**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 March 31, 2007**

**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  telephone number, including area code:**(617) 638-2000**          |

 

Indicate by check mark whether the registrant: (1) hasfiled all reports required to be filed by Section 13 or 15(d) of theSecurities Exchange Act of 1934 during the preceding 12 months (or forsuch shorter period that the registrant was required to file such reports), and(2) has been subject to such filing requirements for the past90 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

Asof May 4, 2007, the registrant had 93,684,825 shares 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                                                                                                         |   |   |   |
|                                            |   | Condensed  Consolidated Balance Sheets as of March 31, 2007 and June 30, 2006                                       |   | 3 |   |
|                                            |   | Condensed  Consolidated Statements of Operations for the three months and nine months  ended March 31, 2007 and 2006     |   | 4 |   |
|                                            |   | Condensed  Consolidated Statement of Changes in Stockholders’ Equity for the nine months  ended March 31, 2007 |   | 5 |   |
|                                            |   | Condensed  Consolidated Statements of Cash Flows for the nine months ended  March 31, 2007 and 2006                      |   | 6 |   |
|                                            |   | Notes to Unaudited Condensed Consolidated Financial  Statements                                                               |   | 7 |   |
| Item 2                                          | — | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                                   |   | 19 |   |
| Item 3                                          | — | Quantitative  and Qualitative Disclosures About Market Risk                                                                   |   | 43 |   |
| Item 4                                          | — | Controls  and Procedures                                                                                                      |   | 43 |   |
| Part II.   Other  Information    |   |                                                                                                                          |   |
| Item 1A                                         | — | Risk Factors                                                                                                                  |   | 45 |   |
| Item 2                                          | — | Unregistered  Sales of Equity Securities and Use of Proceeds                                                                  |   | 60 |   |
| Item 5                                          | — | Other  Information                                                                                                            |   | 61 |   |
| Item 6                                          | — | Exhibits                                                                                                                      |   | 61 |   |
| SIGNATURES                                      |   | 62                                                                                                                            |   |
| EXHIBIT INDEX                                   |   | 63                                                                                                                            |   |

 

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)**

| ** **                                                                                                                                                                                                                                                                                                            | ** ** | **March 31,  2007** | ** ** | **June 30,  2006** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------|------------|-------------------------|------------|
| **ASSETS**                                                                                                                                                                                                                                                                                                            |       |                     |       |                    |       |
| Cash and cash  equivalents                                                                                                                                                                                                                                                                                            |       | $                        | 191,164    |                    | $          | 75,711 |   |
| Investments                                                                                                                                                                                                                                                                                                           |       | 99,005                   |       | 67,250                  |       |
| Loans held for  sale                                                                                                                                                                                                                                                                                                  |       | 14,295                   |       | —                  |       |
| Service receivables:                                                                                                                                                                                                                                                                                                  |       |                     |       |                    |       |
| Structural  advisory fees                                                                                                                                                                                                                                                                                             |       | 123,412                  |       | 88,297                  |       |
| Residuals                                                                                                                                                                                                                                                                                                             |       | 612,199                  |       | 452,823                 |       |
| Processing fees  from The Education Resources Institute (TERI)                                                                                                                                                                                                                                                        |       | 10,917                   |       | 10,447                  |       |
| Total service  receivables                                                                                                                                                                                                                                                                                            |       | 746,528                  |       | 551,567                 |       |
| Property and  equipment                                                                                                                                                                                                                                                                                               |       | 74,295                   |       | 60,358                  |       |
| Less accumulated  depreciation and amortization                                                                                                                                                                                                                                                                       |       | (35,124                  | )          | (23,615                 | )          |
| Property and  equipment, net                                                                                                                                                                                                                                                                                          |       | 39,171                   |       | 36,743                  |       |
| Goodwill                                                                                                                                                                                                                                                                                                              |       | 4,878                    |       | 3,176                   |       |
| Intangible assets,  net                                                                                                                                                                                                                                                                                               |       | 2,767                    |       | 1,897                   |       |
| Prepaid income  taxes                                                                                                                                                                                                                                                                                                 |       | —                   |       | 11,649                  |       |
| Other prepaid expenses                                                                                                                                                                                                                                                                                                |       | 14,529                   |       | 17,272                  |       |
| Other assets                                                                                                                                                                                                                                                                                                          |       | 5,069                    |       | 5,081                   |       |
| Total assets                                                                                                                                                                                                                                                                                                          |       | $                        | 1,117,406  |                    | $          | 770,346 |   |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                                                                                                                                                                         |       |                     |       |                    |       |
| Liabilities:                                                                                                                                                                                                                                                                                                          |       |                     |       |                    |       |
| Deposits                                                                                                                                                                                                                                                                                                              |       | $                        | 38,167     |                    | $          | — |   |
| Accounts payable  and other accrued expenses                                                                                                                                                                                                                                                                          |       | 40,369                   |       | 34,430                  |       |
| Income taxes  payable                                                                                                                                                                                                                                                                                                 |       | 13,255                   |       | —                  |       |
| Net deferred  income tax liability                                                                                                                                                                                                                                                                                    |       | 179,129                  |       | 144,240                 |       |
| Capital lease  obligations                                                                                                                                                                                                                                                                                            |       | 6,302                    |       | 8,789                   |       |
| Notes payable to  TERI                                                                                                                                                                                                                                                                                                |       | 3,940                    |       | 4,537                   |       |
| Other liabilities                                                                                                                                                                                                                                                                                                     |       | 2,252                    |       | 2,181                   |       |
| Total liabilities                                                                                                                                                                                                                                                                                                     |       | 283,414                  |       | 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 March 31, 2007 and  June 30, 2006; 100,846 and 100,334 shares issued at March 31, 2007  and June 30, 2006, respectively; 94,639 and 94,564 shares outstanding at  March 31, 2007 and June 30, 2006, respectively |       | 1,008                    |       | 1,004                   |       |
| Additional paid-in  capital                                                                                                                                                                                                                                                                                           |       | 231,067                  |       | 217,620                 |       |
| Retained earnings                                                                                                                                                                                                                                                                                                     |       | 737,294                  |       | 479,090                 |       |
| Treasury stock,  6,207 and 5,770 shares held at March 31, 2007 and June 30, 2006,  respectively, at cost                                                                                                                                                                                                    |       | (135,471                 | )          | (121,545                | )          |
| Accumulated other  comprehensive income                                                                                                                                                                                                                                                                               |       | 94                       |       | —                  |       |
| Total  stockholders’ equity                                                                                                                                                                                                                                                                                      |       | 833,992                  |       | 576,169                 |       |
| Total liabilities  and stockholders’ equity                                                                                                                                                                                                                                                                      |       | $                        | 1,117,406  |                    | $          | 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  March 31,** | ** ** | **Nine months ended  March 31,** | ** ** |
|-----------------------------------------------|------------|--------------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                                    | ** ** | **2007**                                         | ** ** | **2006**                                        | ** ** | **2007** | ** ** | **2006** | ** ** |
| Service Revenues:                             |       |                                             |       |                                            |       |   |   |   |   |
| Up-front structural advisory fees             |       | $                                                | 103,879    |                                            | $          | 58,457 |   | $ | 365,807 |   | $ | 154,627 |   |
| Additional  structural advisory fees:         |       |                                             |       |                                            |       |   |   |   |   |
| From new securitizations                      |       | 9,128                                            |       | 8,764                                           |       | 34,575 |   | 23,542 |   |
| Trust updates                                 |       | (2,353                                           | )          | (37                                             | )          | 540 |   | 1,403 |   |
| Total additional structural advisory fees     |       | 6,775                                            |       | 8,727                                           |       | 35,115 |   | 24,945 |   |
| Residuals:                                    |       |                                             |       |                                            |       |   |   |   |   |
| From new securitizations                      |       | 34,371                                           |       | 47,432                                          |       | 139,441 |   | 125,648 |   |
| Trust updates                                 |       | (5,838                                           | )          | 5,623                                           |       | 19,935 |   | 25,596 |   |
| Total residuals                               |       | 28,533                                           |       | 53,055                                          |       | 159,376 |   | 151,244 |   |
| Processing fees from TERI                     |       | 32,282                                           |       | 26,583                                          |       | 98,961 |   | 77,779 |   |
| Administrative and other fees                 |       | 6,048                                            |       | 2,352                                           |       | 15,001 |   | 6,145 |   |
| Total service revenues                        |       | 177,517                                          |       | 149,174                                         |       | 674,260 |   | 414,740 |   |
| Net interest income                           |       | 2,646                                            |       | 1,369                                           |       | 6,614 |   | 4,233 |   |
| Total revenues                                |       | 180,163                                          |       | 150,543                                         |       | 680,874 |   | 418,973 |   |
| Non-interest  expenses:                       |       |                                             |       |                                            |       |   |   |   |   |
| Compensation and benefits                     |       | 27,391                                           |       | 25,107                                          |       | 84,894 |   | 66,009 |   |
| General and administrative expenses           |       | 33,506                                           |       | 24,140                                          |       | 100,585 |   | 72,956 |   |
| Total non-interest expenses                   |       | 60,897                                           |       | 49,247                                          |       | 185,479 |   | 138,965 |   |
| Income from operations                        |       | 119,266                                          |       | 101,296                                         |       | 495,395 |   | 280,008 |   |
| Other income                                  |       | 13                                               |       | 25                                              |       | 13 |   | 2,526 |   |
| Income before income tax expense              |       | 119,279                                          |       | 101,321                                         |       | 495,408 |   | 282,534 |   |
| Income tax  expense                           |       | 48,107                                           |       | 42,099                                          |       | 202,077 |   | 117,393 |   |
| Net income                                    |       | $                                                | 71,172     |                                            | $          | 59,222 |   | $ | 293,331 |   | $ | 165,141 |   |
| Net income per share, basic                   |       | $                                                | 0.75       |                                            | $          | 0.63 |   | $ | 3.11 |   | $ | 1.73 |   |
| Net income per share, diluted                 |       | 0.75                                             |       | 0.62                                            |       | 3.09 |   | 1.71 |   |
| Cash dividends declared per share             |       | 0.15                                             |       | 0.08                                            |       | 0.37 |   | 0.24 |   |
| Weighted average shares outstanding, basic    |       | 94,629                                           |       | 94,284                                          |       | 94,471 |   | 95,670 |   |
| Weighted average  shares outstanding, diluted |       | 95,110                                           |       | 95,046                                          |       | 95,055 |   | 96,588 |   |

 

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)**

| ** **                                                       | ** ** | **Common stock** | ** ** | **Additional**       | ** ** | ** **        | ** ** | **Accumulated  other  comprehensive** | ** ** | **Total**            | ** ** |
|------------------------------------------------------------------|------------|-----------------------|------------|----------------------|------------|-------------------|------------|---------------------------------------|------------|----------------------|------------|
| ** **                                                       | ** ** | **Issued**            | ** ** | **In treasury** | ** ** | **paid-in ** | ** ** | **Retained**                          | ** ** | **income, net** | ** ** | **stockholders’** | ** ** |
| ** **                                                       | ** ** | ** **            | ** ** | ** **           | ** ** | ** **        | ** ** | ** **                            | ** ** | ** **           | ** ** | ** ** | ** ** |
| ** **                                                       | ** ** | **Shares**            | ** ** | **Amount**           | ** ** | **Shares**        | ** ** | **Amount**                            | ** ** | **capital**          | ** ** | **earnings** | ** ** | **of 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                                                       |       | —                |       |                 | —     |              |       | —                                |       | —               |       |   | — |   |   | 293,331 |   |   | — |   |   |   | 293,331 |   |   |
| Unrealized gains on investments, net                             |       | —                |       |                 | —     |              |       | —                                |       | —               |       |   | — |   |   | — |   |   | 94 |   |   |   | 94 |   |   |
| Total  comprehensive income                                      |       | —                |       |                 | —     |              |       | —                                |       | —               |       |   | — |   |   | — |   |   | — |   |   |   | 293,425 |   |   |
| Options exercised                                                |       | 432                   |       |                 | 4          |              |       | —                                |       | —               |       |   | 1,337 |   |   | — |   |   | — |   |   |   | 1,341 |   |   |
| Stock issuances through employee stock purchase plan             |       | 36                    |       |                 | —     |              |       | —                                |       | —               |       |   | 886 |   |   | — |   |   | — |   |   |   | 886 |   |   |
| Stock issuances from vesting of restricted stock units      |       | 47                    |       |                 | —     |              |       | —                                |       | —               |       |   | — |   |   | — |   |   | — |   |   |   | — |   |   |
| Repurchases of common stock                                      |       | —                |       |                 | —     |              |       | (437                                  | )          | (13,926              | )          |   | — |   |   | — |   |   | — |   |   |   | (13,926 | ) |   |
| Stock-based compensation                                         |       | —                |       |                 | —     |              |       | —                                |       | —               |       |   | 5,116 |   |   | — |   |   | — |   |   |   | 5,116 |   |   |
| Cash dividends ($0.37 per share)                                 |       | —                |       |                 | —     |              |       | —                                |       | —               |       |   | — |   |   | (34,980 | ) |   | — |   |   |   | (34,980 | ) |   |
| Cash paid in lieu of fractional shares in effecting  stock split |       | (3                    | )          |                 | —     |              |       | —                                |       | —               |       |   | — |   |   | (147 | ) |   | — |   |   |   | (147 | ) |   |
| Tax benefit from employee stock options                          |       | —                |       |                 | —     |              |       | —                                |       | —               |       |   | 6,108 |   |   | — |   |   | — |   |   |   | 6,108 |   |   |
|                                                             |       |                  |       |                 |       |              |       |                                  |       |                 |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| **Balance at March 31, 2007**                               |       | 100,846               |       |                 | $          | 1,008             |       |                                  | (6,207     | )                    | $          | (135,471 | ) |   | $ | 231,067 |   |   | $ | 737,294 |   |   | $ | 94 |   |   |   | $ | 833,992 |   |   |

 

See accompanying notes to unaudited condensed consolidated financialstatements.

