures of third parties with which we do business to complywith the registration, licensing and other requirements that apply to them.***

Third parties with whichwe do business, including federal and state chartered financial institutions,non-bank loan marketers, as well as TERI, are subject to registration,licensing and extensive governmental regulations, including Truth-in-Lendinglaws and other consumer protection laws and regulations. For example, some ofthe third-party marketers with which we do business may be subject to stateregistration or licensing requirements and laws and regulations, includingthose relating to small loans, loan brokers and credit services organizations.As a result of the activities that we conduct for our clients, it may beasserted that we have some responsibility for compliance by third parties withwhich we do business with the laws and regulations applicable to them, whetheron contractual or other grounds. If it is determined that we have failed tocomply with our obligations with respect to these third parties, we could besubject to civil or criminal liability.

***We could alsobecome subject to registration or licensing and other regulatory requirementsin Massachusetts and other states by expanding the scope or extent of ourservices.***

We are in the process ofexpanding the scope of the services we provide on behalf of lenders to includecertain advertising and marketing coordination functions. As a result of thisexpansion of our services, or if we expand our services in the future toinclude, among others, loan guarantees or direct solicitation of consumers, ourcurrent exemption from the Massachusetts Small Loan Act could be invalidated,and consequently, we may need to obtain a license from the MassachusettsDivision of Banks or secure an alternative exemption. In addition, we maybecome subject to the laws and regulations of other states governing suchexpanded services. We may also become subject to state regulatory requirementsif the extent 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. To the extent that ourengagement in marketing related activities becomes part of the business ofUnion Federal, such activities will not be subject to licensing requirementsimposed under the laws of the Commonwealth of Massachusetts or other statelaws.

***Failure to complywith consumer protection laws could subject us to civil and criminal penaltiesand have a material adverse effect on our business.***

The federal government andstate 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, result in greatercompliance costs, adversely affect the collection of balances due on the loanassets held by securitization trusts or otherwise adversely affect ourbusiness. For 

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example,the enactment in October 2006 of 10 U.S.C. section 987 (“Limitations onTerms of Consumer Credit Extended to Service Members and Dependents”) imposedextensive new disclosure requirements on all consumer loans made to servicemembers and their dependents other than mortgages and personal propertyfinance. The Department of Defense is currently considering regulations toexempt other loan types, such as education loans, from the requirements of theAct. If the requested exemption is not granted, we will incur substantialadditional expense complying with the requirements of the Act, and may berequired to create new types of products for persons protected by the Act. Therequirements of the Act become effective October 1, 2007. Moreover,changes in the consumer protection laws and related regulations, or in theprevailing interpretations thereof, could invalidate or call into question thelegality of certain of our services and business practices. Recent or futurechanges in federal and state bankruptcy and debtor relief laws may increasecredit 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.

***Recent litigationhas sought to re-characterize certain loan marketers 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 and educational institutions, aswell as other organizations, with an integrated suite of services in support ofprivate student loan programs. All of the lenders with which we work arefederally-insured banks and credit unions and, therefore, are not subject tomany state consumer protection laws, including limitations on certain interestrates, fees and other charges. In providing our private student loan services,we do not act as a lender, guarantor or loan servicer, and the terms of theloans that we securitize are regulated in accordance with the laws andregulations applicable to the lenders.

The association between high-interest “payday loans”marketers and out-of-state national banks has come under recent scrutiny.Recent litigation asserts that payday loan marketers use out-of-state lendersin order to evade the usury and interest rate caps, and other consumerprotection laws, imposed by the states where they do business. Such litigationhas sought, successfully in some instances, to re-characterize the loanmarketer as the lender for purposes of state consumer protection lawrestrictions. Similar civil actions have been brought in the context of giftcards. We believe that our activities, and the activities of third partieswhose marketing on behalf of lenders is coordinated by us, are distinguishablefrom the activities involved in these cases.

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 alender, and the loans (or the provisions governing interest rates, fees andother charges) could be unenforceable. In addition, we could be subject toclaims by consumers, as well as enforcement actions by regulators. Even if wewere not required to cease doing business with residents of certain states orto change our business practices to comply with applicable laws and regulations,we could be required to register or obtain licenses or regulatory approvalsthat could impose a substantial cost on us. To date, there have been no actionstaken or threatened against us on the theory that we have engaged inunauthorized lending. However, such actions could have a material adverseeffect on our business.

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***The price of our common stock may be volatile.***

The trading priceof our common stock may fluctuate substantially, depending on many factors,some of which 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:

·       actualor anticipated changes in our earnings or fluctuations in our operating resultsor in the expectations of securities analysts;

·       difficultieswe may encounter in the securitizations that we structure or the loss ofopportunities to structure securitization transactions;

·       anyvariance between the actual performance of the securitization trusts and thekey assumptions that we have used to estimate the fair value of our additionalstructural advisory fees and residuals receivables;

·       changesin the key assumptions we use to estimate the fair value of our additionalstructural advisory fees and residuals receivables, including discount, defaultand prepayment rates;

·       announcementby us, our competitors or our potential competitors of acquisitions, newproducts or services, significant contracts, commercial relationships orcapital commitments;

·       priceand volume fluctuations in the overall stock market from time to time;

·       significantvolatility in the market price and trading volume of financial services andprocess outsourcing companies;

·       generaleconomic conditions and trends;

·       negativepublicity about the student loan market generally or us specifically;

·       legislativeinitiatives effecting federal or private student loans;

·       majorcatastrophic events;

·       lossof a significant client or clients;

·       purchasesor sales of large blocks of our stock; or

·       departuresof 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.

