**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,D.C. 20549**

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**FORM 10-Q**

**(MARK ONE)**
| **x**                                                                                                                           | ** ** | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|---------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------|
| **For The Quarterly Period Ended December 31,  2005**                                                                      |
| **OR**                                                                                                                          |
| **o**                                                                                                                           | ** ** | **TRANSITION REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**     |
| **For the transition period  from               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              |       | (I.R.S. Employer     |
| Incorporation or  Organization)               |       | Identification  No.) |
| **The Prudential Tower**                      | ** ** | ** **           |
| **800  Boylston Street, 34****th Floor** | ** ** | ** **           |
| **Boston,  Massachusetts**                    | ** ** | **02199-8157**       |
| (Address of  Principal Executive Offices)     |       | (Zip Code)           |

 

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

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

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Indicate by check mark whether the registrant is anaccelerated filer (as defined in Rule 12b-2 of the Exchange Act).  Yes x  No o

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

As of January 31, 2006, the registrant had62,822,660 shares of Common Stock, $0.01 par value per share, outstanding.

 

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**THE FIRST MARBLEHEAD CORPORATION AND SUBSIDIARIES**

**Table of Contents**

|                                     | ** ** |                                                                                                                            | **Page** |
|-------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------|----------|
| Part I.  Financial Information |       |                                                                                                                       |     |
| Item 1—                        |       | Financial Statements                                                                                                       |     |   |   |
|                                |       | Condensed Consolidated  Balance Sheets as of December 31, 2005 and June 30,

   2005                   |     | 3 |   |
|                                |       | Condensed Consolidated Statements of Operations for  the three months and six months ended December 31, 2005 and 2004 |     | 4 |   |
|                                |       | Condensed  Consolidated Statement of Changes in Stockholders’ Equity for the six months  ended December 31, 2005 |     | 5 |   |
|                                |       | Condensed  Consolidated Statements of Cash Flows for the six months ended  December 31, 2005 and 2004                 |     | 6 |   |
|                                |       | Notes to Unaudited Condensed Consolidated Financial  Statements                                                            |     | 7 |   |
| Item 2—                        |       | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                                |     | 18 |   |
| Item 3—                        |       | Quantitative  and Qualitative Disclosures About Market Risk                                                                |     | 43 |   |
| Item 4—                        |       | Controls and  Procedures                                                                                                   |     | 43 |   |
| Part II. Other  Information    |       |                                                                                                                       |     |
| Item  1A—                      |       | Risk  Factors                                                                                                              |     | 44 |   |
| Item 2—                        |       | Unregistered  Sales of Equity Securities and Use of Proceeds                                                               |     | 57 |   |
| Item 4—                        |       | Submission of  Matters to a Vote of Security Holders                                                                       |     | 58 |   |
| Item 6—                        |       | Exhibits                                                                                                                   |     | 58 |   |
| SIGNATURES                          |       | 59                                                                                                                         |     |
| EXHIBIT INDEX                  |       |                                                                                                                       |     |
|                                     |            |                                                                                                                            |          |  |  |  |  |

 

2

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**Part I.   FinancialInformation**

**Item 1—FinancialStatements**

**THEFIRST MARBLEHEAD CORPORATION AND SUBSIDIARIES**

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

| ** **                                                                                                                                                                                                                                                                                                                                       | ** ** | **December 31,  2005** | ** ** | **June 30,  2005** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------|------------|-------------------------|------------|
| **ASSETS**                                                                                                                                                                                                                                                                                                                                       |       |                        |       |                    |       |   |   |
| Cash and cash equivalents                                                                                                                                                                                                                                                                                                                        |       |                        | $          | 152,476                 |       |   | $ | 193,796 |   |
| Service receivables:                                                                                                                                                                                                                                                                                                                             |       |                        |       |                    |       |   |   |
| Structural advisory fees                                                                                                                                                                                                                                                                                                                         |       |                        | 69,589     |                    |       | 53,371 |   |
| Residuals                                                                                                                                                                                                                                                                                                                                        |       |                        | 345,464    |                    |       | 247,275 |   |
| Processing fees from The Education Resources  Institute (TERI)                                                                                                                                                                                                                                                                                   |       |                        | 8,842      |                    |       | 8,944 |   |
|                                                                                                                                                                                                                                                                                                                                             |       |                        | 423,895    |                    |       | 309,590 |   |
| Property and equipment                                                                                                                                                                                                                                                                                                                           |       |                        | 57,263     |                    |       | 49,269 |   |
| Less accumulated depreciation and amortization                                                                                                                                                                                                                                                                                                   |       |                        | (16,265    | )                       |       | (10,174 | ) |
| Property and equipment, net                                                                                                                                                                                                                                                                                                                      |       |                        | 40,998     |                    |       | 39,095 |   |
| Goodwill                                                                                                                                                                                                                                                                                                                                         |       |                        | 3,176      |                    |       | 3,176 |   |
| Intangible assets, net                                                                                                                                                                                                                                                                                                                           |       |                        | 2,278      |                    |       | 2,620 |   |
| Prepaid income taxes                                                                                                                                                                                                                                                                                                                             |       |                        | —     |                    |       | 2,594 |   |
| Other prepaid  expenses                                                                                                                                                                                                                                                                                                                          |       |                        | 6,970      |                    |       | 4,163 |   |
| Other assets                                                                                                                                                                                                                                                                                                                                     |       |                        | 5,036      |                    |       | 3,159 |   |
| Total assets                                                                                                                                                                                                                                                                                                                                     |       |                        | $          | 634,829                 |       |   | $ | 558,193 |   |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                                                                                                                                                                                                                                   |       |                        |       |                    |       |   |   |
| Liabilities:                                                                                                                                                                                                                                                                                                                                     |       |                        |       |                    |       |   |   |
| Accounts payable and accrued expenses                                                                                                                                                                                                                                                                                                            |       |                        | $          | 23,109                  |       |   | $ | 33,318 |   |
| Income taxes payable                                                                                                                                                                                                                                                                                                                             |       |                        | 33,597     |                    |       | — |   |
| Net deferred income tax liability                                                                                                                                                                                                                                                                                                                |       |                        | 107,508    |                    |       | 84,208 |   |
| Capital lease obligations                                                                                                                                                                                                                                                                                                                        |       |                        | 10,918     |                    |       | 12,118 |   |
| Notes payable to TERI                                                                                                                                                                                                                                                                                                                            |       |                        | 4,920      |                    |       | 5,292 |   |
| Other liabilities                                                                                                                                                                                                                                                                                                                                |       |                        | 3,550      |                    |       | 1,691 |   |
| Total liabilities                                                                                                                                                                                                                                                                                                                                |       |                        | 183,602    |                    |       | 136,627 |   |
| Commitments and  contingencies                                                                                                                                                                                                                                                                                                                   |       |                        |       |                    |       |   |   |
| Stockholders’  equity:                                                                                                                                                                                                                                                                                                                      |       |                        |       |                    |       |   |   |
| Preferred stock, par value $0.01 per share;  20,000,000 shares authorized; no shares issued or outstanding                                                                                                                                                                                                                                  |       |                        | —     |                    |       | — |   |
| Common stock, par value $0.01 per share; 150,000,000  shares authorized at December 31, 2005 and June 30, 2005;  66,613,679 and 66,368,824 shares issued at December 31, 2005 and  June 30, 2005, respectively; 62,766,879 and 64,899,824 shares  outstanding at December 31, 2005 and June 30, 2005, respectively |       |                        | 666        |                    |       | 664 |   |
| Additional paid-in capital                                                                                                                                                                                                                                                                                                                       |       |                        | 208,290    |                    |       | 206,452 |   |
| Retained earnings                                                                                                                                                                                                                                                                                                                                |       |                        | 364,158    |                    |       | 273,589 |   |
| Deferred compensation                                                                                                                                                                                                                                                                                                                            |       |                        | —     |                    |       | (3,131 | ) |
| Treasury stock, 3,846,800 and 1,469,000 shares held  at December 31, 2005 and June 30, 2005, respectively, at cost                                                                                                                                                                                                                     |       |                        | (121,544   | )                       |       | (55,665 | ) |
| Accumulated other comprehensive loss                                                                                                                                                                                                                                                                                                             |       |                        | (343       | )                       |       | (343 | ) |
| Total stockholders’ equity                                                                                                                                                                                                                                                                                                                  |       |                        | 451,227    |                    |       | 421,566 |   |
| Total liabilities  and stockholders’ equity                                                                                                                                                                                                                                                                                                 |       |                        | $          | 634,829                 |       |   | $ | 558,193 |   |

 

See accompanying notes to unaudited condensed consolidated financial statements.