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

| ** **                                                                         | ** ** | **Nine months ended  March 31,** | ** ** |
|------------------------------------------------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                                                                         | ** ** | **2007**                                        | ** ** | **2006** | ** ** |
| Cash flows from operating  activities:                                             |       |                                            |       |   |   |
| Net income                                                                         |       | $                                               | 293,331    |   | $ | 165,141 |   |
| Adjustments to reconcile  net income to net cash provided by operating activities: |       |                                            |       |   |   |
| Depreciation and amortization                                                      |       | 12,039                                          |       | 10,478 |   |
| Deferred income tax expense                                                        |       | 34,889                                          |       | 43,492 |   |
| Stock-based compensation                                                           |       | 5,116                                           |       | 2,229 |   |
| Change in  assets/liabilities net of effects of acquisition activity:              |       |                                            |       |   |   |
| Decrease in loans held for sale                                                    |       | 2,852                                           |       | — |   |
| (Increase) in structural advisory fees                                             |       | (35,115                                         | )          | (24,945 | ) |
| (Increase) in residuals                                                            |       | (159,376                                        | )          | (151,244 | ) |
| (Increase) decrease in processing fees from TERI                                   |       | (470                                            | )          | 1 |   |
| Net change in income taxes                                                         |       | 24,904                                          |       | 4,417 |   |
| (Increase) decrease in other prepaid expenses                                      |       | 2,764                                           |       | (2,084 | ) |
| (Increase) decrease in other assets                                                |       | 809                                             |       | (824 | ) |
| Increase (decrease) in accounts payable, accrued  expenses, and other liabilities  |       | 5,697                                           |       | (2,883 | ) |
| Net cash provided by operating activities                                          |       | 187,440                                         |       | 43,778 |   |
| Cash flows from  investing activities net of effects of acquisition activity:      |       |                                            |       |   |   |
| Dispositions of investments                                                        |       | 59,048                                          |       | — |   |
| Purchases of investments                                                           |       | (74,800                                         | )          | — |   |
| Net cash paid for acquisition                                                      |       | (471                                            | )          | — |   |
| Purchases of property and equipment                                                |       | (13,343                                         | )          | (7,493 | ) |
| Payments to TERI for loan database updates                                         |       | (186                                            | )          | (558 | ) |
| Net cash used in investing activities                                              |       | (29,752                                         | )          | (8,051 | ) |
| Cash flows from  financing activities net of effects of acquisition activity:      |       |                                            |       |   |   |
| Increase in deposits                                                               |       | 2,039                                           |       | — |   |
| Repayment of capital lease obligations                                             |       | (2,959                                          | )          | (3,524 | ) |
| Repayment of notes payable due to TERI                                             |       | (597                                            | )          | (562 | ) |
| Tax benefit from stock-based compensation                                          |       | 6,108                                           |       | 4,279 |   |
| Issuances of common stock                                                          |       | 2,227                                           |       | 1,630 |   |
| Repurchases of common stock                                                        |       | (13,926                                         | )          | (65,880 | ) |
| Cash dividends on common stock and cash paid in lieu  of fractional shares         |       | (35,127                                         | )          | (22,898 | ) |
| Net cash used in financing activities                                              |       | (42,235                                         | )          | (86,955 | ) |
| Net increase (decrease) in cash and cash equivalents                               |       | 115,453                                         |       | (51,228 | ) |
| Cash and cash equivalents, beginning of period                                     |       | 75,711                                          |       | 193,796 |   |
| Cash and cash equivalents, end of period                                           |       | $                                               | 191,164    |   | $ | 142,568 |   |
| Supplemental  disclosures of cash flow information:                                |       |                                            |       |   |   |
| Interest paid                                                                      |       | $                                               | 1,100      |   | $ | 633 |   |
| Income taxes paid                                                                  |       | $                                               | 135,974    |   | $ | 65,206 |   |
| Supplemental disclosure  of non-cash activities:                                   |       |                                            |       |   |   |
| Acquisition of  property and equipment through capital leases                      |       | $                                               | 472        |   | $ | 1,135 |   |

 

See accompanying notes to unaudited condensed consolidated financial statements.

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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(“Union Federal”) is a federally chartered thrift that offers residentialretail mortgage loans, retail savings products, time deposit products and, asof April 2007, private student loans (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, alladjustments (consisting of only normal recurring accruals) considered necessaryfor a fair statement of the results for the interim periods have been included.The preparation of financial statements in conformity with GAAP requiresmanagement to make estimates and assumptions, including the determination ofthe fair value of expected future cash flows, that affect the amounts reportedin the condensed consolidated financial statements and accompanying notes.Interim results are not necessarily indicative of results to be expected forthe entire fiscal year. All significant intercompany balances and transactionshave been eliminated in consolidation. These unaudited financial statementsshould be read in conjunction with the audited consolidated financialstatements and related notes for the year ended June 30, 2006 included inthe Company’s Annual Report on Form 10-K filed with the Securitiesand Exchange Commission 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, second and third quarters offiscal 2007 and expects to close two securitization transactions in the fourthquarter 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 theInternal Revenue Code. Incorporated in 1985, TERI is the oldest and largestguarantor of alternative, or private, student loans. In its role as guarantorin the private education lending market, TERI agrees to reimburse lenders orsecuritization trusts for unpaid principal and interest on defaulted loans.TERI is the exclusive third-party provider of borrower default guarantees forthe Company’s clients’ private student loans. As of March 31, 2007, TERIhad a Baa3 counterparty rating from Moody’s Investors Service, which is thelowest investment grade rating, and an insurer financial strength rating of A+from Fitch Ratings which was reaffirmed on April 2, 2007. If these ratingsare lowered, the Company’s direct to consumer program agreements with Bank ofAmerica could terminate, Bank of America could suspend the processing of newapplications for school channel loans, or FMC’s clients may not wish to enterinto guarantee arrangements with TERI. In addition, market conditions coulddictate that FMC obtain additional credit enhancement for the asset-backedsecuritizations that it structures, the cost of which could result in lowerrevenues.

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 addition, the Master Loan Guaranty Agreement provides a beneficialinterest for TERI in a portion of the residual value of securitization truststhat purchase TERI-guaranteed loans. In June 2001, the Company acquiredTERI’s loan processing operations and the Master Loan Guaranty Agreement wasautomatically extended for a five-year term from the date of the acquisitionclosing. The loans guaranteed pursuant to the Master Loan Guaranty Agreementcomprise only a portion of TERI’s guarantee business, and the Master LoanGuaranty Agreement does not preclude TERI from continuing to provide itsguarantees to loan originators not associated with FMC. In October 2004,the Company renewed the Master Loan Guaranty Agreement and certain additionalagreements with TERI, in each case for an additional term throughJune 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 the programlender until the student loans are securitized, at 

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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)**

which point the account ispledged to the securitization trust that purchases the loans. The Master LoanGuarantee Agreement, as implemented through guaranty agreements with individuallenders, entitles TERI to retain a portion of its guaranty fees as anadministrative fee rather than place them in the pledged account.

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 pointsmultiplied by the principal balance of the loans originated and securitized.For securitizations completed during fiscal 2006, TERI’s ownership of theresidual value of the TERI-guaranteed loans securitized ranged between 12 and15 percent.

InAugust 2006, the Company entered into a supplement to the Master LoanGuarantee Agreement that 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 and subjectto the parameters of each securitization trust. The Company has agreed toattempt in good faith to structure its securitization transactions toaccommodate 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, 221 basis points for the securitization transaction theCompany completed in the second quarter of fiscal 2007 and 215 basis points forthe securitization transaction the Company completed in the third quarter offiscal 2007. TERI elected to receive an administrative fee of 240 basis pointsfor the private label securitization transaction the Company plans to completein the fourth 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, defaultprevention, default processing, accounting services, guarantee claimsmanagement and administrative services, in support of TERI’s loan guaranteefunction. FMC guarantees the full and timely performance by FMER of itsobligations pursuant to this Master Servicing Agreement. 

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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)**

FMC usesthe acquired TERI assets, including historical loan data, to support the designand implementation of loan programs facilitated by FMC and loan programsjointly created by FMC and TERI. In addition, TERI has the right to designateone of three representatives to serve on the board of directors of FMER. Duringthe three and nine months ended March 31, 2007, processing fees from TERIrepresented approximately 18% and 15%, respectively, of the Company’s totalrevenue.

**PHEAA**

As of March 31, 2007,there were seven TERI-approved student loan servicers. Servicers provideadministrative services relating to loans, including processing deferment andforbearance requests, sending out account statements and accrual notices, respondingto borrower inquiries, and collecting and crediting payments received fromborrowers. As of March 31, 2007, the Company utilized six of theseservicers. These arrangements allow the Company to increase the volume of loansin 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 ofMarch 31, 2007, Pennsylvania Higher Education Assistance Agency (PHEAA)serviced a majority of the student loans for which the Company facilitatesorigination. PHEAA also operates under the name American Education Services(AES). If the Company’s relationship with PHEAA terminates, the Company wouldeither need to expand or develop a relationship with another TERI-approvedstudent loan servicer, which could be time-consuming and costly.

**RevenueConcentration**

Securitization-relatedfees from the private label loan trusts used to securitize student loans inSeptember 2006, December 2006 and March 2007 representedapproximately 36%, 21% and 21%, respectively of total revenue for the firstnine months of fiscal 2007. These securitization trusts purchased privatestudent loans from several lenders including JP Morgan Chase Bank, N.A., Bankof America, N.A., and Charter One Bank, N.A. The Company did not recognize morethan 10% of total revenue from any other customer. Charter One Bank, N.A.serves as a program lender for the Company’s proprietary loan program as wellas for additional education loan programs marketed by third parties and fundedby Charter One Bank, N.A.

***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. For a discussion of our critical accounting policies, see“Management’s Discussion and Analysis of Financial Condition and Results ofOperations—Application of Critical Accounting Policies 

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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)**

andEstimates”. For a discussion of changes to assumptions used to determine thefair value of the Company’s service receivables made in the third quarter offiscal 2007 see Note 2.

***Cash and Cash Equivalents***

Cash and cash equivalentsat March 31, 2007 included $182,882 held in money market funds and $8,282of federal funds sold. Included in cash and cash equivalents are compensatingbalances held in money market funds supporting various financing arrangementsof $8,720 and $10,158 at March 31, 2007 and June 30, 2006,respectively.

***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. The net deferred income tax liability increased during thefirst nine months of fiscal 2007 primarily as a result of the increase inresidual revenue recognized during the first nine months of fiscal 2007, whichmore than offset the recognition of taxable income from the securitizationtrusts.

**(2)**          ServiceReceivables

Additional structural advisory fees and residualsreceivables represent the estimated fair value of additional structuraladvisory fees and residuals expected to be collected over the life of thesecuritization trusts. The fees are expected to be paid to the Company from thevarious separate securitization trusts that have purchased student loansfacilitated by the Company. Private label loans guaranteed by TERI havegenerally been purchased by several private label loan trusts. GATE loans, anda limited number of TERI-guaranteed and other loans, have been purchased byseparate securitization trusts established by the National Collegiate Trust(NCT trusts). Processing fees receivable from TERI represents amounts due fromTERI for expenses incurred by FMER on TERI’s behalf.

The Company conducted a securitization transaction inthe third quarter of each of fiscal 2007 and fiscal 2006. On a quarterly basis,the Company updates its estimates of the fair value of its structural advisoryfees and residuals receivables to reflect the passage of time, any change indiscount rates used to estimate their fair value, any changes in the estimatedoperational expenses for the separate securitization trusts and any changes tothe trust performance metrics that the Company considers in its fair valueestimates, such as default, recovery, prepayment and forward London InterbankOffered Rate, or LIBOR, rates.

During the first nine months of fiscal 2007, theCompany facilitated three securitization transactions involving the issuance ofTriple B rated securities, the only such issuances by any of the Company’ssecuritization trusts. Triple B rated issuances have, in effect, enabled theCompany to monetize a portion of its securitization-related revenues that previouslywould have been recognized as residuals. Accordingly, the Company believes thatmarket developments have now provided it with a meaningful basis for thediscount rate to be applied in estimating the fair value of pre-fiscal 2007private label securitization trust 

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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)**

residuals. Beginning withthe third quarter of fiscal 2007, the Company applied a discount rate equal tothe trailing 12 month average of the one month LIBOR + 1.75% to value theportion of the residuals that it believes qualifies as investment grade inpre-fiscal 2007 private label trusts. That portion of the residuals that theCompany believes does not qualify as investment grade will be discounted at13%, as it is in the securitization trusts that have issued Triple B ratedsecurities. The aggregated average discount rate at March 31, 2007 was11.52% for all outstanding trusts. This decrease in the aggregated averagediscount rate resulted in an increase in the fair value of our residualreceivable of $26.7 million.

Loans in the securitization trusts have beenexperiencing higher prepayment rates than the Company had estimated would occurat these points in the life of the loans as a result of a number of factors,including a prolonged and unfavorable interest rate environment. During thethird quarter of fiscal 2007, the Company altered its assumption regarding theannual rate of prepayments that it uses to estimate the fair value of itsresidual and structural advisory fee receivables. The increase of thisassumption from an average over the life of the loan of 7% to 8% resulted in adecrease in the fair value of the residual receivable of $36.2 million and adecrease in the fair value of the additional structural advisory fee receivableof $3.5 million.

Except for the changes to the prepayment rate and thediscount rates applied to residuals and additional structual advisory fees, theCompany did not change any valuation assumptions during the first nine monthsof fiscal 2007 or fiscal 2006. The Company will continue to monitor theperformance of the trust assets against its expectations, and will make suchadjustments to its estimates as it believes are necessary to value properly itsreceivables balances at each balance sheet date.

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

| ** **                                | ** ** | **Nine months ended  March 31,** | ** ** |
|-------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                                | ** ** | **2007**                                        | ** ** | **2006** | ** ** |
| Fair value at  beginning of period        |       | $                                               | 88,297     |   | $ | 53,371 |   |
| Additions from new securitizations        |       | 34,575                                          |       | 23,542 |   |
| Trust updates                             |       |                                            |       |   |   |
| Passage of time (present value accretion) |       | 5,413                                           |       | 2,967 |   |
| Increase in average prepayment rates      |       | (3,529                                          | )          | — |   |
| Other factors                             |       | (1,344                                          | )          | (1,564 | ) |
| Net accretion                             |       | 540                                             |       | 1,403 |   |
| Fair value at end of  period              |       | $                                               | 123,412    |   | $ | 78,316 |   |

 

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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 nine months of fiscal 2007 andfiscal 2006:

| ** **                                | ** ** | **Nine months ended  March 31,** | ** ** |
|-------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                                | ** ** | **2007**                                        | ** ** | **2006** | ** ** |
| Fair value at  beginning of period        |       | $                                               | 452,823    |   | $ | 247,275 |   |
| Additions from new securitizations        |       | 139,441                                         |       | 125,648 |   |
| Trust updates                             |       |                                            |       |   |   |
| Passage of time (present value accretion) |       | 48,369                                          |       | 27,578 |   |
| Increase in average prepayment rates      |       | (36,236                                         | )          | — |   |
| Decrease in discount rate assumption      |       | 26,680                                          |       | — |   |
| Other factors                             |       | (18,878                                         | )          | (1,982 | ) |
| Net accretion                             |       | 19,935                                          |       | 25,596 |   |
| Fair value at end of  period              |       | $                                               | 612,199    |   | $ | 398,519 |   |

 

For a discussion of thesensitivity of the additional structural advisory fees and residuals receivableto variations in our assumptions and estimates, see “Management’s Discussionand Analysis 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 will be amortized on astraight-line basis over a five year period and will be reviewed for impairmentwhen it is determined that facts or circumstances may affect the recoverabilityof the asset.

**(4)**          RelatedParty Transaction

At March 31, 2007,the Company had invested approximately $170,215 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 $82,224 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 March 31, 2007was $1,945.

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 monthly installmentsof $44 commencing on July 20, 2001 and ending on June 20, 2011. Thenote payable is secured by the loan database. The outstanding balance of thisnote payable at March 31, 2007 was $1,995.

**(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 onDecember 30, 2005, allowed the Company to finance up to $20,000 worth offurniture and equipment purchased before December 30, 2005. The Companyexpects to repay amounts drawn down on the line of credit at terms ranging fromthree to five years. At March 31, 2007, the outstanding principal balanceon amounts borrowed under this line of credit was $5,381.

**(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 nine months of fiscal 2007, the Companygranted 374 restricted stock units, each such restricted stock unitrepresenting the right to receive one share of Common Stock upon vesting. As ofMarch 31, 2007, there were 870 restricted stock units outstanding and3,133 shares available for future grant under 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 

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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)**

Stockwere issued in January 2007 and July 2006, respectively. AtMarch 31, 2007, 451 shares were available for future purchase under theStock Purchase Plan.