***If a substantialnumber of shares become available for sale and are sold in a short period oftime, 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 January 31, 2007,we had 94,609,549 shares of common stock outstanding. Subject to limitationsunder federal securities laws, including in some cases the volume limitationsof Rule 144, these shares are eligible for sale in the public market. Themarket price of shares of our common stock may drop significantly if ourexisting stockholders sell a substantial number of shares. A decline in theprice of shares of our common stock might impede our ability to raise capitalthrough the issuance of additional shares of our common stock or other equitysecurities.

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***Insiders havesubstantial 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 30% of the outstanding shares of our common stock. As a result,these stockholders, if acting together, could substantially influence 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.

***We do not have experience with being regulated as asavings and loan holding company.***

As a result of our acquisition of Union FederalSavings Bank on November 30, 2006, we are now subject to regulation as asavings and loan holding company and our business is limited to activities thatare financial or real-estate related. We have registered with the OTS and arerequired to file periodic reports. In addition, we are subject to examinationby the OTS, which has certain types of enforcement powers over us, includingthe ability to issue cease-and-desist orders, force divestiture of Union Federaland impose civil and monetary penalties for violations of federal banking lawsand regulations or for unsafe or unsound banking practices.

In addition, Union Federal is subject to extensiveregulation, supervision and examination by the OTS and the Federal DepositInsurance Corporation. Such regulation covers all banking business, includingactivities and investments, lending practices, safeguarding deposits,capitalization, risk management policies and procedures, relationships withaffiliated companies, recordkeeping and conduct and qualifications ofpersonnel. In particular, the failure to meet minimum capital requirementscould initiate certain mandatory, and possibly additional discretionary,actions by regulators that, if undertaken, could have a direct material adverseeffect on our operations and financial statements.

There is a risk that wecould incur additional costs in complying with regulations applicable tosavings and loan holding companies and savings banks, or significant penalties ifwe fail to comply. Our ability to comply with all applicable laws and rules willdepend largely on our establishment and maintenance of a system to ensure suchcompliance, as well as our ability to attract and retain qualified compliancepersonnel. We could be subject to disciplinary or other actions due to claimednoncompliance in the future, which could have an adverse effect on ourbusiness, financial condition and operating results.

***Some provisions inour restated certificate of incorporation and amended and restated by-laws maydeter third-parties from acquiring us.***

Our restatedcertificate of incorporation and amended and restated by-laws containprovisions that may make the acquisition of our company more difficult withoutthe approval of our board of directors, including the following:

·       onlyour board of directors, the chairman of our board of directors or our presidentmay call special meetings of our stockholders;

·       ourstockholders may take action only at a meeting of our stockholders and not bywritten consent;

·       wehave authorized undesignated preferred stock, the terms of which may beestablished and shares of which may be issued without stockholder approval;

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·       ourdirectors may be removed only for cause by the affirmative vote of a majority ofthe directors present at a meeting duly held at which a quorum is present, orthe holders of 75% of the votes that all stockholders would be entitled to castin the election of directors; and

·       weimpose advance notice requirements for stockholder proposals.

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 or cause us to take other corporate actions you desire.

***Section 203 ofthe 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 to Section 203of the Delaware General Corporation Law which, subject to certain exceptions,prohibits “business combinations” between a Delaware corporation and an “interestedstockholder,” which is generally defined as a stockholder who becomes abeneficial owner of 15% or more of a Delaware corporation’s voting stock, for athree-year period following the date that such stockholder became an interestedstockholder. Section 203 could have the effect of delaying, deferring orpreventing a change in control that our stockholders might consider to be intheir best interests.

**Item 2—UnregisteredSales 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 11,859,375 shares of common stock, including anover-allotment option of 1,547,625 shares, pursuant to a registration statementon Form S-1 (File No. 333-108531) that was declaredeffective by the SEC on October 30, 2003. We received in aggregate netproceeds of approximately $115.1 million, after deducting underwritingdiscounts and commissions of approximately $8.9 million and expenses of theoffering of approximately $2.5 million. From the effective date of theregistration statement through December 31, 2006, we have not spent any ofthe net proceeds from the IPO, which have been invested in cash, cashequivalents and investments. Accordingly, none of the net proceeds of the IPOhas been paid by us, directly or indirectly, to any director, officer, orgeneral partner of us, or any of their associates, or to any person owing tenpercent or more of any class of our equities securities or any of ouraffiliates.