3

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**THEFIRST MARBLEHEAD CORPORATION AND SUBSIDIARIES**

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

| ** **                                    | ** ** | **Three months ended  December 31,** | ** ** | **Six months ended  December 31,** | ** ** |
|-----------------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                    | ** ** | **2005**                                            | ** ** | **2004**                                          | ** ** | **2005** | ** ** | **2004** | ** ** |
| Service revenues:                             |       |                                                |       |                                              |       |   |   |   |   |
| Up-front structural advisory fees             |       | $                                                   | 96,170     |                                              | $          | 65,050 |   | $ | 96,170 |   | $ | 65,050 |   |
| Additional  structural advisory fees:         |       |                                                |       |                                              |       |   |   |   |   |
| From new securitizations                      |       | 14,778                                              |       | 9,931                                             |       | 14,778 |   | 9,931 |   |
| Trust updates                                 |       | 1,241                                               |       | 191                                               |       | 1,440 |   | 810 |   |
| Total additional structural advisory fees     |       | 16,019                                              |       | 10,122                                            |       | 16,218 |   | 10,741 |   |
| Residuals:                                    |       |                                                |       |                                              |       |   |   |   |   |
| From new securitizations                      |       | 78,216                                              |       | 57,057                                            |       | 78,216 |   | 57,057 |   |
| Trust updates                                 |       | 12,491                                              |       | 6,166                                             |       | 19,973 |   | 9,626 |   |
| Total residual revenue                        |       | 90,707                                              |       | 63,223                                            |       | 98,189 |   | 66,683 |   |
| Processing fees from TERI                     |       | 25,268                                              |       | 16,579                                            |       | 51,196 |   | 33,936 |   |
| Administrative and other fees                 |       | 2,331                                               |       | 863                                               |       | 3,793 |   | 1,831 |   |
| Total service revenues                        |       | 230,495                                             |       | 155,837                                           |       | 265,566 |   | 178,241 |   |
| Operating  expenses:                          |       |                                                |       |                                              |       |   |   |   |   |
| Compensation and benefits                     |       | 21,160                                              |       | 15,318                                            |       | 40,902 |   | 30,198 |   |
| General and administrative expenses           |       | 22,891                                              |       | 14,355                                            |       | 48,816 |   | 31,314 |   |
| Total operating expenses                      |       | 44,051                                              |       | 29,673                                            |       | 89,718 |   | 61,512 |   |
| Income from operations                        |       | 186,444                                             |       | 126,164                                           |       | 175,848 |   | 116,729 |   |
| Other income (expense):                       |       |                                                |       |                                              |       |   |   |   |   |
| Interest expense                              |       | (200                                                | )          | (115                                              | )          | (430 | ) | (234 | ) |
| Interest income                               |       | 1,835                                               |       | 873                                               |       | 3,294 |   | 1,355 |   |
| Other                                         |       | 2,501                                               |       | —                                            |       | 2,501 |   | — |   |
| Net other income                              |       | 4,136                                               |       | 758                                               |       | 5,365 |   | 1,121 |   |
| Income before income tax expense              |       | 190,580                                             |       | 126,922                                           |       | 181,213 |   | 117,850 |   |
| Income tax  expense                           |       | 79,219                                              |       | 52,392                                            |       | 75,294 |   | 48,672 |   |
| Net income                                    |       | $                                                   | 111,361    |                                              | $          | 74,530 |   | $ | 105,919 |   | $ | 69,178 |   |
| Net income per share, basic                   |       | $                                                   | 1.75       |                                              | $          | 1.15 |   | $ | 1.65 |   | $ | 1.07 |   |
| Net income per share, diluted                 |       | 1.74                                                |       | 1.12                                              |       | 1.63 |   | 1.04 |   |
| Weighted average shares outstanding, basic    |       | 63,549                                              |       | 64,624                                            |       | 64,232 |   | 64,473 |   |
| Weighted average  shares outstanding, diluted |       | 64,177                                              |       | 66,821                                            |       | 64,895 |   | 66,803 |   |

 

See accompanying notes to unaudited condensed consolidated financial statements.

4

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**THE FIRST MARBLEHEAD CORPORATION AND SUBSIDIARIES**

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

| ** **                                           | ** ** | ** **            | ** ** | ** **           | ** ** | ** **  | ** ** | ** **   | ** ** | ** **   | ** ** | ** **        | ** ** | ** **             | ** ** | **Accumulated**                     | ** ** | ** ** | ** ** |
|------------------------------------------------------|------------|-----------------------|------------|----------------------|------------|-------------|------------|--------------|------------|--------------|------------|-------------------|------------|------------------------|------------|-------------------------------------|------------|------------|------------|
| ** **                                           | ** ** | **Common stock** | ** ** | **Additional**       | ** ** | ** **  | ** ** | ** **   | ** ** | **other**    | ** ** | **Total**         | ** ** |
| ** **                                           | ** ** | **Issued**            | ** ** | **In treasury** | ** ** | **Paid-in** | ** ** | **Retained** | ** ** | **Deferred** | ** ** | **comprehensive** | ** ** | **stockholders’** | ** ** |
| ** **                                           | ** ** | **Shares**            | ** ** | **Amount**           | ** ** | **Shares**  | ** ** | **Amount**   | ** ** | **capital**  | ** ** | **earnings**      | ** ** | **compensation**       | ** ** | **loss, net of tax** | ** ** | **equity** | ** ** |
| **Balance at June 30, 2005**                    |       | 66,368                |       |                 | $          | 664         |       |         | (1,469     | )            | $          | (55,665           | )          |                   | $          | 206,452                             |       |       | $          | 273,589 |   |   | $ | (3,131 | ) |   |   | $ | (343 | ) |   |   | $ | 421,566 |   |   |
| Adoption of FAS 123 (R)                              |       | —                |       |                 | —     |        |       | —       |       | —       |       |              | (3,131     | )                      |       | —                              |       |       | 3,131      |   |   |   | — |   |   |   | — |   |   |
| Net income                                           |       | —                |       |                 | —     |        |       | —       |       | —       |       |              | —     |                   |       | 105,919                             |       |       | —     |   |   |   | — |   |   |   | 105,919 |   |   |
| Options exercised                                    |       | 234                   |       |                 | 2          |        |       | —       |       | —       |       |              | 624        |                   |       | —                              |       |       | —     |   |   |   | — |   |   |   | 626 |   |   |
| Stock issuances through employee stock purchase plan |       | 11                    |       |                 | —     |        |       | —       |       | —       |       |              | 340        |                   |       | —                              |       |       | —     |   |   |   | — |   |   |   | 340 |   |   |
| Repurchase of common stock                      |       | —                |       |                 | —     |        |       | (2,378       | )          | (65,879      | )          |              | —     |                   |       | —                              |       |       | —     |   |   |   | — |   |   |   | (65,879 | ) |   |
| Recognition of stock-based compensation              |       | —                |       |                 | —     |        |       | —       |       | —       |       |              | 1,535      |                   |       | —                              |       |       | —     |   |   |   | — |   |   |   | 1,535 |   |   |
| Cash dividends ($0.24 per share)                     |       | —                |       |                 | —     |        |       | —       |       | —       |       |              | —     |                   |       | (15,350                             | )          |       | —     |   |   |   | — |   |   |   | (15,350 | ) |   |
| Tax benefit from employee stock options              |       | —                |       |                 | —     |        |       | —       |       | —       |       |              | 2,470      |                   |       | —                              |       |       | —     |   |   |   | — |   |   |   | 2,470 |   |   |
| **Balance at December 31, 2005**                |       | 66,613                |       |                 | $          | 666         |       |         | (3,847     | )            | $          | (121,544          | )          |                   | $          | 208,290                             |       |       | $          | 364,158 |   |   | $ | — |   |   |   | $ | (343 | ) |   |   | $ | 451,227 |   |   |

 

See accompanying notes to unaudited condensed consolidated financial statements.