***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 March 31, 2007, the Company had repurchased anaggregate of 3,957 shares of its Common Stock under this program. FromApril 1, 2007 through May 4, 2007, the Company repurchased 956 sharesof Common Stock at an average purchase price per share, excluding commissions,of $35.58. On April 24, 2007, the Board of Directors authorized therepurchase of up to 10,000 shares of Common Stock from time to time on the openmarket or privately negotiated transactions. The 10,000 shares authorized forrepurchase included 3,393 remaining shares available for repurchase as ofApril 25, 2007 under the previously authorized repurchase program. Therepurchase program approved on April 24, 2007 does not have a fixedexpiration date.

***Cash Dividend***

Duringthe first nine months of fiscal 2007 the Board of Directors declared thefollowing cash dividends:

| **Record Date**     | ** ** | ** ** | ** ** | **Dividend per share** | ** ** |
|--------------------------|------------|------------|------------|----------------------------------|------------|
| September 18,  2006 |       |       | $          | 0.10                             |       |   |
| November 20,  2006  |       |       | $          | 0.12                             |       |   |
| March 5, 2007       |       |       | $          | 0.15                             |       |   |

 

***Stock Split***

On November 9, 2006,the Board of Directors approved a three-for-two split of Common Stock which waseffected in the form of a stock dividend distributed on December 4, 2006to 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.

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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)**

**(8)**          Net Income per Share

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

| ** **                                                         | ** ** | **Three months ended   March 31,** | ** ** | **Nine months ended   March 31,** | ** ** |
|--------------------------------------------------------------------|------------|--------------------------------------------------------|------------|-------------------------------------------------------|------------|
| ** **                                                         | ** ** | **2007**                                               | ** ** | **2006**                                              | ** ** | **2007** | ** ** | **2006** | ** ** |
| Net income                                                         |       | $                                                      | 71,172     |                                                  | $          | 59,222 |   | $ | 293,331 |   | $ | 165,141 |   |
| Shares used in  computing net income per common share—basic   |       | 94,629                                                 |       | 94,284                                                |       | 94,471 |   | 95,670 |   |
| Effect of  dilutive securities:                                    |       |                                                   |       |                                                  |       |   |   |   |   |
| Stock options                                                      |       | 150                                                    |       | 671                                                   |       | 293 |   | 890 |   |
| Restricted stock units                                             |       | 331                                                    |       | 91                                                    |       | 291 |   | 28 |   |
| Dilutive potential common shares                                   |       | 481                                                    |       | 762                                                   |       | 584 |   | 918 |   |
| Shares used in  computing net income per common share—diluted |       | 95,110                                                 |       | 95,046                                                |       | 95,055 |   | 96,588 |   |
| Net income per  common share:                                      |       |                                                   |       |                                                  |       |   |   |   |   |
| Basic                                                              |       | $                                                      | 0.75       |                                                  | $          | 0.63 |   | $ | 3.11 |   | $ | 1.73 |   |
| Diluted                                                            |       | $                                                      | 0.75       |                                                  | $          | 0.62 |   | $ | 3.09 |   | $ | 1.71 |   |

 

**(9)**          New Accounting 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 requireddisclosures, and is effective for fiscal years ending after November 15,2006. The Company will be required to apply this Bulletin in the year endingJune 30, 2007. The adoption of SAB No. 108 is not expected to have amaterial impact on the Company’s consolidated financial condition or results ofoperations.

In February 2007, the Financial AccountingStandards Board (FASB) issued Statement of Financial Accounting Standards(SFAS) No. 159, *Fair Value Option forFinancial Assets and Financial Liabilities, an amendment of FASB StatementsNo. 115*. SFAS No. 159 will be effective for the Companybeginning in the first quarter of fiscal 2009. The statement permits entitiesto measure many financial instruments and certain other items at fair valuethat are not currently required to be measured at fair value. The adoption ofSFAS No. 159 is not expected to have a material impact on the Company’sconsolidated financial condition or results of operations.

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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 September 2006, the FASB issued SFASNo. 158, *Employers’ Accounting for Defined BenefitPension and Other Postretirement Plans, an amendment of FASB StatementsNo. 87, 88, 106 and 132(R).* SFAS No. 158 requires an entityto recognize in its statement of financial position an asset for a definedbenefit postretirement plan’s overfunded status or a liability for a plan’sunderfunded status, measure a defined benefit postretirement plan’s assets andobligations that determine its funded status as of the end of the employer’sfiscal year, and recognize changes in the funded status of a defined benefitpostretirement plan in comprehensive income in the year in which the changesoccur. SFAS No. 158 will be effective for the Company beginning in thefourth quarter of fiscal 2007. The adoption of SFAS No. 158 is notexpected to have a material impact on the Company’s consolidated financialcondition or results of operations.

In September 2006, the FASB issued SFASNo. 157, *Fair Value Measurements*,which provides guidance for using fair value to measure assets and liabilities.The standard also responds to investors’ requests for expanded informationabout the extent to which companies measure assets and liabilities at fairvalue, the information 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 value hierarchy.SFAS No. 157 is effective for financial statements issued for fiscal yearsbeginning after November 15, 2007, and interim periods within those fiscalyears. The Company does not expect the adoption of SFAS No. 157 to have amaterial impact on its results of operations and financial position.

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 does not expect the adoption of FINNo. 48 to have a material impact on its results of operations andfinancial position.

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 a material impact on theCompany’s consolidated financial condition or results of operations.

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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 February 2006, the FASB issued SFASNo. 155, *Accounting for Certain Hybrid FinancialInstruments, an amendment of FASB Statements No. 133 and 140*.SFAS No. 155 will be effective for the Company beginning in the firstquarter of fiscal 2008. The statement permits interests in hybrid financialinstruments that contain an embedded derivative that would otherwise requirebifurcation, to be accounted for as a single financial instrument at fairvalue, with changes in fair value recognized in earnings. This election ispermitted on an instrument-by-instrument basis for all hybrid financialinstruments held, obtained, or issued as of the adoption date. The adoption ofSFAS No. 155 is not expected to have a material impact on the Company’sconsolidated financial 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:

·       program design andmarketing coordination;

·       borrower inquiry andapplication;

·       loan origination anddisbursement;

·       loan securitization; and

·       loan servicing.

We receive fees for the services we provide inconnection with our clients’ private student loans, including processing andstructuring 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 34 securitization transactions since our formation in 1991.

We offer servicesin connection with two primary student loan programs:

·       *Private label* programs that are:

·        “direct to consumer,” ormarketed directly to prospective student borrowers and their families by:

·       lenders;

·       businesses, unions,affinity groups and other organizations;

·       third parties that are notthemselves lenders but which market loans on behalf of the lenders that fundthe loans. We refer to these third parties as loan marketers, and we refer tothe lenders that fund these loans as program lenders; and

·        “school channel,” ormarketed directly to educational institutions by:

·       lenders; and

·       education loan marketers onbehalf of program lenders.

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

During the first nine 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 guarantor with respectto any student loan programs that we facilitate. We assist the lenders in ourloan programs in selecting the underwriting criteria used in deciding whether astudent loan will be made to an applicant. However, each lender has ultimatecontrol over the selection of these criteria, and in providing our services, weare obligated by contract to observe them. Our lender clients have theopportunity to mitigate their credit risk through a loan repayment guarantee byThe Education Resources Institute, Inc., or TERI, pursuant to which TERIguarantees repayment of the borrower’s loan principal, together withcapitalized or accrued interest, on defaulted loans. Lenders that wish to havetheir loans guaranteed by TERI are required to meet TERI’s underwritingcriteria. Beginning in April 2007, our wholly-owned subsidiary UnionFederal Savings Bank, or Union Federal, began funding some of the loans for ourproprietary brand. Although we oversee loan servicing as a component of ouradministrative 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 nine months of fiscal 2007and fiscal 2006.

| ** **                                                                                                            | ** ** | **Nine months ended  March 31,** | ** ** | **%**      | ** ** |
|-----------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------|------------|------------|------------|
| ** **                                                                                                            | ** ** | **2007**                                        | ** ** | **2006**   | ** ** | **Increase** | ** ** |
| ** **                                                                                                            | ** ** | **(dollars in thousands)**            | ** ** | ** ** | ** ** |
| Approximate  student loan applications processed                                                                      |       | 984,000                                         |       | 702,000    |       |   | 40 | % |   |
| Approximate  number of student loans facilitated                                                                      |       | 359,000                                         |       | 301,000    |       |   | 19 | % |   |
| Approximate  number of student loans facilitated that were also available to us for  securitization              |       | 304,000                                         |       | 246,000    |       |   | 24 | % |   |
| Principal amount  of student loans facilitated                                                                        |       | $                                               | 3,454,024  |       | $          | 2,740,715 |   |   | 26 | % |   |
| Principal amount  of student loans facilitated that were also available to us for  securitization                     |       | $                                               | 3,081,300  |       | $          | 2,350,867 |   |   | 31 | % |   |
| Principal and  accrued interest balance of student loans securitized                                                  |       | $                                               | 2,886,152  |       | $          | 2,006,642 |   |   | 44 | % |   |
| Principal balance of  student loans facilitated and available to us at period end for  later securitization |       | $                                               | 904,854    |       | $          | 746,906 |   |   | 21 | % |   |

 

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 

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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 programs. In October 2004, werenewed 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 of the following factors can materiallyaffect our financial results:

·       the demand for privateeducation financing;

·       the competition forproviding private education financing;

·       the education financingpreferences of students and their families;

·       applicable laws andregulations, which may affect the terms upon which our clients agree to makeprivate student loans and the cost and complexity of our loan facilitationoperations;

·       the private student loansecuritization market, including the costs or availability of financing andmarket receptivity to Triple B rated student loan asset backed notes;

·       the general interest rateenvironment, including its effect on our discount and prepayment rates;

·       our critical accountingpolicies and estimates;

·       borrower default rates andour ability to recover principal and interest from such borrowers;

·       prepayment rates, includingprepayments through loan consolidation of private student loans held by ourtrusts; and

·       the availability of studentloans through federal programs.

On November 30, 2006,we completed the acquisition of Union Federal, a community savings bank locatedin North Providence, Rhode Island. Union Federal is a federally charteredthrift that offers residential retail mortgage loans, retail savings products,time deposit products and, as of April 2007, private student loans. UnionFederal had total assets of approximately $41 million as of the acquisitiondate. The financial results of Union Federal are included in our financialstatements subsequent to the acquisition date. The purchase price was allocatedto acquired assets and liabilities based on their respective fair values atNovember 30, 2006. We recorded additional goodwill of $1.7 million and acore deposit intangible of $1.3 million as a result of this acquisition.Goodwill will be reviewed for impairment at least annually. The core depositintangible represents the present value of the difference in expected futurecash flows between the costs to replace such deposits (based on applicable equivalentborrowing rates) versus the then-current yield on core deposits acquired. Theaggregate future cash flows are based on the average expected life of thedeposits acquired for each product less the cost to service them. The 

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coredeposit intangible will be amortized on a straight-line basis over a five yearperiod and will be reviewed for impairment when it is determined that facts orcircumstances may affect the recoverability of the asset.

***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 refer to the trusts utilized in thesecuritization of TERI-guaranteed private label loans as private label loantrusts. In addition, the National**Collegiate Trust, or NCT, was formed in fiscal 1993 andhas established separate securitization trusts, which we refer to as the NCTtrusts, which have purchased primarily GATE loans and a limited number ofTERI-guaranteed and other loans. In the future, we may securitize private labelor GATE loans using NCT trusts, private label loan trusts or new trustvehicles.

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 charge structuraladvisory fees that are paid in two portions:

·        *Up-front*.   We receive a portion of the structuraladvisory fees at the time the securitization trust purchases the loans, orshortly thereafter. In exchange for these fees, we structure the debt securitiessold in the securitization, coordinate the attorneys, accountants, trustees,loan servicers, loan originators and other transaction participants and preparethe cash flow modeling for rating agencies as needed. For the securitizationsthat we facilitated during the first nine months of fiscal 2007, these feesranged from 12.2% to 13.1% 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. The securitization trusts wefacilitated in the first nine months of fiscal 2007 issued Triple B ratedsecurities, the only such issuances by any of our securitizations trusts. Theissuance of Triple B rated securities enabled us to increase the up-frontstructural advisory fee yield, with a decrease in the amount of residuals weexpect to receive, from these securitization transactions; and

·        *Additional*.   We receive a portion ofthe structural advisory fees over time, based on the amount of loansoutstanding in the trust from time to time over the life of the trust. Thisportion accumulates monthly from the date of a securitization transaction at arate of 15 to 30 basis points per year. We begin to receive this additionalportion, plus interest, once the ratio of trust assets to trust liabilities,which we refer to as the “parity ratio,” reaches a stipulated level, whichranges from 103% to 105%. The level applicable to a particular trust isdetermined at the time of securitization. We currently expect to receive theadditional fees beginning five to seven years after the date of a particularsecuritization transaction*.*

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

·        in connection with thesecuritizations of exclusively private label loans, 66% to 88% of the net cashflows of the particular securitization trust once a parity ratio of 103% to103.5%, depending on the particular trust, is reached and maintained;

·        in connection withsecuritizations in the NCT trusts, our share of residual cash flows once all ofthe debtholders of the securitization trust have been repaid, plus, in the caseof GATE loans securitized in fiscal years prior to fiscal 2005, an additional10% of the residual cash flows. We are entitled to receive 100% of the residualcash flows for GATE loans securitized after fiscal 2004.

Our residualinterest derives almost exclusively from the services we perform in connectionwith each securitization rather than from a direct cash contribution to thesecuritization trust. In the case of securitizations of exclusively privatelabel loans, we currently expect to receive the residuals beginningapproximately five to seven years after the date of a particularsecuritization. In the case of securitizations in the NCT trusts that occurredprior to fiscal 2005, we expect to receive the residuals beginning 12 to 15years after the date of a particular securitization. In the case of thesecuritization in the NCT trusts that occurred after fiscal 2004, we currentlyexpect to receive residuals beginning five to six years after the date ofsecuritization.

·       *Administrative and other fees*.   Ouradministrative and other fees represent the reimbursement of out of pocketcosts we receive at the time of securitization related to marketingcoordination services performed for some of our clients. Our administrative andother fees also include the administrative fees we receive from the trusts fortheir daily management and services we provide in obtaining information fromthe loan servicers and reporting this and other information to the partiesrelated to the securitization. Our fees for performing these services rangefrom 5 to 20 basis points per year based on the student loan balance in thetrust.

***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 the fairvalue of additional structural advisory fees and residuals as revenue at thattime, as they are deemed to be earned at the time of the securitization butbefore we actually receive payment. These amounts are deemed earned becauseevidence of an arrangement exists, we have provided the services, the fee isfixed and determinable based upon a discounted cash flow analysis, there are nofuture contingencies or obligations and collection is reasonably assured.

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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.

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, second and third quarters.We expect to facilitate two securitizations in the fourth quarter of fiscal2007. 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 the first three quarters of fiscal 2007 and fiscal 2006:

| ** **     | ** ** | **Fiscal 2007**    | ** ** |
|----------------|------------|-------------------------|------------|
| ** **     | ** ** | **First  Quarter**      | ** ** | **Second  Quarter** | ** ** | **Third  Quarter** | ** ** | **Total** | ** ** |
| ** **     | ** ** | **(in thousands)** | ** ** |
| Total revenues |       | $                       | 302,945    |   | $ | 197,766 |   | $ | 180,163 |   | $ | 680,874 |   |
| Net income     |       | 141,008                 |       | 81,151 |   | 71,172 |   | 293,331 |   |
|                |            |                         |            |  |  |  |  |  |  |  |  |  |  |

 

| ** **        | ** ** | **Fiscal 2006**    | ** ** |
|-------------------|------------|-------------------------|------------|
| ** **        | ** ** | **First  Quarter**      | ** ** | **Second  Quarter** | ** ** | **Third  Quarter** | ** ** | **Total** | ** ** |
| ** **        | ** ** | **(in thousands)** | ** ** |
| Total revenues    |       | $                       | 36,300     |   | $ | 232,130 |   | $ | 150,543 |   | $ | 418,973 |   |
| Net income (loss) |       | (5,442                  | )          | 111,361 |   | 59,222 |   | 165,141 |   |
|                   |            |                         |            |  |  |  |  |  |  |  |  |  |  |

 

***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 the reportedamounts of assets and liabilities and the reported amounts of income andexpenses during the reporting periods. We base our estimates, assumptions andjudgments on historical experience and on various other factors that we believeare reasonable under the circumstances. Actual results may differ from theseestimates under varying assumptions or conditions.