***(c)   IssuerPurchases of Equity Securities***

On September 29,2005, we announced a repurchase program of up to 7,500,000 shares of our commonstock. We did not repurchase any shares of common stock pursuant to thisprogram during the three months ended December 31, 2006. ThroughDecember 31, 2006, we repurchased an aggregate of 3,956,700 shares underthis program at an average price paid per share, excluding commissions, of$19.91. As of December 31, 2006, 3,543,300 shares of our common stock mayyet be purchased under this program, which does not have a fixed expirationdate.

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**Item 4**—Submission ofMatters to a Vote of Security Holders

On November 9,2006 the following proposals were voted on at our 2006 annual meeting ofstockholders:

| **Proposal**                                                                                                                                                                                                                                                                                                                                                                                   | ** ** | ** ** | ** ** | **For** | ** ** | **Against/Withheld** | ** ** | **Abstentions** | ** ** | **Broker  Non-Votes** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------|------------|---------|------------|----------------------|------------|-----------------|------------|-----------------------|------------|
| To elect the following  nine persons to serve as directors until the next annual meeting of  stockholders and until their successors are duly elected and qualified  (subject to such director’s earlier death, resignation or removal):                                                                                                                                                  |       |       |       |    |       |                 |       |            |       |                  |       |   |   |   |   |
| Jack L. Kopnisky                                                                                                                                                                                                                                                                                                                                                                               |       | 59,102,404 |       |    | 791,473    |                 |       |            | N/A        |                  |       |   | N/A |   |   |
| Peter B. Tarr                                                                                                                                                                                                                                                                                                                                                                                  |       | 59,053,603 |       |    | 840,274    |                 |       |            | N/A        |                  |       |   | N/A |   |   |
| Stephen E.  Anbinder                                                                                                                                                                                                                                                                                                                                                                           |       | 58,933,646 |       |    | 960,231    |                 |       |            | N/A        |                  |       |   | N/A |   |   |
| Leslie L.  Alexander                                                                                                                                                                                                                                                                                                                                                                           |       | 59,054,299 |       |    | 839,578    |                 |       |            | N/A        |                  |       |   | N/A |   |   |
| William R.  Berkley                                                                                                                                                                                                                                                                                                                                                                            |       | 58,535,610 |       |    | 1,358,267  |                 |       |            | N/A        |                  |       |   | N/A |   |   |
| Dort A. Cameron  III                                                                                                                                                                                                                                                                                                                                                                           |       | 58,758,151 |       |    | 1,135,726  |                 |       |            | N/A        |                  |       |   | N/A |   |   |
| George G. Daly                                                                                                                                                                                                                                                                                                                                                                                 |       | 59,246,965 |       |    | 646,912    |                 |       |            | N/A        |                  |       |   | N/A |   |   |
| Peter S. Drotch                                                                                                                                                                                                                                                                                                                                                                                |       | 59,248,121 |       |    | 645,756    |                 |       |            | N/A        |                  |       |   | N/A |   |   |
| William D. Hansen                                                                                                                                                                                                                                                                                                                                                                              |       | 59,245,855 |       |    | 648,022    |                 |       |            | N/A        |                  |       |   | N/A |   |   |
| To approve an amendment to the Executive Incentive  Compensation Plan to enable qualified performance based compensation granted  pursuant to the plan to be settled in either cash or equity securities of an  equivalent value issued under First Marblehead’s current or future equity plans  approved by stockholders, or a combination of cash and such equity  securities |       | 58,109,703 |       |    | 1,567,626  |                 |       |            | 216,548    |                  |       |   | N/A |   |   |
| To ratify the  appointment of KPMG LLP as First Marblehead’s independent registered  accounting firm for the fiscal year ending June 30, 2007                                                                                                                                                                                                                                        |       | 59,640,913 |       |    | 206,668    |                 |       |            | 46,296     |                  |       |   | N/A |   |   |

 

**Item 6—Exhibits**

See the Exhibit Index on the page immediatelypreceding the exhibits for a list of exhibits filed as part of this quarterlyreport which Exhibit Index is incorporated herein by this reference.

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**SIGNATURES**

Pursuantto the requirements of the Securities Exchange Act of 1934, the Registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.
|                              | **THE FIRST MARBLEHEAD  CORPORATION** |
|------------------------------|---------------------------------------|
| Date: February 8,  2007 | By:                                   | /s/ JACK L. KOPNISKY |
|                         |                                  | Jack L. Kopnisky |
|                         |                                  | *Chief Executive Officer, President &  Chief Operating Officer* |
|                         |                                  | *(Duly authorized officer)* |
| Date: February 8,  2007 | By:                                   | /s/ JOHN  A. HUPALO |
|                         |                                  | John A. Hupalo |
|                         |                                  | *Senior Executive Vice President and Chief Financial  Officer* |
|                         |                                  | *(Principal financial officer)* |
| Date: February 8,  2007 | By:                                   | /s/ KENNETH S. KLIPPER |
|                         |                                  | Kenneth S. Klipper |
|                         |                                  | *Senior Vice President, Treasurer and Chief Accounting  Officer* |
|                         |                                  | *(Principal accounting officer)* |

 

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**EXHIBITINDEX**

| Exhibit   Number | ** ** | ** **                                                                                                                                                                                                                           | ** ** | **Description** |
|-----------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------|
| 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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