5

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**THE FIRST MARBLEHEAD CORPORATION AND SUBSIDIARIES**

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

| ** **                                                                                              | ** ** | **Six months ended  December 31,** | ** ** |
|---------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                                                              | ** ** | **2005**                                          | ** ** | **2004** | ** ** |
| Cash flows from  operating activities:                                                                  |       |                                              |       |   |   |
| Net income                                                                                              |       | $                                                 | 105,919    |   | $ | 69,178 |   |
| Adjustments to reconcile  net income to net cash provided by operating activities:                      |       |                                              |       |   |   |
| Depreciation and amortization                                                                           |       | 6,805                                             |       | 2,564 |   |
| Deferred income tax expense                                                                             |       | 23,300                                            |       | 27,340 |   |
| Tax benefit from employee stock options                                                                 |       | —                                            |       | 2,705 |   |
| Stock-based compensation                                                                                |       | 1,535                                             |       | 135 |   |
| Change in  assets/liabilities:                                                                          |       |                                              |       |   |   |
| (Increase) in structural advisory fees                                                                  |       | (16,218                                           | )          | (491 | ) |
| (Increase) in residuals                                                                                 |       | (98,189                                           | )          | (66,683 | ) |
| Decrease (increase) in processing fees from TERI                                                        |       | 102                                               |       | (426 | ) |
| Decrease in prepaid income taxes                                                                        |       | 2,594                                             |       | 20,267 |   |
| (Increase) in other prepaid expenses                                                                    |       | (2,807                                            | )          | (4,073 | ) |
| (Increase) in other assets                                                                              |       | (1,877                                            | )          | (1,620 | ) |
| Increase (decrease) in accounts payable, accrued  expenses, income taxes payable, and other liabilities |       | 25,247                                            |       | (4,446 | ) |
| Net cash provided by operating activities                                                               |       | 46,411                                            |       | 44,450 |   |
| Cash flows from  investing activities:                                                                  |       |                                              |       |   |   |
| Purchases of property and equipment                                                                     |       | (6,859                                            | )          | (7,355 | ) |
| Payments to TERI for loan database updates                                                              |       | (372                                              | )          | (373 | ) |
| Net cash used in investing activities                                                                   |       | (7,231                                            | )          | (7,728 | ) |
| Cash flows from  financing activities:                                                                  |       |                                              |       |   |   |
| Repayment of capital lease obligations                                                                  |       | (2,335                                            | )          | (278 | ) |
| Repayment of notes payable                                                                              |       | (372                                              | )          | (7,601 | ) |
| Tax benefit from employee stock options                                                                 |       | 2,470                                             |       | — |   |
| Issuances of common stock                                                                               |       | 966                                               |       | 1,529 |   |
| Repurchases of common stock                                                                             |       | (65,879                                           | )          | — |   |
| Cash dividends on common stock                                                                          |       | (15,350                                           | )          | — |   |
| Net cash used in financing activities                                                                   |       | (80,500                                           | )          | (6,350 | ) |
| Net (decrease)  increase in cash and cash equivalents                                                   |       | (41,320                                           | )          | 30,372 |   |
| Cash and cash  equivalents, beginning of period                                                         |       | 193,796                                           |       | 168,712 |   |
| Cash and cash  equivalents, end of period                                                               |       | $                                                 | 152,476    |   | $ | 199,084 |   |
| Supplemental  disclosures of cash flow information:                                                     |       |                                              |       |   |   |
| Interest paid                                                                                           |       | $                                                 | 430        |   | $ | 484 |   |
| Income taxes paid                                                                                       |       | $                                                 | 13,333     |   | $ | — |   |
| Supplemental  disclosure of non-cash activities:                                                        |       |                                              |       |   |   |
| Acquisition of  property and equipment through capital leases                                           |       | $                                                 | 1,135      |   | $ | — |   |

 

See accompanying notes to unaudited condensed consolidated financial statements.

6

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**THE FIRST MARBLEHEAD CORPORATION AND SUBSIDIARIES NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands, except share and 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 and educational institutions, aswell as businesses and other enterprises, with an integrated suite of servicesfor designing and implementing student loan programs for their respectivecustomers, students, employees and members. The Company focuses primarily onprivate student loan programs for undergraduate, graduate and professionaleducation, and, to a lesser degree, on continuing education programs, theprimary and secondary school market, career training and study abroad programs.The Company is entitled to receive structural advisory fees and residuals forits services in connection with securitizations of loans generated by the loanprograms that it facilitates. The Company facilitates two primary loanprograms, private label and Guaranteed Access to Education, or GATE. TheCompany also receives reimbursement from The Education Resources Institute, Inc.(TERI) for outsourced services the Company performs on TERI’s behalf andreceives fees for administrative services that the Company provides to thediscrete trust vehicles that the Company forms for securitizations itfacilitates.

***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 normal recurring accruals and mark to marketadjustments for service receivables) considered necessary for a fair statementof the results for the interim periods have been included. The preparation offinancial statements in conformity with GAAP requires management to makeestimates and assumptions that affect the amounts reported in the consolidatedfinancial statements and accompanying notes. Interim results are notnecessarily indicative of results to be expected for the entire fiscal year.All significant intercompany balances and transactions have been eliminated inconsolidation. These unaudited financial statements should be read inconjunction with the audited consolidated financial statements and relatednotes for the year ended June 30, 2005 included in the Company’s AnnualReport on Form 10-K filed with the Securities and ExchangeCommission on September 7, 2005.

***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 December and January, asstudents and their families seek to borrow money to pay tuition costs for thespring semester. This seasonality of loan originations impacts the amount ofprocessing fees from TERI that the Company earns in a particular quarter.

7

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

** **

** **

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

***Concentrations***

**TERI**

TERI is a private, not-for-profit Massachusettsorganization as described under section 501(c)(3) of the InternalRevenue Code. Incorporated in 1985, TERI is the oldest and largest guarantor ofalternative, or private, student loans. In its role as guarantor in the privateeducation lending market, TERI agrees to reimburse lenders or securitizationtrusts for unpaid principal and interest on defaulted loans. TERI is theexclusive third-party provider of borrower default guarantees for the Company’sclients’ private student loans. As of December 31, 2005, TERI had a Baa3counterparty rating from Moody’s Investors Service, which is the lowestinvestment grade rating, and an insurer financial strength rating of A+ fromFitch Ratings. If these ratings are lowered, FMC’s clients may not wish toenter into guarantee arrangements with TERI. In addition, FMC may receive lowerstructural advisory fees because the costs of obtaining financial guaranteeinsurance for the asset-backed securitizations that FMC structures couldincrease.