Our significantaccounting policies are more fully described in Note 2 of the notes to theaudited consolidated financial statements for the fiscal year endedJune 30, 2006, which are included in our Annual Report on Form 10-Kfiled with the Securities and Exchange Commission on September 12, 2006.On an ongoing basis, we evaluate our estimates and judgments, particularly asthey relate to accounting policies that we believe are most important to theportrayal of our financial condition and results of operations. We 

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regardan accounting estimate or assumption underlying our financial statements to bea “critical accounting estimate” where:

·       the nature of the estimateor assumption is material due to the level of subjectivity and judgmentnecessary to account for highly uncertain matters or the susceptibility of suchmatters to change; and

·       the impact of the estimates andassumptions on our financial condition or operating performance ismaterial.

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 andReceivables*

For a discussion of our revenue recognition policies,see “—Recognition and Valuation of Service Revenue.”

Because there areno quoted market prices for our additional structural advisory fees orresiduals receivable, we use discounted cash flow modeling techniques and thefollowing key assumptions to estimate their values:

·       the discount rate, which weuse to calculate the fair value of our additional structural advisory fees andresiduals;

·       the annual rate of studentloan prepayments;

·       the trend of interest ratesover the life of the loan pool, including the forward LIBOR curve, and thespread between LIBOR and auction rates;

·       expected loan defaults; and

·       expected recoveries ofdefaulted loans.

We base these estimates on our proprietary historicaldata, third-party data and our industry experience, adjusting for specificprogram and borrower characteristics such as loan type and borrowercreditworthiness. We also monitor trends in loan performance over time and makeadjustments we believe are necessary to value properly our receivables balancesat each balance sheet date.

Thefollowing table shows the approximate weighted average loan performanceassumptions at March 31, 2007:

| ** **                                                     | ** ** | ** **    | ** ** | **Percentage rate** | ** ** | **Percentage discount rate** | ** ** |
|----------------------------------------------------------------|------------|---------------|------------|--------------------------|------------|----------------------------------------|------------|
| **Trust**                                                      | ** ** | ** **    | ** ** | **Loan type**       | ** ** | **Default**                            | ** ** | **Recovery** | ** ** | **Prepayments** | ** ** | **Residuals** | ** ** | **Structural  advisory fees** | ** ** |
| Private label  loan trusts with Triple B rated securities |       | Private label |       |                     | 10.33      | %                                      |       |   | 40 | % |   |   | 8 | % |   |   | 13.00 | % |   |   | 6.64 | % |   |
| Private label  loan trusts without Triple B rated securities   |       | Private label |       |                     | 8.93       |                                   |       |   | 40 |   |   |   | 8 |   |   |   | 11.06 |   |   |   | 6.64 |   |   |
| NCT trusts                                                     |       | GATE/Other    |       |                     | 17.87      |                                   |       |   | 48 |   |   |   | 6 |   |   |   | 12.00 |   |   |   | 6.64 |   |   |
|                                                                |            |               |            |                          |            |                                        |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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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.

Our private label loanprograms, under which approximately 80% of the borrowers have creditworthyco-borrowers, typically a family member, have an extensive credit underwritingprocess. GATE programs had a borrower approval rate of approximately 83% infiscal 2006 as a result of the credit support provided by the participatingschools. Accordingly, we believe that borrowers in our private label programswill prepay at a higher rate and default at a lower rate than borrowers in ourGATE programs.

*Prepayment Rates.*   Loansin the securitization trusts have been experiencing higher prepayment ratesthan we had estimated would occur at these points in the life of the loans as aresult of a number of factors, including a prolonged and unfavorable interestrate environment. During the third quarter of fiscal 2007, we altered ourassumption regarding the annual rate of prepayments that we use to estimate thefair value of our residual and structural advisory fee receivables. Theincrease of this assumption from an average over the life of the loan of 7% to8% resulted in a decrease in the fair value of the residual receivable of $36.2million and a decrease in the fair value of the additional structural advisoryfee receivable of $3.5 million.

*Discount Rate—Residuals.*   Indetermining an appropriate discount rate for valuing our residuals, wehistorically have reviewed the rates used by student loan securitizers as wellas rates used in the much broader asset-backed securities, or ABS, market.Prior to fiscal 2007, we applied a discount rate of 12% in estimating thepresent value of our residuals, based on the expected timing of cash flows andthe maximum 24-year life of the trust assets and residuals.

During the first ninemonths of fiscal 2007, we facilitated three securitization transactionsinvolving the issuance of Triple B rated securities, the only such issuances byany of our securitization trusts. Triple B rated issuances have, in effect,allowed us to monetize a portion of our securitization—related revenues thatpreviously would have been recognized as residuals. Accordingly, we believethat market developments have now provided us with a meaningful basis for thediscount rate to be applied in estimating the fair value of pre-fiscal 2007private label securitization trust residuals. Beginning with the third quarterof fiscal 2007, we applied a discount rate equal to the trailing 12 monthaverage of the one month LIBOR + 1.75% to value the portion of the residualsthat we believe qualifies as investment grade in pre-fiscal 2007 private labeltrusts. That portion of the residuals that we believe does not qualify asinvestment grade will be discounted at 13%, as it is in the securitizationtrusts that have issued Triple B rated securities. The aggregated averagediscount rate at March 31, 2007 was 11.52% for all outstanding trusts.This decrease in the aggregated average discount rate resulted in an increasein the fair value of our residual receivable of $26.7 million.

*Discount Rate—AdditionalStructural Advisory Fees.*   We base the discountrate that we use to calculate the fair value of our additional structuraladvisory fees on the 10-year U.S. Treasury Note rate plus 200 basispoints. During the first nine months of fiscal 2007 and fiscal 2006, the 10-yearU.S. Treasury Note rate decreased 52 basis points and increased 89 basispoints, respectively. We applied a discount rate of 6.64% at March 31,2007, 7.16% at June 30, 2006, 6.85% at March 31, 2006 and 5.96% atJune 30, 2005. A decrease in the 10-year U.S. Treasury Note rate hasthe effect of increasing the estimated fair value of our structural advisoryfees receivable, while an increase in the rate has the opposite effect on ourestimate of fair value.

Two private label loantrusts have issued predominately senior auction rate notes to finance thepurchase of student loans. Interest rates for the auction rate notes aredetermined from time to time at auction. At March 31, 2007, we used a 10basis point spread over LIBOR to project the future cost of 

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fundingof the senior auction rate notes in the trusts. Since inception of the firsttrust, the average spread over LIBOR for the senior auction rate notes of thattrust has been 5.2 basis points. Since the inception of the second trust,the average spread over LIBOR for the senior auction rate notes of that trusthas been 6.2 basis points.

Except for the changes tothe prepayment rate and the discount rates applied to residuals and additionalstructural advisory fees, we did not change any valuation assumptions duringthe first nine months of fiscal 2007 or fiscal 2006. We will continue tomonitor the performance of the trust assets against our expectations, and willmake such adjustments to our estimates as we believe are necessary to valueproperly our receivables balances at each balance sheet date. For a discussionof the sensitivity of the additional structural advisory fees and residualsreceivable to variations in our assumptions and estimates, see “—ExecutiveSummary—Application of Critical Accounting Policies and Estimates—ServiceRevenue and Receivables—Sensitivity Analysis.”

*SensitivityAnalysis*

Increases in our estimates of defaults, prepaymentsand discount rates, increases in the spread between LIBOR and auction ratesindices, as well as decreases in default recovery rates and the multi-yearforward estimates of LIBOR, would have a negative effect on the value of ouradditional structural advisory fees and residuals. Student loan prepaymentsinclude either full or partial payments by a borrower in advance of thematurity schedule specified in the note, including payments as a result of loanconsolidation activity. Because most credit defaults are reimbursable by thirdparties, increases in defaults generally have the same effect as increases inprepayments. If defaults increase beyond the level of expected third-partyreimbursement, then these changes will have an additional negative effect onthe value of our additional structural advisory fees and residuals. LIBOR isthe reference rate for a substantial majority of the loan assets and, webelieve, a reasonable index for borrowings of the trusts. Because the trusts’student loan assets earn interest based on LIBOR and some trusts haveoutstanding securities that pay interest based on the results of auction rates,changes in the spread between LIBOR and the auction rate can affect theperformance 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 March 31, 2007 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 March 31, 2007, and changes in the assumedspread between 1-month LIBOR rates and auction rates, which are based on..05% and .10% changes from the assumed levels for each key assumption:

| ** **                             | ** ** | **Percentage change in  assumptions** | ** ** | **Receivables**   | ** ** | **Percentage change in  assumptions** | ** ** |        |
|----------------------------------------|------------|-------------------------------------------------|------------|-------------------|------------|-------------------------------------------------|------------|-------------|
| **Structural advisory fees** | ** ** | ** **                                      | ** ** | **Down 20%** | ** ** | **Down 10%**                               | ** ** | **balance** | ** ** | **Up 10%** | ** ** | **Up 20%** | ** ** |   |
| ** **                             | ** ** | **(dollars in thousands)**            | ** ** |              |
| Default rate:                          |       |                                            |       |              |       |                                            |       |        |   |   |   |   |   |
| Total structural advisory fees         |       | $                                               | 124,580    |              | $          | 123,995                                         |       |        | $ | 123,412 |   |   | $ | 122,827 |   | $ | 122,239 |   |
| Change in receivables balance          |       | 0.95                                            | %          | 0.47              | %          |                                            |       |        |   | (0.47 | )% | (0.95 | )% |
| Default recovery rate:                 |       |                                            |       |              |       |                                            |       |        |   |   |   |   |   |
| Total structural advisory fees         |       | $                                               | 123,247    |              | $          | 123,329                                         |       |        | $ | 123,412 |   |   | $ | 123,501 |   | $ | 123,591 |   |
| Change in receivables balance          |       | (0.13                                           | )%         | (0.07             | )%         |                                            |       |        |   | 0.07 | % | 0.15 | % |
| Annual prepayment  rate:               |       |                                            |       |              |       |                                            |       |        |   |   |   |   |   |
| Total structural advisory fees         |       | $                                               | 129,696    |              | $          | 126,468                                         |       |        | $ | 123,412 |   |   | $ | 120,516 |   | $ | 117,773 |   |
| Change in receivables balance          |       | 5.09                                            | %          | 2.48              | %          |                                            |       |        |   | (2.35 | )% | (4.57 | )% |
| Discount rate:                         |       |                                            |       |              |       |                                            |       |        |   |   |   |   |   |
| Total structural advisory fees         |       | $                                               | 132,678    |              | $          | 127,889                                         |       |        | $ | 123,412 |   |   | $ | 118,988 |   | $ | 114,842 |   |
| Change in  receivables balance         |       | 7.51                                            | %          | 3.63              | %          |                                            |       |        |   | (3.58 | )% | (6.94 | )% |
|                                        |            |                                                 |            |                   |            |                                                 |            |             |  |  |  |  |  |  |  |  |  |  |  |  |  |

                                                                                                                                                                                                                                                

| ** **                      | ** ** | **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 structural advisory  fees |       |                                 | $          | 115,468                              |       |                               |       | $ | 119,312 |   |   |   | $ | 123,412 |   |   |   | $ | 127,372 |   |   |   | $ | 131,683 |   |   |
| Change in  receivables  balance |       |                                 | (6.44      | )%                                   |       |                               | (3.32      | )% |   |   |   |   |   |   | 3.21 | % |   |   | 6.70 | % |   |
|                                 |            |                                      |            |                                      |            |                                    |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

| ** **                     | ** ** | **Percentage change in  assumptions** | ** ** | **Receivables**   | ** ** | **Percentage change in  assumptions** | ** ** |
|--------------------------------|------------|-------------------------------------------------|------------|-------------------|------------|-------------------------------------------------|------------|
| **Residuals**                  | ** ** | ** **                                      | ** ** | **Down 20%** | ** ** | **Down 10%**                               | ** ** | **balance** | ** ** | **Up 10%** | ** ** | **Up 20%** | ** ** |
| ** **                     | ** ** | **(dollars in thousands)**            | ** ** |
| Default rate:                  |       |                                            |       |              |       |                                            |       |   |   |   |   |   |   |
| Total residual fees            |       | $                                               | 625,043    |              | $          | 618,596                                         |       |   | $ | 612,199 |   |   | $ | 605,774 |   | $ | 599,326 |   |
| Change in receivables balance  |       | 2.10                                            | %          | 1.04              | %          |                                            |       |   |   | (1.05 | )% | (2.10 | )% |
| Default recovery  rate:        |       |                                            |       |              |       |                                            |       |   |   |   |   |   |   |
| Total residual fees            |       | $                                               | 610,473    |              | $          | 611,312                                         |       |   | $ | 612,199 |   |   | $ | 613,062 |   | $ | 613,941 |   |
| Change in receivables balance  |       | (0.28                                           | )%         | (0.14             | )%         |                                            |       |   |   | 0.14 | % | 0.28 | % |
| Annual prepayment  rate:       |       |                                            |       |              |       |                                            |       |   |   |   |   |   |   |
| Total residual fees            |       | $                                               | 678,899    |              | $          | 644,672                                         |       |   | $ | 612,199 |   |   | $ | 581,339 |   | $ | 552,065 |   |
| Change in receivables balance  |       | 10.90                                           | %          | 5.30              | %          |                                            |       |   |   | (5.04 | )% | (9.82 | )% |
| Discount rate:                 |       |                                            |       |              |       |                                            |       |   |   |   |   |   |   |
| Total residual fees            |       | $                                               | 728,326    |              | $          | 667,117                                         |       |   | $ | 612,199 |   |   | $ | 562,744 |   | $ | 518,291 |   |
| Change in  receivables balance |       | 18.97                                           | %          | 8.97              | %          |                                            |       |   |   | (8.08 | )% | (15.34 | )% |
|                                |            |                                                 |            |                   |            |                                                 |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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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            |       |                                       | $          | 592,633                                    |       |                               |       | $ | 602,858 |   |   |   | $ | 612,199 |   |   |   | $ | 618,537 |   |   |   | $ | 623,105 |   |   |
| Change in  receivables balance |       |                                       | (3.20      | )%                                         |       |                               | (1.53      | )% |   |   |   |   |   |   | 1.04 | % |   |   | 1.78 | % |   |
|                                |            |                                            |            |                                            |            |                                    |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

| ** **                                                        | ** ** | **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                                               |       |                                   | $          | 617,182                               |       |                               |       | $ | 614,692 |   |   |   | $ | 612,199 |   |   |   | $ | 609,710 |   |   |   | $ | 607,221 |   |   |
| Change in  receivables balance                                    |       |                                   | 0.81       | %                                     |       |                               | 0.41       | % |   |   |   |   |   |   | (0.41 | )% |   |   | (0.81 | )% |   |
|                                                                   |            |                                        |            |                                       |            |                                    |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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 toJuly 1, 2003, this accounting treatment was in accordance with variousEmerging Issues Task Force issues and related interpretations. We considered,among other things, the following factors in assessing consolidation of thesecuritization trusts:

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

·       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 FINNo. 46, in assessing consolidation. FIN No. 46 provided a newframework for identifying variable interest entities and determining when acompany should include the assets, liabilities, non-controlling interests andresults of activities of a variable interest entity in its consolidatedfinancial statements.