On February 2, 2001, FMC and TERI entered into atwo-year Master Loan Guaranty Agreement, which granted TERI a right of firstrefusal to guarantee loans under existing and future private label loanprograms facilitated by FMC, as well as new loan programs jointly created byFMC and TERI. In June 2001, as a result of the closing of the Company’sacquisition of TERI’s loan processing operations, the Master Loan Guaranty Agreementwas automatically extended for a five-year term from the date of theacquisition closing. The loans guaranteed pursuant to the Master Loan GuarantyAgreement comprise only a portion of TERI’s guarantee business, and the MasterLoan Guaranty Agreement does not preclude TERI from continuing to provide itsguarantees to loan originators not associated with FMC. Under the terms of theoriginal Master Loan Guaranty Agreement, FMC also agreed to provide abeneficial interest for TERI of 25% of the residual value of TERI-guaranteedloans owned by the securitization trusts that purchase the loans.

In October 2004, FMC renewed its Master LoanGuaranty Agreement and certain additional agreements with TERI, in each casefor an additional term through June 2011. Under the terms of the MasterLoan Guaranty Agreement, TERI is required to place into a segregated reservethe majority of the guarantee fees it receives for loans that are originated.The segregated reserve amounts are then pledged to each trust that purchasesloans at the time of securitization. TERI is entitled to retain as anadministrative fee a portion of the guarantee fee, calculated based on theprincipal balance of loans originated and securitized. In October 2004,FMC entered into a fourth supplement to the Master Loan Guaranty Agreement,under which FMC granted to TERI a right to elect once each fiscal year toincrease the amount of its administration fee by 25 basis points, with acorresponding reduction from 25% to 20% in TERI’s ownership of the residualvalue of the TERI-guaranteed loans purchased during that year by thesecuritization trusts and a resulting increase from 75% to 80% in FMC’sresidual ownership. TERI made 

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such an election forfiscal 2005. In October 2005, FMC entered into a fifth supplement to theMaster Loan Guaranty Agreement. Under the terms of this fifth supplement, forsecuritizations of TERI-guaranteed loans in fiscal 2006, TERI’s administrativefee will increase, and the amount deposited in the segregated reserve willdecrease, by 90 basis points. In addition, TERI’s residual interest in thetrusts created at the time of securitization will be reduced by the fair valueof this 90 basis point reduction in the amount placed in the segregatedreserve, using a residual discount factor of 12%. Therefore, TERI’sadministrative fee for securitizations of TERI-guaranteed loans in fiscal 2006will be 240 basis points multiplied by the principal balance of loansoriginated and securitized.

Under a Master ServicingAgreement with a term through June 2011, First Marblehead EducationalResources, Inc. (FMER), a wholly owned subsidiary of FMC, provides to TERIunderwriting, documentation and other origination services, as well astechnical support, disbursements, customer service, collections, accountingservices and guarantee claims management and administrative services, insupport of TERI’s loan guarantee function. FMC guarantees the full and timelyperformance by FMER of its obligations pursuant to this Master ServicingAgreement. FMC also benefits from use of the acquired TERI assets, includinghistorical loan data, to support the design and implementation of future loanprograms facilitated by FMC and new loan programs jointly created by FMC andTERI. In addition, TERI has the right to designate one of three representativesto serve on the board of directors of FMER.

**PHEAA**

As of December 31,2005, there were nine TERI-approved loan servicers. Servicers provideadministrative services relating to loans, including processing deferment andforbearance requests, sending out account statements and accrual notices,responding to borrower inquiries, and collecting and crediting paymentsreceived from borrowers. As of December 31, 2005, the Company utilizedfive of these servicers. As of December 31, 2005, Pennsylvania HigherEducation Assistance Agency (PHEAA) serviced a majority of the loans for whichthe Company facilitates origination. This arrangement allows the Company toincrease the volume of loans in the Company’s clients’ loan programs withoutincurring the overhead investment of servicing operations. As with any externalservice provider, there are risks associated with inadequate or untimelyservices. In addition, if the Company’s relationship with PHEAA terminates, theCompany would either need to expand or develop a relationship with anotherTERI-approved loan servicer, which could be time-consuming and costly.

**SignificantCustomers**

During the three and sixmonths ended December 31, 2005, processing fees from TERI representedapproximately 11% and 19%, respectively, of total service revenue.Securitization-related fees from a single trust represented approximately 71%of total service revenue for the first six months of fiscal 2006. This trustpurchased private label loans from several lenders, including JP Morgan ChaseBank, N.A., Bank of America, N.A. and Charter One Bank N.A., in thesecuritization that the Company facilitated in the second quarter of fiscal2006. The Company did not recognize more than 10% of total service revenue fromany other customer for the three and six months ended December 31, 2005.

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

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***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 relate toaccounting 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 financial results of thesecuritization trusts that it facilitates. See “Management’s Discussion andAnalysis of Financial Condition and Results of Operations—Executive Summary—Applicationof Critical Accounting Policies and Estimates”.

***Cash and cash equivalents***

Cash and cash equivalentsat December 31, 2005 included $132,108 held 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. Includedin cash and cash equivalents are compensating balances supporting variousfinancing arrangements of $12,432 and $23,309 at December 31, 2005 and June 30,2005, respectively.

***Income taxes***

Indetermining a quarterly provision for income taxes, the Company uses anestimated annual effective tax rate which is based on its expected annualincome, statutory tax rates and tax planning opportunities available to it inthe various jurisdictions in which it operates. The Company has a net deferredincome tax liability primarily because, under GAAP, it recognizes residuals infinancial statement income earlier than they are recognized for income taxpurposes.

**(2)   Stock Options**

At December 31, 2005, the Company had fourstock-based compensation plans, which are described more fully in Notes 9 andNote 13 of the Company’s Annual Report on Form 10-K filed with theSecurities and Exchange Commission on September 7, 2005. Prior to July 1,2005, the Company accounted for those plans under the recognition andmeasurement provisions of Accounting Principles Board (APB) Opinion No. 25,*Accounting for Stock Issued to Employees*(Opinion25), and related Interpretations, as permitted by FASB Statement No. 123, *Accounting for Stock-Based Compensation*(Statement 123). Nostock-based compensation cost was recognized in the Statement of Operations forthe years ended on or prior to June 30, 2005, as options granted underthose plans had an exercise price equal to or greater than the market value ofthe underlying common stock on the date of grant. Effective July 1, 2005,the Company adopted the fair value recognition provisions of FinancialAccounting Standards Board (FASB) Statement No. 123(R), *Share-Based Payment*(Statement 123(R)), using themodified-prospective transition method. 

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Under this transitionmethod, compensation cost recognized in the first six months of fiscal 2006includes: (a) compensation cost for all share-based payments granted priorto, but not yet vested, as of July 1, 2005, based on the grant date fairvalue estimated in accordance with the original provisions of Statement 123,and (b) compensation cost for all share-based payments granted on orsubsequent to July 1, 2005, based on the grant-date fair value estimatedin accordance with the provisions of Statement 123(R). Results for priorperiods have not been restated.

As a result of adopting Statement 123(R) on July 1,2005, the Company’s income before income taxes for the first six months offiscal 2006 was approximately $419 lower, and net income for the first sixmonths of fiscal 2006 was approximately $307 lower, than if it had continued toaccount for share-based compensation under Opinion 25. The Company’s basicearnings per share for the first six months of fiscal 2006 would have remained$1.65 if it had continued to account for share-based compensation under Opinion25. The Company’s diluted earnings per share for the first six months of fiscal2006 would have been $1.64 if it had continued to account for share-basedcompensation under Opinion 25.

As required, prior to the adoption of Statement123(R), the Company presented all tax benefits of deductions resulting from theexercise of stock options as operating cash flows in the Condensed ConsolidatedStatement of Cash Flows. Statement 123(R) requires the cash flowsresulting from the tax benefits from tax deductions in excess of thecompensation cost recognized for those options (excess tax benefits) to beclassified as financing cash flows. The $2,470 excess tax benefits classifiedas a financing cash inflow during the first six months of fiscal 2006 wouldhave been classified as an operating cash inflow if the Company had not adoptedStatement 123(R).

Forpurposes of pro forma disclosures for periods prior to July 1, 2005, theestimated fair value of the stock options is amortized to expense over thevesting period of the options. The Company’s consolidated pro forma net incomeand net income per share for the three and six-month periods ended December 31,2004, had the Company elected to recognize compensation expense for thegranting of options under SFAS No. 123 using the Black-Scholes optionpricing model, is as follows:

| ** **                                                                                                                      | ** ** | **Three months endedDecember 31, 2004** | ** ** | **Six months endedDecember 31, 2004** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------|------------|-----------------------------------------------------------|------------|
| Net income—as  reported                                                                                                    |       |                                                        | $          | 74,530                                                    |       |   |   | $ | 69,178 |   |   |
| Add: Total  stock-based employee compensation expense included in reported net income,  net of tax                              |       |                                                        | 80         |                                                      |       |   | 80 |   |   |
| Less: Total  stock-based employee compensation expense determined under the fair value  based method for all awards, net of tax |       |                                                        | (182       | )                                                         |       |   | (853 | ) |   |
| Net income—pro  forma                                                                                                      |       |                                                        | $          | 74,428                                                    |       |   |   | $ | 68,405 |   |   |
| Net income per  share—basic—as reported                                                                               |       |                                                        | $          | 1.15                                                      |       |   |   | $ | 1.07 |   |   |
| Net income per  share—basic—pro forma                                                                                 |       |                                                        | $          | 1.15                                                      |       |   |   | $ | 1.06 |   |   |
| Net income per  share—diluted—as reported                                                                             |       |                                                        | $          | 1.12                                                      |       |   |   | $ | 1.04 |   |   |
| Net income per  share—diluted—pro forma                                                                               |       |                                                        | $          | 1.11                                                      |       |   |   | $ | 1.02 |   |   |

 

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**(3)   ServiceReceivables**

Structural advisory fees and residuals receivablesrepresent the estimated fair value of additional structural advisory fees andresiduals expected to be collected over the life of the securitization trust,net of prepayment, default and recovery estimates on the student loans. Thefees are paid to the Company from the various separate securitization truststhat have purchased student loans facilitated by the Company. Private labelloans guaranteed by TERI have generally been purchased by several private labelloan trusts. GATE loans, and a limited number of TERI-guaranteed and otherloans, have been purchased by separate securitization trusts (NCT trusts)established by the National Collegiate Trust. Processing fees receivable fromTERI represents amounts due from TERI for expenses incurred by FMER on TERI’sbehalf.

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

TheCompany conducted a securitization transaction of private label loans in thesecond quarter of each of fiscal 2006 and fiscal 2005. The following tablesummarizes the changes in the structural advisory fees receivable for the firstsix months of fiscal 2006 and fiscal 2005: 

| ** **                                                                | ** ** | **Six months endedDecember 31,** | ** ** |
|---------------------------------------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                                                                | ** ** | **2005**                                        | ** ** | **2004** | ** ** |
| Fair value of  additional structural advisory fees at beginning of period |       | $                                               | 53,371     |   | $ | 24,084 | (1) |
| Additions from  structuring new securitizations                           |       | 14,778                                          |       | 9,931 |   |
| Fair value  adjustments                                                   |       | 1,440                                           |       | 810 |   |
| Total structural  advisory fees receivable at end of period               |       | $                                               | 69,589     |   | $ | 34,825 |   |

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

The following table summarizes the changes in theresiduals receivable for the first six months of fiscal 2006 and fiscal 2005:

| ** **                                      | ** ** | **Six months  endedDecember 31,** | ** ** |
|-------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                      | ** ** | **2005**                                         | ** ** | **2004** | ** ** |
| Fair value at  beginning of period              |       |                                             | $          | 247,275 |   |   | $ | 108,495 |   |
| Additions from  structuring new securitizations |       |                                             | 78,216     |   |   | 57,057 |   |
| Fair value  adjustments                         |       |                                             | 19,973     |   |   | 9,626 |   |
| Fair value at end of  period                    |       |                                             | $          | 345,464 |   |   | $ | 175,178 |   |

 

Refinements to the Company’s prepayment rateassumptions and the Company’s use of an enhanced cash-flow model, both of whichare described more fully below, resulted in an increase in the fair value of 

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structural advisory feesreceivable at December 31, 2005 of approximately $0.5 million and anincrease in the fair value of residuals receivable at December 31, 2005 ofapproximately $3.1 million. These adjustments to the carrying value ofthese assets were incorporated into the Company’s fair value adjustments duringthe second quarter of fiscal 2006.

A market-based fair value estimate of private student loanresiduals and structural advisory fees receivables cannot be readily determinedbecause these types of assets are not actively traded. As a result, the Companyestimates the fair value of these assets using discounted cash flow modelingtechniques and certain key assumptions, including the rate of student loanprepayments.

During the second quarter of fiscal 2006, the Companycompleted an analysis of historical prepayments of certain loans included inits proprietary private student loan performance database. The analysisindicated that the average prepayment rate throughout the life of the loan wasnot materially different from the Company’s previous estimate. At the sametime, the analysis enabled the Company to refine its valuation approach toincorporate prepayment assumptions specific to particular points of time in thelife of the student loans. The Company has used these refined prepaymentassumptions to estimate the fair value of the Company’s residuals andstructural advisory fees receivables at December 31, 2005.

In addition, during the second quarter of fiscal 2006,the Company completed the development of a proprietary software program thatallows for a detailed loan by loan simulation of projected trust cash flows.The Company believes that the implementation of this software program improvesits methodology for estimating the fair value of its structural advisory feesand residuals receivables.

Insummary, during the second quarter of fiscal 2006, the Company changed thediscount rate to be applied to additional structural advisory fees and refinedits prepayment rate assumption. Except for these changes, the Company did notchange any loan performance assumptions regarding default rates, recovery ratesor discount rates in valuing projected trust cash flows during the first sixmonths of fiscal 2006 or fiscal 2005. For a discussion of the sensitivity ofthe additional structural fees and residuals to variations in our assumptionsand estimates, see “Management’s Discussion and Analysis of Financial Conditionand Results of Operations—Executive Summary—Application of Critical AccountingPolicies and Estimates—Service Revenue—Sensitivity Analysis”.

**(4)   Related PartyTransactions**

At December 31, 2005,the Company had invested approximately $132,108 of cash and cash equivalents ina money market fund. The investment adviser for this fund is Milestone CapitalManagement, LLC (MCM), an institutional money management firm. MCM is a whollyowned subsidiary of Milestone Group Partners. Members of the immediate familyof one of the Company’s directors own approximately 65% of Milestone GroupPartners.

**(5)   Notes Payable toTERI**

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 

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

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related to the acquiredworkforce-in-place. Under the terms of the note payable, principal and interestat an annual rate of 6% are payable in 120 monthly installments of $43commencing on July 20, 2001 and ending on June 20, 2011. The notepayable is secured by the software and network assets. At December 31,2005, the outstanding balance of this note payable was $2,429.

The Company also enteredinto a second note payable with TERI on June 20, 2001, in the principalamount of $4,000, to fund the acquisition of TERI’s loan database. Principaland interest at an annual rate of 6% are payable in 120 monthlyinstallments of $44 commencing on July 20, 2001 and ending on June 20,2011. The note payable is secured by the loan database. At December 31,2005, the outstanding balance of this note payable was $2,491.