On December 24, 2003, the FASB issued FINNo. 46 (revised December 2003), “Consolidation of Variable InterestEntities,” or FIN No. 46R, which addressed how a business enterpriseshould evaluate 

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whether it has acontrolling interest in an entity through means other than voting rights andaccordingly should consolidate the entity. FIN No. 46R has replaced FINNo. 46. At March 31, 2007, each securitization trust created afterJanuary 31, 2003 has met the criteria to be a qualified special-purposeentity, or QSPE, as defined in paragraph 35 of FASB StatementNo. 140, “Accounting for the Transfers and Servicing of Financial Assetsand Extinguishments of Liabilities.” Accordingly, we did not consolidate theseexisting securitization trusts in our financial statements. In addition, thesecuritization trusts created prior to January 31, 2003 in which we hold avariable interest that could result in us being considered the primarybeneficiary of such trust, have been amended in order for them to be consideredQSPEs. The adoption of FIN No. 46R, which we began to apply inDecember 2003, did not have a material impact on our consolidatedfinancial condition, results of operations, earnings per share or cash 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 entity mustmeet to be considered a QSPE. We are monitoring the status of the exposuredraft to assess its impact, if any, on our financial statements.

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**Results ofOperations**

***Three and nine months ended March 31, 2007 and2006***

***Revenue Related to Securitization Transactions***

Ourprivate label loan products are marketed through two marketing channels:(a) direct to consumer, which generally refers to programs that lenders,education loan marketers, businesses, affinity groups or other organizationsmarket directly to prospective borrowers, and (b) school channel, whichrefers to programs that lenders or third parties market indirectly througheducational institutions. Private label loans do not include GATE loans. Ourestimates of the allocation by marketing channel of our securitization revenuesfor the first nine months of fiscal 2007 and 2006, expressed as a percentage ofthe total principal and accrued interest of private label loans securitized ineach channel at the date of securitization, 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**                                                          | ** ** | ** **                          | ** ** | ** **             | ** ** | ** **                             |       |                                         | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** |   |   |
| March 2007                                                          |       | Direct to consumer                  |       | $                      | 583        | ** **                             | 75         | %                                            |       | 14.7 | % |   |   | 1.2 | % |   |   | 5.2 | % |   |   | 21.1 | % |   |
|                                                                          |       | School channel                      |       | 193                    | ** ** | 25                                     |       |                                         | 8.5        |   |   |   | 1.2 |   |   |   | 2.0 |   |   |   | 11.6 |   |   |
|                                                                          |       | Total                               |       | $                      | 776        | ** **                             |       |                                         |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
|                                                                          |       | Blended yield(1)                    |       | ** **             | ** ** |                                   |       |                                         | 13.1       |   |   |   | 1.2 |   |   |   | 4.4 |   |   |   | 18.7 |   |   |
| 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 nine months of fiscal 2007                               |       | Blended yield(1)                    |       | $                      | 2,886      | ** **                             |       |                                         |       | 12.6 |   |   |   | 1.2 |   |   |   | 4.8 |   |   |   | 18.6 |   |   |
| **Fiscal 2006**                                                          | ** ** | ** **                          | ** ** | ** **             | ** ** | ** **                             |       |                                         | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** |   |   |
| March 2006                                                          |       | Direct to Consumer                  |       | $                      | 527        | ** **                             | 71         | %                                            |       | 8.7 | % |   |   | 1.2 | % |   |   | 7.7 | % |   |   | 17.5 | % |   |
|                                                                          |       | School Channel                      |       | 214                    | ** ** | 29                                     |       |                                         | 5.9        |   |   |   | 1.2 |   |   |   | 3.2 |   |   |   | 10.3 |   |   |
|                                                                          |       | Total                               |       | $                      | 741        | ** **                             |       |                                         |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
|                                                                          |       | Blended Yield(1)                    |       | ** **             | ** ** |                                   |       |                                         | 7.9        |   |   |   | 1.2 |   |   |   | 6.4 |   |   |   | 15.5 |   |   |
| 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 nine months of fiscal 2006                               |       | Blended Yield(1)                    |       | $                      | 2,006      | ** **                             |       |                                         |       | 7.7 |   |   |   | 1.2 |   |   |   | 6.3 |   |   |   | 15.1 |   |   |
|                                                                          |            |                                     |            |                        |            |                                        |            |                                              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

----

(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.

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(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 relative profitabilityof these loans, and should be read with caution. Furthermore, these yields aredependent on a number of factors, including the mix of loans between marketingchannels that are included in a particular securitization, the average life ofloans, which can be impacted by prepayments, the time of year that the loansare securitized and the relative mix of loans from students with variousexpected terms to graduation, the structure of, and prevailing marketconditions at the time of, a securitization, the marketing fees which ourclients earn on loans we securitize for them, along with a number of otherfactors. Therefore, readers are cautioned that the approximated blended yieldsand yields by marketing channel above may not be indicative of yields that wemay be able to achieve in future securitizations.

*Up-front structuraladvisory fees*

The up-front component of structural advisory feesincreased to $365.8 million for the first nine months of fiscal 2007 from$154.6 million for the first nine months of fiscal 2006. Up-front structuraladvisory fees increased to $103.9 million for the third quarter of fiscal 2007from $58.5 million for the third quarter of fiscal 2006. The increase inup-front structural advisory fees for the first nine months of fiscal 2007compared to the first nine months of fiscal 2006 was primarily due to anincrease in up-front structural advisory fees as a percentage of the privatelabel loan volume securitized, or up-front structural advisory fee yield, andan increase in loan facilitation volume, which enabled us to securitize agreater amount of loans. The securitization trusts we facilitated in the firstnine months of fiscal 2007 issued Triple B rated securities, the only suchissuances by any of our securitization trusts. The issuance of Triple B ratedsecurities enabled us to increase the up-front structural advisory fee yield,with a decrease in the amount of residuals we expect to receive, from thesesecuritization transactions.

The increase in up-front structural advisory fees forthe third quarter of fiscal 2007 compared to the third quarter of fiscal 2006was primarily due to an increase in up-front structural advisory fee yield and,to a lesser extent, an increase in loan facilitation volume. We expect ourup-front structural advisory fee yield for future securitizations to fluctuateas a result of market conditions at the time of securitization and thetransaction 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, changes in the fee yieldand loan mix, and the receipt of cost of issuance funds for the nine and threemonths ended March 31, 2007 and 2006:

| ** **                                                                            | ** ** | **Up-front structural advisory fees** | ** ** |
|---------------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                                            | ** ** | **Total volume  of loans  securitized**    | ** ** | **Change  attributable  to increase  securitization  volume** | ** ** | **Change  attributable to  change in fee  yield and loan  mix** | ** ** | **Receipt of  cost of  issuance  funds** | ** ** | **Total  change** | ** ** |
| ** **                                                                            | ** ** | **(in thousands)**                              | ** ** |
| Nine months ended  March 31, 2007 vs. nine months ended March 31, 2006 |       | $                                                    | 2,886,152  |   |   | $ | 67,545 |   |   |   | $ | 142,275 |   |   |   | $ | 1,360 |   |   | $ | 211,180 |   |
| Three months ended  March 31, 2007 vs. three months ended March 31, 2006    |       | $                                                    | 776,468    |   |   | $ | 2,777 |   |   |   | $ | 40,768 |   |   |   | $ | 1,877 |   |   | $ | 45,422 |   |

 

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*Additionalstructural advisory fees*

Theadditional component of structural advisory fees increased to $35.1 million forthe first nine months of fiscal 2007 from $24.9 million for the first ninemonths of fiscal 2006. Additional structural advisory fees decreased to $6.8million for the third quarter of fiscal 2007 from $8.7 million for the thirdquarter of fiscal 2006. The increase in additional structural advisory feesbetween the nine-month periods was primarily due to increases in the aggregatesecuritization volume partially offset by the change in prepayment assumption.The decrease in the additional structural advisory fees between the three-monthperiods was primarily due to the negative impact of a change in our assumptionregarding the annual rate of student loan prepayments that we use to estimatethe fair value of this receivable, which more than offset the positive impactof an increase in the aggregate securitization volume. The following tablesummarizes the changes in our estimate of the fair value of the structuraladvisory fees receivable for the nine and three months ended March 31,2007 and 2006:

| ** **                                | ** ** | **Nine months ended  March 31,** | ** ** |
|-------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                                | ** ** | **2007**                                        | ** ** | **2006** | ** ** |
| ** **                                | ** ** | **(in thousands)**                         | ** ** |
| Fair value at  beginning of period        |       | $                                               | 88,297     |   | $ | 53,371 |   |
| Additions from new securitizations        |       | 34,575                                          |       | 23,542 |   |
| Trust updates                             |       |                                            |       |   |   |
| Passage of time (present value accretion) |       | 5,413                                           |       | 2,967 |   |
| Increase in average prepayment rates      |       | (3,529                                          | )          | — |   |
| Other factors                             |       | (1,344                                          | )          | (1,564 | ) |
| Net accretion                             |       | 540                                             |       | 1,403 |   |
| Fair value at end of  period              |       | $                                               | 123,412    |   | $ | 78,316 |   |

 

| ** **                                | ** ** | **Three months  ended March 31,** | ** ** |
|-------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                | ** ** | **2007**                                         | ** ** | **2006** | ** ** |
| ** **                                | ** ** | **(in thousands)**                          | ** ** |
| Fair value at  beginning of period        |       | $                                                | 116,637    |   | $ | 69,589 |   |
| Additions from new securitizations        |       | 9,128                                            |       | 8,764 |   |
| Trust updates                             |       |                                             |       |   |   |
| Passage of time (present value accretion) |       | 2,001                                            |       | 1,163 |   |
| Increase in average prepayment rates      |       | (3,529                                           | )          | — |   |
| Other factors                             |       | (825                                             | )          | (1,200 | ) |
| Net accretion                             |       | (2,353                                           | )          | (37 | ) |
| Fair value at end of  period              |       | $                                                | 123,412    |   | $ | 78,316 |   |

 

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

During the first nine months of fiscal 2007, ourestimates of the fair value of our additional structural advisory fees resultedin an increase in their carrying value of approximately $0.5 million. This was 

33

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primarily due to theaccretion of the discounting inherent in the fair value estimates and theimpact of a decrease in the 10-year U.S. Treasury Note rate, offset inpart by the impact of a change in our assumption regarding future prepaymentsthat we use to estimate the fair value of this receivable and the effect ofhigher prepayment rates than we had estimated would occur during the period.During the first nine months of fiscal 2006, our estimates of the fair value ofour additional structural advisory fees resulted in an increase in theircarrying value of approximately $1.4 million. This increase was primarily dueto the accretion of discounting inherent in the fair value estimates and theimpact of an increase in the implied forward LIBOR curve during the period,offset by an increase in the discount rate. During the third quarter of fiscal2007, our estimate of the fair value of our additional structural advisory feesresulted in a decrease in their carrying value of approximately $2.4 million.During the third quarter of fiscal 2006, the change in our estimate of the fairvalue of our additional structural advisory fees was not material. The decreaseduring the third quarter of fiscal 2007 was due primarily to the impact of achange in our prepayment assumption and the performance of the trust assets,offset in part by the accretion of the discounting inherent in the fair valueestimates.

For a discussion ofchanges we made during the third quarter of fiscal 2007 to certain assumptionswe use to estimate the fair value of our additional structural advisory feesreceivable, see “—Executive Summary—Application of Critical Accounting Policiesand Estimates—Service Revenue and Receivables.”

*Residuals*

Service revenues from residuals increased to $159.4million for the first nine months of fiscal 2007 from $151.2 million for thefirst nine months of fiscal 2006, and decreased to $28.5 million for the thirdquarter of fiscal 2007, from $53.1 million for the third quarter of fiscal2006. The increase in service revenues from residuals in the first nine monthsof fiscal 2007 compared to the first nine months of fiscal 2006 was primarily aresult of an increase in securitization volume, an increase in the positiveimpact of the passage of time and an increase in the fair value of our residualreceivable as a result of a decrease in the discount rate we use to value theresidual receivable for certain securitization trusts, offset in part by theimpact of a higher up-front structural advisory fee yield in the fiscal 2007period and an increase in our assumption for future prepayments that we use tovalue the residual receivable. The decrease in service revenues from residualsfor the third quarter of fiscal 2007 compared to the third quarter of fiscal2006 was due primarily to actual prepayments during the quarter, the impact ofa higher up-front structural advisory fee yield in the fiscal 2007 period andan increase in our assumption for future prepayments that we use to value theresidual receivable, which more than offset the positive impact of the passageof time and an increase in the fair value of our residual receivable as aresult of a decrease in the discount rate we use to value certainsecuritization trusts. The issuance of Triple B rated securities in thesecuritizations completed during the fiscal 2007 periods enabled us to increasethe up-front structural advisory fee yield, but decreased the amount ofresiduals we expect to receive, from these securitizations.