**(6)   Other Borrowings**

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

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

***(b)   Equipment Line of Credit***

In January 2005, theCompany entered into an equipment financing lease agreement which it used tofinance purchases of furniture and equipment. The agreement, which expired on December 30,2005, allowed the Company to finance up to $20,000 worth of furniture andequipment purchased before December 30, 2005. The Company expects to repayamounts drawn down on the line of credit at terms ranging from three to fiveyears. At December 31, 2005, the outstanding principal balance on amountsborrowed under this line of credit was $9,498.

**(7)**   Stockholders’Equity

***2002 Director Stock Plan***

In September 2002, the Board of Directorsapproved, and in August 2003, the Company’s stockholders approved, the2002 Director Stock Plan and reserved 200,000 shares of common stock, $0.01 parvalue per share (Common Stock), for issuance to the Company’s non-employeedirectors. As of December 31, 2005, options to purchase 88,000 shares ofCommon Stock have been issued under this plan.

***2003 Stock Incentive Plan***

In September 2003, the Board of Directors andstockholders approved the 2003 Stock Incentive Plan and reserved 1,200,000shares of Common Stock for issuance under this plan. On August 9, 2005,the Board of Directors authorized, subject to stockholder approval, anamendment increasing the number of 

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shares of Common Stockreserved for issuance under the 2003 Stock Incentive Plan from 1,200,000 to2,700,000. On October 27, 2005, the Company’s stockholders approved thisamendment. As of December 31, 2005, there were 327,914 restricted stockunits outstanding under this plan. Each restricted stock unit represents theright to receive at no cost one share of Common Stock upon vesting.

***2003 Employee StockPurchase Plan***

In October 2003, theBoard of Directors and stockholders approved the 2003 Employee Stock PurchasePlan (Stock Purchase Plan). A total of 400,000 shares of Common Stock areauthorized for issuance under this plan. The Stock Purchase Plan permitseligible employees to purchase shares of Common Stock at the lower of 85% ofthe fair market value of the Common Stock at the beginning or at the end ofeach offering period. Employees who own 5% or more of the Common Stock are noteligible to participate in the Stock Purchase Plan. Participation is voluntary.Under the Stock Purchase Plan, 13,261, 11,420, 10,050 and 40,499 shares ofCommon Stock were issued in January 2006, July 2005, January 2005and July 2004, respectively.

***Share RepurchaseProgram***

In the fourth quarter offiscal 2005, the Board of Directors approved the repurchase of up to 1,500,000 sharesof Common Stock from time to time on the open market or in privately negotiatedtransactions. In September 2005, the Board of Directors approved therepurchase of up to an additional 5,000,000 shares of Common Stock. As of December 31,2005, the Company had repurchased in aggregate 3,846,800 shares of Common Stockat an aggregate cost of $121,544.

***Cash Dividends***

On September 15,2005, the Board of Directors declared a cash dividend of $0.12 per share on theCommon Stock. The dividend was paid on October 5, 2005 to stockholders ofrecord at the close of business on September 26, 2005. On December 7,2005, the Board of Directors declared a cash dividend of $0.12 per share on theCommon Stock. The dividend was paid on December 27, 2005 to stockholdersof record at the close of business on December 19, 2005.

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**(8)   Net Income perShare**

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

| ** **                                                         | ** ** | **Three months ended   December 31,** | ** ** | **Six months ended   December 31,** | ** ** |
|--------------------------------------------------------------------|------------|-----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                                         | ** ** | **2005**                                                  | ** ** | **2004**                                                | ** ** | **2005** | ** ** | **2004** | ** ** |
| Net income                                                         |       |                                                      | $          | 111,361                                                 |       |   |   | $ | 74,530 |   |   | $ | 105,919 |   | $ | 69,178 |   |
| Shares used in  computing net income per common share—basic   |       |                                                      | 63,549,000 |                                                    |       |   | 64,624,000 |   |   | 64,232,000 |   | 64,473,000 |   |
| Effect of  dilutive securities:                                    |       |                                                      |       |                                                    |       |   |   |   |   |   |   |   |   |
| Stock options                                                      |       |                                                      | 623,000    |                                                    |       |   | 2,193,000 |   |   | 660,000 |   | 2,330,000 |   |
| Restricted stock units                                             |       |                                                      | 5,000      |                                                    |       |   | 4,000 |   |   | 3,000 |   | — |   |
| Dilutive potential common shares                              |       |                                                      | 628,000    |                                                    |       |   | 2,197,000 |   |   | 663,000 |   | 2,330,000 |   |
| Shares used in  computing net income per common share—diluted |       |                                                      | 64,177,000 |                                                    |       |   | 66,821,000 |   |   | 64,895,000 |   | 66,803,000 |   |
| Net income per  common share:                                      |       |                                                      |       |                                                    |       |   |   |   |   |   |   |   |   |
| Basic                                                              |       |                                                      | $          | 1.75                                                    |       |   |   | $ | 1.15 |   |   | $ | 1.65 |   | $ | 1.07 |   |
| Diluted                                                            |       |                                                      | $          | 1.74                                                    |       |   |   | $ | 1.12 |   |   | $ | 1.63 |   | $ | 1.04 |   |

 

**(9)   Pension Plan**

FMERhas a non-contributory defined benefit pension plan that covers substantiallyall FMER employees employed on or before December 31, 2004. During thesecond quarter of fiscal 2005, the benefits under the plan were frozen. Thefollowing table sets forth the amounts recognized related to FMER’s defined benefitpension plan in the Company’s condensed consolidated financial statements forthe three- and six-month periods ended December 31, 2005 and 2004:

| ** **                                    | ** ** | **Three months endedDecember 31,** | ** ** | **Six months ended  December 31,** | ** ** |
|-----------------------------------------------|------------|---------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                    | ** ** | **2005**                                          | ** ** | **2004**                                          | ** ** | **2005** | ** ** | **2004** | ** ** |
| **Components  of net periodic pension cost:** |       |                                              |       |                                              |       |   |   |   |   |
| Service cost                                  |       | $                                                 | —     |                                              | $          | 157 |   | $ | — |   | $ | 315 |   |
| Interest on projected benefit obligations     |       | 44                                                |       | 62                                                |       | 88 |   | 124 |   |
| Loss recognized                               |       | 5                                                 |       | 9                                                 |       | 10 |   | 18 |   |
| Expected return on plan assets                |       | (47                                               | )          | (42                                               | )          | (94 | ) | (84 | ) |
| Net periodic pension cost before curtailment  |       | 2                                                 |       | 186                                               |       | 4 |   | 373 |   |
| Curtailment gain                              |       | —                                            |       | (655                                              | )          | — |   | (655 | ) |
| Net periodic  pension cost (gain)             |       | $                                                 | 2          |                                              | $          | (469 | ) | $ | 4 |   | $ | (282 | ) |

 

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***Employer Contributions***

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

**(10)   New AccountingPronouncements**

The FASB has issued exposure drafts that would amendFASB Statement No. 140, “Accounting for the Transfers and Servicing ofFinancial Assets and Extinguishments of Liabilities.”  The proposed amendments would, among otherthings, change the requirements that an entity must meet to be considered aqualified special-purpose entity (QSPE). The FASB has announced that it expectsto issue final guidance in the first or second calendar quarter of 2006. TheCompany is monitoring the status of the exposure drafts to assess their impact,if any, on its financial statements.

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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 elsewhere in this filing. 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 the applicationof our critical accounting policies and other important factors including, butnot limited to, those set forth under “Risk Factors” below.*

**Executive Summary**

***Overview***

We provideoutsourcing services for private education lending in the United States. Weprovide services in connection with each of the five typical phases of thestudent loan lifecycle, offering our clients a single point of interface for:

**•**     programdesign and marketing;

**•**     borrowerinquiry and application;

**•**     loanorigination and disbursement;

**•**     loansecuritization; and

**•**     loanservicing.

We receive fees for the services we provide inconnection with both processing our clients’ private student loans and structuringand administering securitizations of those loans. Securitization refers to thetechnique of pooling loans and selling them to a special purpose, bankruptcyremote entity, typically a trust, which issues securities to investors backedby those loans.