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Thefollowing table reflects the changes in residuals attributable to the changesin securitization volume, changes in the fee yield and loan mix, and theupdates to prior trusts: 

| ** **                                                                         | ** ** | **Residuals**                                     | ** ** |
|------------------------------------------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                                         | ** ** | **Total volume  of loans  securitized** | ** ** | **Change  attributable  to increased  securitization  volume** | ** ** | **Change  attributable  to change in  fee yield and  loan mix** | ** ** | **Change  attributable to  trust updates** | ** ** | **Total change** | ** ** |
| ** **                                                                         | ** ** | **(in thousands)**                           | ** ** |
| Nine months ended  March 31, 2007 vs. nine months ended March 31, 2006   |       |                                              | $          | 2,886,152 |   |   |   | $ | 55,072 |   |   |   | $ | (41,279 | ) |   |   | $ | (5,661 | ) |   |   | $ | 8,132 |   |   |
| Three months  ended March 31, 2007 vs. three months ended March 31, 2006 |       |                                              | $          | 776,468 |   |   |   | $ | 2,253 |   |   |   | $ | (15,314 | ) |   |   | $ | (11,461 | ) |   |   | $ | (24,522 | ) |   |

 

Thefollowing table summarizes the changes in our estimate of the fair value of theresiduals receivable for the nine and three months ended March 31, 2007and 2006:

| ** **                                | ** ** | **Nine months ended  March 31,** | ** ** |
|-------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                                | ** ** | **2007**                                        | ** ** | **2006** | ** ** |
| ** **                                | ** ** | **(in thousands)**                         | ** ** |
| Fair value at  beginning of period        |       | $                                               | 452,823    |   | $ | 247,275 |   |
| Additions from new securitizations        |       | 139,441                                         |       | 125,648 |   |
| Trust updates                             |       |                                            |       |   |   |
| Passage of time (present value accretion) |       | 48,369                                          |       | 27,578 |   |
| Increase in average  prepayment rates     |       | (36,236                                         | )          | — |   |
| Decrease in discount  rate assumption     |       | 26,680                                          |       | — |   |
| Other factors                             |       | (18,878                                         | )          | (1,982 | ) |
| Net accretion                             |       | 19,935                                          |       | 25,596 |   |
| Fair value at end of  period              |       | $                                               | 612,199    |   | $ | 398,519 |   |

 

| ** **                                | ** ** | **Three months ended  March 31,** | ** ** |
|-------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                | ** ** | **2007**                                         | ** ** | **2006** | ** ** |
| ** **                                | ** ** | **(in thousands)**                          | ** ** |
| Fair value at  beginning of period        |       | $                                                | 583,666    |   | $ | 345,464 |   |
| Additions from new securitizations        |       | 34,371                                           |       | 47,432 |   |
| Trust updates                             |       |                                             |       |   |   |
| Passage of time (present value accretion) |       | 18,229                                           |       | 10,917 |   |
| Increase in average prepayment rates      |       | (36,236                                          | )          | — |   |
| Decrease in discount rate assumption      |       | 26,680                                           |       | — |   |
| Other factors                             |       | (14,511                                          | )          | (5,294 | ) |
| Net accretion                             |       | (5,838                                           | )          | 5,623 |   |
| Fair value at end of  period              |       | $                                                | 612,199    |   | $ | 398,519 |   |

 

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 or other assumptions that weuse in estimating the fair value of these receivables. We used a 12% discountrate during the first six months of fiscal 2007 and throughout fiscal 2006 invaluing residuals for securitizations completed prior to fiscal 2007. As aresult of our Triple B financing structure, we used a 

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13% discount rate invaluing residuals for the securitizations completed in the first nine months offiscal 2007. We also monitor the performance of trust assets, includingdefault, recovery, prepayment and forward LIBOR rates experience, which we alsoconsider in our estimates. We use an implied forward LIBOR curve to estimatetrust cash flows. For a discussion of the assumptions we make in estimating ourresiduals, see “—Executive Summary—Application of Critical Accounting Policiesand Estimates—Service Revenue and Receivables.” Loans in the securitizationtrusts have been experiencing higher prepayment rates than we had estimatedwould occur at these points in the life of the trusts. As a result, during thethird quarter of fiscal 2007, we increased our prepayment assumption from anaverage over the life of the loan of 7% to 8%, which offset the positive netaccretion that comes from updating the carrying value of our additionalstructural advisory fees and residuals receivables for the passage of time. Thenegative effect of the increase in our prepayment rate assumptions was offsetin part by a reduction in the discount rates we use to estimate the fair valueof a portion of our residuals receivable.

Our estimates of the fair value of our residualsreceivable resulted in an increase in their aggregate carrying value ofapproximately $19.9 million during the first nine months of fiscal 2007 and$25.6 million during the first nine months of fiscal 2006. During the firstnine months of fiscal 2007, the positive impact of the passage of time and thedecrease in our discount rate assumption was offset by the net negative impactof changes to the prepayment assumptions we use to estimate the fair value ofthis receivable as well as the negative impact of other factors. Included inother factors is the negative impact of a higher rate of prepayments during theperiod than we had estimated would occur. Our estimates of the fair value ofour residuals receivable resulted in a decrease in their aggregate carryingvalue of approximately $5.8 million during the third quarter of fiscal2007 and an increase in their aggregate carrying value of approximately $5.6million during the third quarter of fiscal 2006. The decrease during the thirdquarter of fiscal 2007 was primarily due to the negative impact of changes tothe prepayment assumption we use to estimate the fair value of this receivableand the performance of trust assets, offset in part by the positive impacts ofthe passage of time and the decrease in our discount rate assumption. Theincrease during the third quarter of fiscal 2006 was primarily due to thepositive impact of the passage of time.

We believe that the 13%discount rate we use for fiscal 2007 securitization trusts for cash flows lowerin priority to those received by holders of Triple B rated securities (or whichwe believe would not qualify as investment grade for pre-fiscal 2007 privatelabel trusts) is appropriate given the maximum 24-year life of the trustassets and residuals. For a discussion of changes we made during the thirdquarter of fiscal 2007 to certain assumptions, see “—Executive Summary—Applicationof Critical Accounting Policies and Estimates—Service Revenue and Receivables—SensitivityAnalysis.”

*Processing feesfrom TERI*

Processing fees from TERIincreased to $99.0 million for the first nine months of fiscal 2007 from $77.8million for the first nine months of fiscal 2006 and increased to $32.3 millionfor the third quarter of fiscal 2007 from $26.6 million for the third quarterof fiscal 2006. The increase was primarily due to increased reimbursableexpenses required to process the increased volume of private label loans thatwe actively disbursed during the fiscal 2007 periods. The volume of privatelabel loans we actively disbursed increased to $2.99 billion for the first ninemonths of fiscal 2007 from $2.24 billion for the first nine months of fiscal2006 and to $819 million for the third quarter of fiscal 2007 from $635 millionfor the third quarter of fiscal 2006.

*Administrative andother fees*

Administrative and otherfees increased to $15.0 million for the first nine months of fiscal 2007 from$6.1 million for the first nine months of fiscal 2006 and increased to $6.0million for the third quarter of fiscal 2007 from $2.4 million for the thirdquarter of fiscal 2006. The increases were primarily due to increasedreimbursed expenses that we generated between periods from marketingcoordination services 

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providedto some of our clients as well as for our proprietary brand. To a lesserextent, the increase was due to increasing student loan balances in thesecuritization trusts during the fiscal 2007 periods compared to the fiscal2006 periods. We generated approximately $10.8 million in reimbursable expensesfrom marketing coordination services during the first nine months of fiscal2007, compared to approximately $2.6 million in reimbursable expenses frommarketing coordination services during the first nine months of fiscal 2006. Wegenerated approximately $4.6 million in reimbursable expenses from marketingcoordination services during the third quarter of fiscal 2007, compared toapproximately $1.2 million in reimbursable expenses from marketing coordinationservices during the third quarter of fiscal 2006. We earned administrative feesfor the daily management of the securitization trusts of approximately $4.2million during the first nine months of fiscal 2007 and $3.0 million during thefirst nine months of fiscal 2006. We earned administrative fees for the dailymanagement of the securitization trusts of approximately $1.5 million duringthe third quarter of fiscal 2007 and $1.1 million during the third quarter offiscal 2006.

***Net Interest Income***

Net interest incomeincreased to $6.6 million for the first nine months of fiscal 2007 from$4.2 million for the first nine months of fiscal 2006. Net interest incomeincreased to $2.6 million for the third quarter of fiscal 2007 from $1.4million for the third quarter of fiscal 2006. The increases in the current yearperiods were due primarily to higher average cash balances available forinvestment and higher average yields.

***Non-interest Expenses***

Total non-interest expenses increased to $185.5million for the first nine months of fiscal 2007 from $139.0 million for thefirst nine months of fiscal 2006 and increased to $60.9 million for the thirdquarter of fiscal 2007 from $49.2 million for the third quarter of fiscal 2006.Compensation and benefits increased to $84.9 million for the first nine monthsof fiscal 2007 from $66.0 million for the first nine months of fiscal 2006 andincreased to $27.4 million for the third quarter of fiscal 2007 from $25.1 millionfor the third quarter of fiscal 2006. General and administrative expensesincreased to $100.6 million for the first nine months of fiscal 2007 from $73.0million for the first nine months of fiscal 2006, and increased to $33.5million for the third quarter of fiscal 2007 from $24.1 million for the thirdquarter of fiscal 2006.

The increase in compensation and benefits expense wasprimarily the result of an increase in personnel. Our average total number ofemployees was 8% higher during the first nine months of fiscal 2007 than duringthe corresponding prior year period. Our average total number of employees was9% higher during the third quarter of fiscal 2007 than during the third quarterof fiscal 2006. We hired additional personnel during the fiscal 2007 periods tomeet the needs of our growing loan processing and securitization activities.Compensation and benefits expense for the first nine months of fiscal 2007 alsoincreased due to an increase in accruals related to our employee incentivecompensation plans, primarily as a result of our positive financial resultsduring the first nine months of fiscal 2007.

General and administrative expenses increased duringthe first nine months of fiscal 2007 as compared to the first nine months offiscal 2006 as a result of increases in several subcategories of expenses.Marketing coordination expenses increased from $8.8 million for the first ninemonths of fiscal 2006 to $20.5 million for the first nine months of fiscal2007. The increase in marketing coordination expense was primarily due to theexpansion of our marketing coordination services to a larger client base aswell as the testing of our proprietary brand. Depreciation and amortizationexpense increased from $10.5 million for the first nine months of fiscal 2006to $12.0 million for the first nine months of fiscal 2007. The increase indepreciation and amortization expense is due to the expansion of our loanprocessing operations which resulted in additional purchases of fixed assets aswell as the amortization of capitalized software development costs. Equipmentexpenses increased from $8.2 million for the first nine months of fiscal 2006to $9.3 million for the first nine months of fiscal 2007. The increase inequipment expenses was primarily 

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due to an increase insoftware maintenance and license costs. External call center costs increasedfrom $6.2 million for the first nine months of fiscal 2006 to $15.0 million forthe first nine months of fiscal 2007. The increase in external call centercosts was primarily due to increases in personnel necessary to process thevolume of loans facilitated during the fiscal 2007 period and the expansion ofour marketing expenses in the television medium that need call center support.

General and administrative expenses increased duringthe third quarter of fiscal 2007 as compared to the third quarter of 2006 as aresult of increases in several subcategories of expenses. Marketingcoordination expenses increased from $2.9 million for the third quarter offiscal 2006 to $5.2 million for the third quarter of fiscal 2007. The increasein marketing coordination expense was primarily due to the expansion of ourmarketing coordination services to a larger client base as well as the testingof our proprietary brand. Equipment expenses increased from $2.7 million forthe third quarter of fiscal 2006 to $3.5 million for the third quarter offiscal 2007. The increase in equipment expenses was primarily due to anincrease in software maintenance, license costs and computer supplies. Externalcall center costs increased from $1.5 million for the third quarter of fiscal2006 to $3.7 million for the third quarter of fiscal 2007. The increase inexternal call center costs is primarily due to an increase in the number ofcustomer service personnel necessary to process the increased volume of loansfacilitated during the fiscal 2007 period. Consulting fees increased from $3.1million for the third quarter of fiscal 2006 to $4.1 million for the thirdquarter of fiscal 2007. The increase in consulting fees is primarily due to anincrease in information systems consulting costs used in the improvement of ourloan facilitation and financial systems.

We expect that ouroperating expenses will continue to increase as we devote additional resourcesto marketing coordination services and the expected increasing loan volumesfacilitated for our existing and new clients.

***Income Tax Expense***

Income tax expense increased to $202.1 million for thefirst nine months of fiscal 2007 from $117.4 million for the first nine monthsof fiscal 2006. The increase in income tax expense was primarily the result ofan increase in the amount of income before income tax expense between periods.During the first nine months of fiscal 2007 our effective tax rate, or the incometax expense as a percentage of income before income tax expense, increased toapproximately 40.8% from an effective tax rate of 38.5% for all of fiscal 2006.The increase in our effective tax rate was primarily due to the change in therelative sources of total revenues as our up-front structural advisory feesincreased and our residual revenues decreased during the first nine 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.

Income tax expenseincreased to $48.1 million for the third quarter of fiscal 2007 from $42.1million for the third quarter of fiscal 2006. The increase in income taxexpense in the third quarter of fiscal 2007 as compared to the third quarter offiscal 2006 was due to the increase in income before taxes between the periodsas a result of the relative sizes and profitability yields of thesecuritization transactions completed during the third quarters of fiscal 2007and 2006.

**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.

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***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 March 31, 2007 and $121.5 million at June 30, 2006.Our treasury stock balance was derived from the repurchases of our common stockin open market transactions. Our board of directors approved the repurchase of2,250,000 shares of our common stock in the fourth quarter of fiscal 2005 andapproved the repurchase of an additional 7,500,000 shares of our common stockin the first quarter of fiscal 2006. As of March 31, 2007, we hadrepurchased an aggregate of 6,206,700 shares at an average price, excludingcommissions, of $21.81 per share. FromApril 1, 2007 through May 4, 2007, we repurchased 956,200 shares ofcommon stock at an average purchase price per share, excluding commissions, of$35.58. Our board of directors approved the repurchase of up to 10,000,000shares of our common stock on April 24, 2007. The 10,000,000 sharesauthorized for repurchase included 3,393,300 shares available for repurchase asof April 25, 2007 under previously authorized repurchase programs.

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

At March 31, 2007, wehad $290.2 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, December 2006 and March 2007securitization transactions, offset by cash used to fund cash dividends andrepurchases of our common stock during the first nine months of fiscal 2007.Cash, cash equivalents and investments at March 31, 2007 primarilyincluded investments in variable rate demand notes, mortgage backed securities,Federal Home Loan Bank bonds and funds deposited in a money market fund thatinvests in short-term obligations of the U.S. Treasury and repurchaseagreements fully collateralized by obligations of the U.S. Treasury.

***Loans Held for Sale***

At March 31, 2007, wehad loans held for sale of $14.3 million as compared to no loans atJune 30, 2006. The increase in loans held for sale resulted from ouracquisition of Union Federal on November 30, 2006. Our loans held for saleat March 31, 2007 were comprised entirely of mortgage loans.

***Service Receivables***

Our service receivablesincreased to $746.5 million at March 31, 2007 from $551.6 million atJune 30, 2006, primarily as a result of the additional structural advisoryfees and residuals generated from the September 2006, December 2006and March 2007 securitization transactions. The increase in service receivableswas also due to a net increase in our estimate of the fair value of ourresiduals receivable of $19.9 million during the first nine months of fiscal2007, primarily as a result of the accretion of the discounting inherent in thefair value estimates due to the passage of time of $48.4 million which was partiallyoffset by changes in assumptions having a net negative impact of $9.6 million.

***Property and Equipment, net***

During the first ninemonths of fiscal 2007, our property and equipment, net increased by $2.4million, as $11.5 million of depreciation expense recorded during the periodwas more than offset by $13.3 million we spent on the expansion andimprovement of our loan processing facilities and systems. During the firstnine months of fiscal 2007, we financed the acquisition of $0.5 million inequipment through capital leases.

***Prepaid Income Taxes***

We had no prepaid incometaxes at March 31, 2007 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 $14.5 million at March 31, 2007 from $17.3 million atJune 30, 2006, primarily due to a decrease in prepaid marketing expensesof approximately $1.3 million and a decrease in prepaid insurance of $1.1million.

***Other Assets***

Other assets of $5.1million at March 31, 2007 and June 30, 2006 remained relativelyunchanged.

***Deposits***

At March 31, 2007, wehad deposits of $38.2 million as compared to no deposits at June 30, 2006.The increase in deposits resulted from our acquisition of Union Federal onNovember 30, 2006.

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***Accounts Payable and Accrued Expenses***

Accounts payable andaccrued expenses increased to $40.4 million at March 31, 2007 from$34.4 million at June 30, 2006. Our accrued bonuses wereapproximately $5.3 million higher at March 31, 2007 as compared toJune 30, 2006 due to an increase in accruals related to our employeeincentive compensation plans, primarily as a result of our positive financialresults during the first nine months of fiscal 2007.

***Income Taxes Payable***

We had income taxespayable of $13.3 million at March 31, 2007 as compared to no income taxespayable at June 30, 2006. Our income taxes payable increased as a resultof the earnings generated during the first nine 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 nine 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 $6.3 million at March 31, 2007 from $8.8 million atJune 30, 2006, primarily due to scheduled principal payments made duringthe first nine months of fiscal 2007.