We do not take a direct ownership interest in theloans our clients generate, nor do we serve as a lender or guarantor withrespect to any 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. Lenders that wish to have theirloans guaranteed by The Education Resources Institute, or TERI, are required tomeet TERI’s underwriting criteria. Although we oversee loan servicing as acomponent of our administrative duties, we do not act as a loan servicer.

We currently focus on facilitating private studentloans for undergraduate, graduate and professional education, although we alsoprovide service offerings for continuing education programs, primary andsecondary schools, career training and study abroad programs. During the firstsix months of fiscal 2006, we processed over 541,000 loan applications andfacilitated approximately $1.9 billion in loans at approximately 5,100 schools.During all of fiscal 2005, we processed over 876,000 loan applications andfacilitated approximately $2.7 billion in loans at over 5,300 schools. We haveprovided structural, advisory and other services for 28 securitizationtransactions since our formation in 1991.

We offer servicesin connection with two primary loan programs:

**•**     *Private label* programs that:

**•**      are“direct to consumer,” or marketed directly to prospective student borrowers andtheir families by:

**•**      lenders;

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**•**      thirdparties who are not themselves lenders but use referral lenders to make loansunder their programs; and

**•**      businesses,unions, affinity groups and other organizations.

**•**     are“school channel,” or marketed directly to educational institutions by:

**•**      lenders;and

**•**      thirdparties who are not themselves lenders but use referral lenders to make loansunder their programs.

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

During fiscal 2005, we securitized both private labelloans and GATE loans. During the first six months of fiscal 2006, we onlyfacilitated the securitization of private label loans. We expect we willsecuritize GATE loans, including those we have facilitated during the first sixmonths of our current fiscal year, in the fourth fiscal quarter. During fiscal2005, our private label programs, including processing fees from TERI,contributed $405.1 million or 97% of our total service revenue, while our GATEprograms contributed $12.8 million or 3% of our total service revenue.

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 loans generated through the private label programs we facilitate, as wellas other TERI-guaranteed loans. TERI reimburses us for the expenses we incur inproviding these services. Under the terms of a master loan guaranty agreementthat we have entered into with TERI, we have also agreed to provide abeneficial interest for TERI of a portion of the residual value ofTERI-guaranteed loans owned by the securitization trusts that purchase theloans, and granted to TERI a right of first refusal to guarantee 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.

Theprimary driver of our results of operations and financial condition is thevolume of loans for which we provide outsourcing services from loan originationthrough securitization. The following table shows the volume of loansfacilitated during the first six months of fiscal 2006 and fiscal 2005:

| ** **                                                                                          | ** ** | **Six months  ended  December 31,** | ** **   |
|-----------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------|--------------|
| ** **                                                                                          | ** ** | **2005**                                                | ** **   | **2004** | ** ** |
| Approximate  number of loans facilitated that were also available to us for securitization          |       | 168,000                                                 |         | 139,000 |   |
| Approximate  number of loans facilitated                                                            |       | 200,000                                                 |         | 176,000 |   |
| Aggregate  principal amount of loans facilitated that were also available to us for  securitization |       | $                                                       | 1.64 billion |   | $ | 1.32 billion |   |
| Aggregate principal  amount of loans facilitated                                                    |       | $                                                       | 1.89 billion |   | $ | 1.59 billion |   |

 

The dollar volume of loans that we facilitated thatwere available to us for securitization increased 25% in the first six monthsof fiscal 2006 as compared to the first six months of fiscal 2005. The totaldollar volume of loans that we facilitated in the first six months of fiscal2006 increased 19% as compared to the first six months of fiscal 2005.

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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, these fees representreimbursement of the direct expenses we incur. Accordingly, we do not earn aprofit 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, we generally enter into agreements with the privatelabel lenders giving us the exclusive right to securitize the loans that theydo not intend to hold. We receive structural advisory fees and residuals forfacilitating securitizations of these loans. Our level of profitability dependson these structural advisory fees and residuals. We discuss the manner in whichwe recognize them as revenue in greater detail below. We may in the futureenter into arrangements with private label lenders under which we provideoutsourcing services, but do not have the exclusive right to securitize theloans that they originate.

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

•     the demand for privateeducation financing;

•     the competition for providingprivate 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;

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

•     our critical accountingpolicies and estimates;

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

•     prepaymentrates on private student loans, including prepayments through loanconsolidation.

***Securitizations and Related Revenue***

We structure and facilitate securitizationtransactions for our clients through a series of bankruptcy remote, qualified specialpurpose statutory trusts. The trusts purchase private student loans from theoriginating lenders, which relinquish to the trust their ownership interest inthe loans. The debt instruments that the trusts issue to finance the purchaseof these student loans are obligations of the trusts, rather than ourobligations or those of originating lenders. As of December 31, 2005, wehave utilized seven special purpose entities for the securitization ofTERI-guaranteed private label loans. We refer to these trusts as private labelloan trusts. In addition, 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 new trust vehicles.

Under the terms of some of our contracts with keylender clients, we have an obligation to securitize periodically, typically twiceper year, the private student loans that these clients originate, and we mayagree with other lenders to securitize more frequently in the future. If we donot honor our obligations to these lenders, we may be required to payliquidated damages, generally not exceeding an amount equal to 1% of the faceamount of the loans available for securitization.

We receive several types of fees in connection withour securitization services:

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

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•                  *Up-front*. We receive a portion ofthe structural advisory fees at the time the securitization trust purchases theloans, or soon thereafter. In exchange for these fees, we structure the debtsecurities sold in the securitization, coordinate the attorneys, accountants,trustees, loan servicers, loan originators and other transaction participantsand prepare the cash flow modeling for rating agencies as needed. Insecuritizations we have facilitated since the beginning of fiscal 2005, thesefees have ranged from 1.6% to 8.5% of the principal and capitalized interest ofthe loans securitized; 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 thisadditional portion, plus interest, once the ratio of trust assets to trustliabilities, which we refer to as the “parity ratio,” reaches a stipulatedlevel, which ranges from 103.0% to 105.0%. The level applicable to a particulartrust is determined at the time of securitization. We currently expect toreceive the additional fees beginning five to seven years after the date of aparticular securitization transaction*.*

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

•                  inconnection with the securitizations of exclusively private label loans, 75% to88% of the residual cash flows once a parity ratio of 103.0% to 103.5%,depending on the particular trust, is reached and maintained;

•                  inconnection with securitizations in the NCT trusts, our share of residual cashflows once all of the debt-holders of the securitization trust have beenrepaid, plus, in the case of GATE loans securitized in fiscal years prior tofiscal 2005, an additional 10% of the residual cash flows. We are entitled toreceive 100% of the residual cash flows for GATE loans securitized in fiscal2005.

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 six years after the date of a particular securitization.In the case of securitizations in the NCT trusts that occurred prior to fiscal2005, we expect to receive the residuals beginning 12-15 years after the dateof each securitization. In the case of securitizations in the NCT trusts thatoccurred in fiscal 2005, we currently expect to receive residuals beginningfive to six years after the date of securitization.

•                 *Administrative and other fees*. Ouradministrative and other fees represent primarily the administrative fees wereceive from the trusts for their daily management and services we provide inobtaining information from the loan servicers and reporting this and otherinformation to the parties related to the securitization. We receive feesranging from five to 20 basis points per year of the student loan balancein the trust. Our administrative and other fees also include fees we receivefrom the securitization trusts for the marketing services we provide to some ofour clients. We also record as administrative and other fees the reimbursementwe receive for certain call center costs.