***Notes Payable to TERI***

Notes payable to TERIdecreased to $3.9 million at March 31, 2007 from $4.5 million atJune 30, 2006. The balance relates to two acquisition notes we issued tofinance the acquisition of TERI’s loan processing operations, as well as itsloan database in 2001. The decrease in notes payable to TERI was due to thescheduled principal payments made during the first nine months offiscal 2007.

***Other Liabilities***

Other liabilitiesincreased to $2.3 million at March 31, 2007 from $2.2 million atJune 30, 2006. The balance at both period ends related primarily todeferred rent related to several operating leases for office space.

***Contractual Obligations***

As of March 31, 2007,our contractual obligations had not changed materially from those describedunder the caption “Item 7. Management’s Discussion and Analysis of FinancialCondition and Results of Operations-Financial Condition, Liquidity and CapitalResources-Contractual Obligations” in our annual report on Form 10-Kfor the fiscal year ended June 30, 2006.

***Cash Flows***

Our net cash provided by operating activitiesincreased to $187.4 million for the first nine months of fiscal 2007, comparedto cash provided by operating activities of $43.8 million for the first ninemonths of fiscal 2006. The increase in cash provided by operations resultedprimarily from increases in net income, which includes our increased up-frontstructural advisory fee revenue, and the net change in the balance 

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sheet accounts for incometaxes offset in part by increases in residual receivables and structuraladvisory fee receivables.

Our cash used in investing activities increased to$30.0 million during the first nine months of fiscal 2007, compared to $8.1million used in investing activities during the first nine months of fiscal2006. Net cash used in investing activities increased during the first ninemonths of fiscal 2007 primarily as a result of net purchases of investmentsand, to a lesser extent, capital expenditures related to the expansion andimprovement of our loan processing facilities and systems.

Net cash used in financing activities decreased to$42.2 million during the first nine months of fiscal 2007, compared to $87.0million during the first nine months of fiscal 2006. Net cash used in financingactivities decreased during the first nine months of fiscal 2007 primarily as aresult of a decrease in cash used for the repurchase of common stock, offset inpart by an increase in cash used for dividends.

We expect that our capitalexpenditure requirements for the final three months of fiscal 2007 will beapproximately $6.8 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 finance theacquisition of TERI’s loan processing operations as well as its loan database.Principal and interest at an annual rate of 6% is payable on these notes in120 monthly payments of $87,706 commencing on July 20, 2001 andending on June 20, 2011. At March 31, 2007, outstanding principal onthese notes totaled $3.9 million as compared to $4.5 million at June 30,2006.

**Off-Balance SheetTransactions**

We offer outsourcing services in connection with thelifecycle of a private student loan, from program design and marketingcoordination through loan administration and, ultimately, to the sale andsecuritization of the loans. We also structure and facilitate thesecuritization of student loans for our clients through a series of bankruptcyremote, qualified special purpose trusts.

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.

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 ThatMay Affect Future 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, andSection 27A of the Securities Act of 1933, as amended. For this purpose,any statements contained herein regarding our strategy, future operations,financial position, future revenues, projected costs, prospects, plans andobjectives of 

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management,other than statements of historical facts, are forward-looking statements. Thewords “anticipates,” “believes,” “estimates,” “expects,” “intends,” “may,”“plans,” “projects,” “will,” “would” and similar expressions are intended toidentify forward-looking statements, although not all forward-lookingstatements contain these identifying words. We cannot guarantee that weactually will achieve the plans, intentions or expectations expressed orimplied 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“critical accounting 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 those forward-lookingstatements as representing our views as of any date subsequent to May 10,2007.

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

***General***

Market risk is the risk ofchange in the fair value of a financial instrument due to changes in interestrates, equity prices, creditworthiness, foreign exchange rates or otherfactors. At June 30, 2006 and March 31, 2007, our primary market riskexposure related to changes in interest rates applicable to our cash, cashequivalents and investments. At March 31, 2007, as a result of ouracquisition of Union Federal, our exposure to market risk also included changesin interest rates applicable to our loans held for sale and deposits. Ouroverall market risk as of March 31, 2007, however, had not changed materiallyas 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 March 31,2007 based on changes in these loan performance assumptions, see “Management’sDiscussion and Analysis of Financial Conditions and Results of Operations—ExecutiveSummary—Application of Critical Accounting Policies and Estimates—SensitivityAnalysis.”

**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 March 31, 2007. The term“disclosure controls and procedures,” as defined in Rules 13a-15(e) and15d-15(e) under the Exchange Act, means controls and otherprocedures of a company that are designed to ensure that information requiredto be disclosed by us in the reports that we file or submit under the ExchangeAct is recorded, processed, summarized and reported, within the time periodsspecified in the SEC’s rules and forms. Disclosure controls and proceduresinclude, without limitation, controls and procedures designed to ensure thatinformation required to be disclosed by a company in the reports that it filesor submits under the Exchange Act is accumulated and communicated to thecompany’s management, including its principal 

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executive and principalfinancial officers, as appropriate to allow timely decisions regarding requireddisclosure. Management recognizes that any controls and procedures, no matterhow well designed and operated, can provide only reasonable assurance ofachieving their objectives and management necessarily applies its judgment inevaluating the cost-benefit relationship of possible controls and procedures.Based on the evaluation of our disclosure controls and procedures as ofMarch 31, 2007, our chief executive officer and chief financial officerconcluded that, as of such date, our disclosure controls and procedures wereeffective at the reasonable assurance level.

No change in our internalcontrol over financial reporting, as defined in Rules 13a-15(f) and 15d-15(f) underthe Exchange Act, occurred during the fiscal quarter ended March 31, 2007that has materially affected, or is reasonably likely to materially affect, ourinternal control over financial reporting.

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**Part II.   Other Information**

**Item 1A.**   RiskFactors

Investing in our commonstock involves a high degree of risk. You should carefully consider the risksand uncertainties described below in addition to the other information includedin this quarterly report. If any of the following risks actually occurs, ourbusiness, financial condition or results of operations would likely suffer. Inthat case, the trading price of our common stock could fall.

Wehave made material changes to the following risk factors compared to the riskfactors disclosed in our quarterly report on Form 10-Q for thequarter ended December 31, 2006:

·       “Inconnection with our recognition of revenue from securitization transactions, ifthe estimates we make, or the assumptions on which we rely, in preparing our financialstatements prove inaccurate, our actual results may vary materially from thosereflected in our financial statements.”

·       “Theoutsourcing services market for education lending is highly competitive and ifwe are not able to compete effectively, our revenue and results of operationsmay be adversely affected.”

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

***We derive a significant portion of our revenue andsubstantially all of our income from structuring securitization transactions;our financial results and future growth would be adversely affected if we areunable to structure securitizations.***

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 34 loansecuritizations since our formation in 1991. In connection withsecuritizations, we receive compensation in the form of structuraladvisory fees, residuals and administrative fees for management of the trusts.The amount and timing of the fees we recognize are affected, in part, by thesize and structure of the securitization transactions, as well as thecomposition of loan pools to be securitized, the return expectations ofinvestors and assumptions we make regarding loan portfolio performance,including defaults, recoveries, prepayments and the cost of funding. Revenuefrom new securitizations constituted 79% of our total revenue for the firstnine months of fiscal 2007, 74% of our total revenue for fiscal 2006 and 75% ofour total revenue for fiscal 2005. Substantially all of our net income in thosefiscal periods was attributable to securitization-related revenue.

***A number of factors, some of which are beyond ourcontrol, may adversely affect our securitization activities and therebyadversely affect our results of operations.***

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

·       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, particularly for subordinate classes ofasset-backed securities, or result in rating agencies modifying theirassumptions with respect to the securitization trusts;

·       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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·       thetiming and size of student loan-backed securitizations that other partiesfacilitate, or the adverse performance of, or other problems with, suchsecuritizations, could impact pricing or demand for our securitizations;

·       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 securitiesissued since 1998 in securitization transactions that we structured were soldto asset-backed commercial paper conduits. If these or similar asset-backedconduits cease to purchase securities in the securitizations that we structure,we may experience a delay in the timing of our securitizations as we seekto find 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 with our recognition of revenue fromsecuritization transactions, if the estimates we make, or the assumptions onwhich we rely, in preparing our financial statements prove inaccurate, ouractual results may vary materially from those reflected in our financialstatements.***

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. Because there are no quoted market prices for ouradditional structural advisory fees or residuals receivable, accountingrules require that we use discounted cash flow modeling techniques andcertain assumptions to estimate fair value. We estimate the fair value both initiallyand in each subsequent quarter and reflect the change in our estimate of fairvalue in earnings for that period. Our key assumptions to estimate the fairvalue include prepayment and discount rates, interest rates and the expectedcredit losses from the underlying securitized loan portfolio, net of recoveries.If the actual performance of some or all of the securitization trusts variesfrom the key assumptions we use, the actual additional structural advisory feesand residuals that we receive from the trusts could be significantly less thanreflected in our current financial statements, and we may incur a materialnegative adjustment to our earnings in the period in which our assumptionschange. In addition, our securitization yields, or our structural advisory feesand residuals from a new securitization transaction expressed as a percentageof the total principal and accrued interest securitized, realized on future securitizatedtransactions could decrease if the actual performance of some or all of the securitizationtrusts varies from the key assumptions we have historically used. During thethird quarter of fiscal 2007 we altered certain key assumptions which couldnegatively impact future securitization yields. For a discussion 

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of these changes and thesensitivity of the additional structural advisory fees and residuals 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 and Receivables—SensitivityAnalysis.” In particular, economic, regulatory, competitive and other factorsaffecting prepayment, default and recovery rates on the underlying securitizedloan portfolio, including full or partial prepayments and prepayments as aresult of loan consolidation activity, could cause or contribute to differencesbetween the actual performance of the securitization trusts and our keyassumptions.

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 financial results could be adversely affected ifwe were required to consolidate the financial results of the entities that weuse for securitizations that we facilitate.***

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 ourrelationships with key clients terminate, our revenue and results of operationswould be adversely affected.***

We structure and supportprivate student loan programs for commercial banks, including JPMorgan ChaseBank and Bank of America. Structural advisory fees and residuals fromsecuritization of JPMorgan Chase Bank loans represented approximately 26% ofour total revenue for fiscal 2006 and approximately 30% of our total revenuefor fiscal 2005. Structural advisory fees and residuals from securitization ofBank of America loans represented approximately 16% of total revenue for fiscal2006 and approximately 18% of total revenue for fiscal 2005. We also structureand support private student loan programs for companies that assist lenderssuch as Charter One Bank, N.A. in marketing their programs to customers.Structural advisory fees and residuals from securitization of loans marketed byCollegiate Funding Services, or CFS, represented approximately 10% of our totalrevenue for fiscal 2006 and approximately 17% of our total revenue for fiscal2005. JPMorgan Chase Bank acquired CFS in March 2006, and we entered intoan agreement with JPMorgan Chase Bank in May 2006 that terminated ourprevious agreement with CFS. Under our new agreement, JPMorgan Chase Bankagreed to increase its marketing expenditures in connection with its EducationOne loan program in an amount equal to CFS’s marketing commitment under itsprevious agreement with us, although we cannot assure you that the resultingloan volume will offset the loss of the loan volume derived from CFS.

We have agreements withlenders that govern the purchase of loans for securitization. Our agreementwith JPMorgan Chase Bank is scheduled to terminate in March 2010. Ouragreements pursuant to which Charter One Bank serves as a program lender aregenerally scheduled to terminate in May 2008. Our agreement with Bank ofAmerica governing the purchase of direct-to-consumer loans expires onMay 31, 2008, provided that either party may terminate this agreementon or after June 1, 2007, upon 90 days notice. Our agreement with Bank ofAmerica governing the purchase of school channel loans expires on June 30,2007, provided that the agreement automatically renews for successive one-yearterms after that 

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date andcan be terminated at any time upon 180 days notice. Our two agreements withBank of America that govern the purchase of GATE loans expire onNovember 30, 2007, but can be terminated by either party with 90 daysnotice. In the absence of termination, both agreements will automatically renewfor successive one-year terms. Each client above has the right to terminate itsagreement on short notice, generally 30 days or less, if we materiallybreach our agreement, including our failure to perform at service levelsspecified in those contracts. In addition, under the terms of our lenderclients’ guaranty agreements with TERI, both the lender and TERImay propose modifications to loan program guidelines during the first calendarquarter of each year. If the parties are unable to agree on a proposedmodification, such as an adjustment of the guarantee fees, the party proposingthe modification has the option of terminating the guaranty agreement,effective as of May 1 of that calendar year. Under its master loanguaranty 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 guidelines withoutour 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 outsourcing services market for education lendingis highly competitive and if we are not able to compete effectively, ourrevenue and results of operations may be adversely affected.***

We assist national andregional financial institutions and educational institutions, as well asbusinesses, education loan marketers and other enterprises, in structuring andsupporting their private education loan programs. We receive fees for serviceswe provide primarily in connection with the securitization of our clients’loans. The outsourcing services market in which we operate includes a large numberof service providers, some of which have greater financial, technical andmarketing resources, larger customer bases, greater name recognition and moreestablished relationships with their clients than we have. Larger competitorswith greater financial resources may be better able than us to respond tothe need for technological changes, compete for skilled professionals, buildupon efficiencies based on a larger volume of loan transactions, fund internalgrowth and compete for market share generally. We may face competitionfrom our clients if they choose, or acquire the ability, to provide directlythe services that we provide. In March 2006, our client JPMorgan ChaseBank completed its acquisition of CFS, a marketer of education loans we facilitated.This acquisition could result in the emergence of a new competitor with theability to offer outsourced services, including securitization services, forprivate student loans. In addition, we may face competition from thirdparties who decide to expand their services to include the suite ofservices that we provide. We are aware of two principal competitors, Sallie Maeand Servus Financial Corporation, an affiliate of Wells Fargo Company, thatoffer a similar range of services to lenders. Our business could also beadversely affected if Sallie Mae’s program to market private student loansdirectly to consumers continues to grow, if Sallie Mae seeks to market moreaggressively to third parties the full range of services for private loanprograms that we provide or if Sallie Mae’s private loan consolidation productresults in increased consolidation of private student loans held by thesecuritization trusts we have facilitated. We are also aware of smallerprivately held venture backed companies that are developing systems andexpertise with plans to compete directly with us. If we are not able to competeeffectively, our revenue and results of operations may be adversely affected.In addition, if third parties choose to provide the range of services that weprovide, pricing for our services may become more competitive, which couldlower our profitability.

In addition, there hasbeen significant consolidation within the banking and financial servicesindustry. On April 16, 2007, an investor group that included Bank ofAmerica and JPMorgan Chase Bank, our two largest lender clients, announced thatthey signed a definitive agreement to purchase Sallie Mae. The 

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investmentin Sallie Mae by these lender clients may result in some reduction in futureloan originations from these lenders. It may also impact our ability tonegotiate favorable fees when negotiating future contracts with these lenderclients. Further consolidation could result in a loss of business if one ormore of our clients were acquired by a competitor or a lender that is not ourclient.

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.Investigations by the New York Attorney General, the Attorneys General of otherstates, the United States Congress or a recently announced federal task forceinto the relationship between lenders and college financial aid officers couldhave a negative impact on the ability of our clients, and Union Federal, tomarket student loans.

***In structuring and facilitating securitizations of ourclients’ loans and as holders of rights to receive residual cash flows in thosetrusts, we may incur liabilities to investors in the asset-backed securitiesthose trusts issue.***

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

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

***If our relationshipwith TERI terminates, our business could be adversely affected.***

InJune 2001, we purchased the loan processing operations of TERI and enteredinto a series of agreements to govern future securitizations of TERI-guaranteedloans. TERI continues to provide private student loan guarantee, educationinformation and counseling services for students, and is the exclusive 

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third-party provider of borrower default guaranteesfor our clients’ private label loans. We have entered into an agreement toprovide various services for TERI and received fees from TERI for servicesperformed of $99.0 million, or 15% of total revenue, for the first nine monthsof fiscal 2007, and $77.8 million or 19% of total revenue, for the firstnine months of fiscal 2006. We also have entered into an agreement to receivefrom TERI updated information about the performance of the student loans it hasguaranteed, to allow us to supplement our database. Each of these agreementswith TERI had an initial term through June 2006. In October 2004, weexercised our option to renew each agreement for an additional five-year term,through June 2011. If our agreements with TERI terminate for any reason,or if TERI fails to comply with its obligations, our business would beadversely affected and the value of our intangible assets could be impaired forthe 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;

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

·       wecould lose access to continuing updates to the database of TERI-guaranteed loanperformance data.

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 March 31, 2007, 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 which was reaffirmed on April 2,2007. If these ratings are lowered, our agreement with Bank of America relatingto the purchase of direct-to-consumer loans could terminate, and Bank ofAmerica could suspend the processing of new applications for school channelloans. In addition, our clients may not wish to enter into guaranteearrangements with TERI, or we may receive lower structural advisory feesbecause it could be necessary to obtain financial guarantee insurance for theasset-backed securitizations that we structure. Finally, the inability of TERIas student loan guarantor to meet its guaranty obligations could reduce theamount of principal or interest paid to the holders of asset-backed securities,which could adversely affect our residual interests in securitization trusts orharm our ability to structure securitizations in the future. In each such case,our business would be adversely affected.

***Our business could be adversely affected if PHEAAfails to provide adequate or timely services or if our relationship with PHEAAterminates.***

As of March 31, 2007,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 to risksassociated with inadequate or untimely services, such as inadequate notice of 

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developmentsin prepayments, delinquencies and defaults. A substantial increase in theserates could adversely affect our ability to access profitably thesecuritization markets for our clients’ loans and the value of our additionalstructural advisory fees and residuals receivables. In addition, if ourrelationship with PHEAA terminates, we would either need to expand or develop arelationship with another TERI-approved loan servicer, which could betime consuming and costly. In such event, our business could be adverselyaffected. Although we periodically review the costs associated withestablishing servicing operations to service loans, we have no plans toestablish and perform servicing operations at this time.

***The growth of our business could be adversely affectedby changes in federal student loan programs or expansions in the population ofstudents eligible for loans under federal student loan programs.***

We focus our business exclusively on the market forprivate education loans, and more than 90% of our business is concentrated inloan programs for post-secondary education. The availability and terms of loansthat the federal government originates or guarantees affects the demand forprivate student loans because students and their families often rely on privateloans to bridge a gap between available funds, including family savings, grantsand federal and state loans, and the costs of post-secondary education. Thefederal government currently places both annual and aggregate limitations onthe amount of federal loans that any student can receive and determines thecriteria for student eligibility. These guidelines are adjusted in connectionwith funding authorizations from the United States Congress for programs underthe Higher Education Act. During February 2006, Congress passed, and thePresident signed, the Deficit Reduction Act of 2005. The Deficit Reduction Actof 2005 includes several changes to federal student loan programs. Althoughaggregate borrowing limits do not change, the Deficit Reduction Act of 2005increases amounts that first and second year college students may borrow andmakes Parent Loans for Undergraduate Students, or PLUS, loans available tograduate and professional students. Loans to fund graduate level educationrepresented approximately 11% during the first nine months of fiscal 2007, 15%during fiscal 2006 and 13% during fiscal 2005 of our total loan facilitationvolume. The loan limit increases take effect July 1, 2007 while most otherprovisions took effect July 1, 2006. Recent legislation, as well as futurelegislation, could weaken the demand for private student loans, or result inincreased competition in the market for private student loans which couldadversely affect the volume of private loans and the securitizationtransactions that we facilitate and structure and, as a result, the growth ofour business.

***Access toalternative means of financing the costs of education may reduce demand for privatestudent loans.***

Thedemand for private student loans could weaken if student borrowers use othervehicles to bridge the gap between available funds and costs of post-secondaryeducation. 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.

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***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, one securitization in the second quarter and one securitization in thethird quarter of fiscal 2007. Variations in the size or structure of eachsecuritization transaction, as well as the composition of the loan pools beingsecuritized, will continue to result in variability of our operating results ona quarterly basis. The timing and size of our planned securitization activitiesmay be affected by the seasonality of student loan applications and loanoriginations, as well as the other factors that could adversely affect oursecuritization activities. Origination of student loans is generally subject toseasonal trends, with the volume of loan applications increasing with theapproach of tuition payment dates. In fiscal 2006, we processed 37% of ourtotal loan facilitation volume in the first quarter ended September 2005,and 19%, 25% and 19% of our total loan facilitation volume in the respectivesuccessive 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 ourservices.***

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 default ratesfor 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.

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***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 processes that we developed isdifficult, and we cannot be certain that the steps that we have taken willprevent unauthorized use of our technology. Furthermore, others mayindependently develop substantially equivalent proprietary information andtechniques or otherwise gain access to our proprietary information. If we areunable to protect the confidentiality of our proprietary information andknow-how, the value of our technology and services will be adversely affected.

***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 

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administerotherwise improperly disclose confidential customer information, such breach orother disclosure could generate negative publicity about us and could adverselyaffect our relationships with our clients, including the lenders andeducational institutions with which we do business. This could have a materialadverse effect on our business. In addition, pending legislative proposals, ifadopted, likely would result in substantial penalties for unauthorizeddisclosure of confidential consumer information. New requirements issued by theFederal Financial Institutions Examination Council regarding authentication ofcustomers accessing account information became effective January 1, 2007.Those requirements have posed technology challenges for us, and we have implementedadditional authentication procedures in order to comply with thoserequirements. Failure to comply with those requirements could result inregulatory sanctions imposed on our client lenders and loss of business for us.

***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, systemsand processes that are better than ours or that gain greater market acceptance,those that we offer or use may become obsolete or noncompetitive. Any one ofthese circumstances could have a material adverse effect on our ability toobtain and retain key clients.

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

***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 March 31, 2007, our assetshave grown to $1.1 billion. Our revenue increased to $680.9 million for thefirst nine months of fiscal 2007 from $419.0 million for the first nine monthsof fiscal 2006. Our growth may place a strain on our management, systems andresources. 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 completed our acquisition of Union FederalSavings Bank, North Providence, Rhode Island. We may face challenges inintegrating our products, services and employees.

We cannot assureyou that we will be able to:

·       expandour systems effectively;

·       allocateour human resources optimally;

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·       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.

***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 our regulatory counsel and, in some states, additional local counselopinions and informal advice from state regulators, we have been operating onthe basis that no registrations or licenses are required of us under lawsapplicable to loan brokers, small lenders and loan arrangers, and other similarlaws. We will continue to review state registration and licensing requirementsthat may become applicable to us in the future, in view of the expansion of thescope of the services we provide, our plans for future activities and the timethat has elapsed since our prior review. As a result of this continuing review,we may determine that registration or licensing is required in jurisdictionswhere we are not currently registered or licensed. Even if we are notphysically present in a state, its regulators may take the position thatregistration or licensing is required because we provide services by mail,telephone, the Internet or other remote means. If we identify any states inwhich registration or licensing is required, we will proceed with registrationor licensing in the affected state. If any state asserts jurisdiction over ourbusiness, we will consider whether to challenge the assertion or proceed withregistration or licensing in the affected state. Compliance with suchrequirements could involve additional costs, which could have a materialadverse effect on our business. Our failure to comply with these laws couldlead 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

·       criminalas well as civil liability. This could have a material adverse effect on ourbusiness.

Our new affiliate, UnionFederal Savings Bank, may conduct business without regard to such statelicensing laws and requirements, because it is chartered by the federal Officeof Thrift Supervision, or OTS. Certain of our advertising and marketingcoordination employees who focus on our proprietary brand loans have becomeemployees of Union Federal, and will support those brands. To the extent thatour engagement in marketing related activities becomes part of the business of UnionFederal, the likelihood of assertion of state regulatory requirements affectingloan brokers, small lenders and credits services organizations will be reduced.

***If the regulatoryexemptions or rulings that allow us to conduct our business without registrationor licensing are modified or revoked, or the statutory and regulatoryrequirements change in the future, our compliance costs could increasesubstantially.***

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 

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making small loans, or inaiding or assisting the borrower or the lender in procuring or making suchloans, to obtain a license. Under the statute, the business of making smallloans includes the making of loans of $6,000 or less with interest rates andexpenses of more than 12% per year. The TERI-guaranteed loans that wefacilitate, as well as GATE loans we support, include amounts as small as$1,000, and a portion of those loans have combined interest rates and feesexceeding 12%. We could therefore become subject to the Small Loan Act withrespect to these loans if the Massachusetts Division of Banks revokes itsprevious determination that our operations are exempt or determines that ouractivities exceed the scope 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 andrules could also require us to implement additional or different programsand information technology systems and could impose licensing, capital andreserve requirements and additional costs, including administrative, complianceand third-party service 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, licensingand extensive governmental regulations, including Truth-in-Lending laws andother consumer protection laws and regulations. For example, some of thethird-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 be subjectto 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.

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***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 in consumerprotection laws or related regulations, or in the prevailing interpretationsthereof, may expose us to litigation, result in greater compliance costs,adversely affect the collection of balances due on the loan assets held bysecuritization trusts or otherwise adversely affect our business. For 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. Proposed regulations recently issued by the Department of Defense wouldlimit application of the Act to loans that have repayment terms of less than 91days, are made in amounts of less than $2,000 and have certain additional terms.If the proposed regulations are not adopted, we could incur substantialadditional expense complying with the requirements of the Act, and may berequired to create new types of products for persons covered 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. Proposed legislationgoverning the marketing of student loans could impose material additional costson our operations and restrict the marketing practices of our clients.Investigations relating to the role of schools in the marketing of both federaland private student loans may affect the ability of some of our clients tomarket loans through schools. Recent or future changes in federal and statebankruptcy and debtor relief laws may increase credit losses on the loans heldby securitization trusts and related administrative expenses. Violations of thelaws or regulations governing our operations, or the operations of TERI or ourother clients, could result in the imposition of civil or criminal penalties,the cancellation of our contracts to provide services or our exclusion fromparticipating in education loan programs. These penalties or exclusions, werethey to occur, would negatively impair our ability to operate our business. Inaddition, the loan assets held by securitization trusts that we have structuredcould be adversely impacted by violation of tax or consumer protection laws. Insuch event, the value of our residual interests could also be adverselyimpacted. In some cases, such violations 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 to individualstate 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 service toour clients, we do not act as a lender, guarantor or loan servicer, and theterms of the loans that we securitize are regulated in accordance with the lawsand regulations 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 

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parties whose marketing onbehalf of lenders is coordinated by us, are distinguishable from the activitiesinvolved in these cases.

Additional state consumerprotection laws would be applicable to the loans we facilitate if we, or anythird-party loan marketer whose activities we coordinate, were re-characterizedas a lender, and the loans (or the provisions governing interest rates, feesand other charges) could be unenforceable. In addition, we could be subject to claimsby consumers, as well as enforcement actions by regulators. Even if we were notrequired to cease doing business with residents of certain states or to changeour business practices to comply with applicable laws and regulations, we couldbe required to register or obtain licenses or regulatory approvals that couldimpose a substantial cost on us. To date, there have been no actions taken orthreatened against us on the theory that we have engaged in unauthorizedlending. However, such actions could have a material adverse effect on ourbusiness.

***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 

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price,we may therefore be the target of securities litigation in the future.Securities litigation could result in substantial costs and divert management’sattention and resources from our business.

***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 May 4, 2007, wehad 93,684,825 shares of common stock outstanding. Subject to limitations underfederal securities laws, including in some cases the volume limitations ofRule 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.

***Insiders havesubstantial control over us and could limit your ability to influence the outcomeof 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 UnionFederal and impose civil and monetary penalties for violations of federalbanking laws and 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, actionsby regulators that, if undertaken, could have a direct material adverse effecton 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 penaltiesif we fail to comply. Our ability to comply with all applicable laws andrules will depend largely on our establishment and maintenance of a systemto ensure such compliance, as well as our ability to attract and retainqualified compliance personnel. We could be subject to disciplinary or otheractions due to claimed noncompliance in the future, which could have an adverseeffect on our business, financial condition and operating results.

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***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;

·       ourdirectors may be removed only for cause by the affirmative vote of a majorityof the directors present at a meeting duly held at which a quorum is present,or the holders of 75% of the votes that all stockholders would be entitled tocast in 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 toSection 203 of the Delaware General Corporation Law which, subject tocertain exceptions, prohibits “business combinations” between a Delawarecorporation and an “interested stockholder,” which is generally defined as astockholder who becomes a beneficial owner of 15% or more of a Delaware corporation’svoting stock, for a three-year period following the date that such stockholderbecame an interested stockholder. Section 203 could have the effect ofdelaying, deferring or preventing a change in control that our stockholdersmight consider to be in their best interests.

**Item 2—UnregisteredSales of Equity Securities and Use of Proceeds**

***(a)   Recent Sales of Unregistered Securities***

None.

***(b)   Use of 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 March 31, 2007, 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.

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***(c)   Issuer Purchases 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 March 31, 2007. ThroughMarch 31, 2007, we repurchased an aggregate of 3,956,700 shares under thisprogram at an average price paid per share, excluding commissions, of $19.91.As of March 31, 2007, 3,543,300 shares of our common stock may yet bepurchased under this program, which does not have a fixed expiration date. From April 1, 2007 through May 4,2007, we repurchased 956,200 shares of common stock at an average purchaseprice per share, excluding commissions, of $35.58. On April 24, 2007, weannounced a repurchase program of up to 10,000,000 shares of our common stock.The 10,000,000 shares now authorized for repurchase includes 3,393,300 sharesavailable for repurchase as of April 25, 2007 under the previouslyauthorized repurchase program.

**Item 5—Other Information**

On May 8, 2007, we entered into a letteragreement with Stephen E. Anbinder extending to December 31, 2007 the termof his Consulting Period, as defined in the letter agreement datedJune 22, 2006 between Mr. Anbinder and us (the “Original Agreement”).

For a summary of the termsof the Original Agreement, we refer you to our current report on Form 8-Kfiled with the Securities and Exchange Commission on June 30, 2006.

**Item 6—Exhibits**

See the Exhibit Index on thepage immediately preceding the exhibits for a list of exhibits filed aspart of this quarterly report which Exhibit Index is incorporated hereinby 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: May 10, 2007 | By:                                   | /s/ JACK L. KOPNISKY |
|                    |                                  | Jack L. Kopnisky |
|                    |                                  | *Chief Executive Officer, President &  Chief Operating Officer* |
|                    | * *                              | *(Duly authorized officer)* |
| Date: May 10, 2007 | By:                                   | /s/ JOHN A. HUPALO |
|                    |                                  | John A. Hupalo |
|                    |                                  | *Senior Executive Vice President and  Chief Financial Officer* |
|                    | * *                              | *(Principal financial officer)* |
| Date: May 10, 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**                                                                                                                                                                                                                       |
|-----------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.1            |       | Letter agreement between the registrant and Stephen  E. Anbinder, dated May 8, 2007                                                                                                                                                   |
| 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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