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***Processing Fees from TERI***

We provide outsourcingservices to TERI, including loan origination, customer service, defaultprevention, default processing 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 accounting principles generallyaccepted in the United States of America, or GAAP, we also recognize additionalstructural advisory fees and residuals as revenue at that time, as they aredeemed to be earned at the time of the securitization but before we actuallyreceive payment. These amounts are deemed earned because evidence of anarrangement exists, we have provided the services, the fee is fixed anddeterminable based upon a discounted cash flow analysis, there are no futurecontingencies or obligations and collection is reasonably assured.

Under GAAP, we are required to estimate the fair valueof the additional structural advisory fees and residuals as if they areinvestments in debt securities classified as available-for-sale or trading,similar to retained interests in securitizations. Accordingly, we recordadditional structural advisory fees and residuals receivables on our balancesheet at fair value using a discounted cash flow model. Because there are noquoted market prices for our additional structural advisory fees and residualsreceivables, we use certain key assumptions to estimate their values. See “—Applicationof Critical Accounting Policies and Estimates—Service Revenue.” We estimate thefair value both initially and at each subsequent quarter and reflect the changein the value in earnings that period.

We recognizeadministrative and other fees, as well as processing fees from TERI, as revenueat the time that we perform the underlying services.

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***Quarterly Fluctuations***

Ourquarterly revenue, operating results and profitability have varied and areexpected to continue to vary on a quarterly basis primarily because of thetiming and size of the securitizations that we structure. In fiscal 2005, wefacilitated one securitization in the second quarter, one securitization in thethird quarter and three securitizations in the fourth quarter. Thus far infiscal 2006, we have facilitated one securitization in the second quarter. Weplan to facilitate one securitization in the third quarter of fiscal 2006 andtwo securitizations in the fourth quarter of fiscal 2006. The following tablesset forth our quarterly service revenue and net income (loss) for the first twoquarters of fiscal 2006 and for each of the quarters of fiscal 2005:

| ** **        | ** ** | **2006 Fiscal Quarters** | ** ** | ** ** | ** ** | ** ** | ** ** |
|-------------------|------------|------------------------------------|------------|------------|------------|------------|------------|
| ** **        | ** ** | **First**                          | ** ** | **Second** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Service revenue   |       | $                                  | 35,071     |       | $          | 230,495    | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net income (loss) |       | (5,442                             | )          | 111,361    | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **        | ** ** | **2005 Fiscal   Quarters**    | ** ** |
| ** **        | ** ** | **First**                          | ** ** | **Second** | ** ** | **Third**  | ** ** | **Fourth** | ** ** |
| Service revenue   |       | $                                  | 22,404     |       | $          | 155,837    |       | $ | 119,534 |   | $ | 120,201 |   |
| Net income (loss) |       | (5,352                             | )          | 74,530     |       | 47,438     |       | 43,048 |   |
|                   |            |                                    |            |            |            |            |            |  |  |  |  |  |  |

 

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

Our condensed consolidated financial statements havebeen prepared in accordance with GAAP. The preparation of these financial statementsrequires us to make estimates, assumptions and judgments that affect thereported amounts of assets and liabilities and the reported amounts of incomeand expenses during the reporting periods. We base our estimates, assumptionsand judgments on historical experience and on various other factors that webelieve are reasonable under the circumstances. Actual results may differ fromthese estimates under varying assumptions or conditions.

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

•     the nature of the estimate orassumption is material due to the level of subjectivity and judgment necessaryto account for highly uncertain matters or the susceptibility of such mattersto change; and

•     the impact of the estimatesand assumptions 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, as described below, fit the definition ofcritical accounting estimates. We also consider our policy with respect to thedetermination of whether or not to consolidate the financial results of thesecuritization trusts that we facilitate to be a critical accounting policy.

***Service***Revenue

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

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Because there areno quoted market prices for our additional structural advisory fees andresiduals receivables, 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 London Interbank OfferedRate, or LIBOR, and the spread between LIBOR and auction rates; and

•     expected loan defaults, netof recoveries.

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 analyze creditworthiness in several tiers, and select loanperformance assumptions based on these tiers. We also monitor trends in loanperformance over time and make adjustments we believe are necessary to valueproperly our receivables balances at each balance sheet date.

Thefollowing table shows the approximate weighted average loan performanceassumptions for the remaining life of the securitization trusts at December 31,2005:

| ** **                 | ** ** | ** **         | ** ** | **Percentage rate** | ** ** | **Percentage  discount rate** | ** ** |
|----------------------------|------------|--------------------|------------|--------------------------|------------|----------------------------------------------|------------|
| **Trust**                  | ** ** | **Loan type** | ** ** | **Default**              | ** ** | **Recovery**                                 | ** ** | **Prepayments** | ** ** | **Structural  advisory fees** | ** ** | **Residuals** | ** ** |
| Private label  loan trusts |       | Private label      |       |                     | 8.80       | %                                            |       |   | 40 | % |   |   | 7 | % |   |   | 6.36 | % |   |   | 12 | % |   |
| NCT trusts                 |       | Private label      |       |                     | 7.11       |                                         |       |   | 46 |   |   |   | 7 |   |   |   | 6.36 |   |   |   | 12 |   |   |
| NCT trusts                 |       | GATE               |       |                     | 21.00      |                                         |       |   | 47 |   |   |   | 4 |   |   |   | 6.36 |   |   |   | 12 |   |   |

 

Our private label loan programs, under whichapproximately 80% of the borrowers have creditworthy co-borrowers, typically afamily member, have an extensive credit underwriting process. GATE programs hada borrower approval rate of approximately 89% in fiscal 2005 as a result of thecredit support provided by the participating schools. Accordingly, we believethat borrowers in our private label programs will prepay at a higher rate anddefault at a lower rate than borrowers in our GATE programs.

At December 31, 2005, we used a 6.36% discountrate for valuing additional structural advisory fees, as compared to a 6.22%discount rate at December 31, 2004. Based on the priority payment statusof additional structural advisory fees in the flow of funds out of thesecuritization trust, we believe these fees are comparable to 10 year spreadson triple-B rated structured finance and corporate debt securities. Based onmarket quotes for such securities, we believe a spread over comparable maturityU.S. Treasury Notes of 200 basis points is an appropriate discount rate invaluing these projected cash flows.

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To our knowledge, there have been no public markettransactions involving the sale of residuals generated by a pool of securitizedstudent loans. In determining an appropriate discount rate for valuing ourresiduals, we review the rates used by student loan securitizers as well asrates used in the much broader asset-backed securities, or ABS, market. Webelieve that the 12% discount rate we use is appropriate given the maximum 24-yearlife of the trust assets and residuals.

Two private label loan trusts have issuedpredominately senior auction rate notes to finance the purchase of studentloans. Interest rates for the auction rate notes are determined from time totime at auction. At December 31, 2005, we used a 10 basis point spreadover LIBOR to project the future cost of funding of the senior auction ratenotes in the trusts. Since inception of the first trust, the average spreadover LIBOR for the senior auction rate notes of that trust has been 7.9basis points. Since the inception of the second trust, the average spreadover LIBOR for the senior auction rate notes of that trust has been 8.3basis points.

We increased our estimate of the fair value ofstructural advisory fees receivable at December 31, 2005 by approximately$0.5 million and increased our estimate of the fair value of residualsreceivable at December 31, 2005 by approximately $3.1 million as aresult of refinements to our prepayment rate assumptions and our use of an enhancedcash-flow model, both of which are described more fully below. We incorporatedthese adjustments to the carrying value of these assets into our trust updatesduring the second quarter of fiscal 2006.

During the second quarter of fiscal 2006, we completedan analysis of historical prepayments of certain loans included in ourproprietary private student loan performance database. The analysis indicatedthat the average prepayment rate throughout the life of the loan was notmaterially different from our previous estimate. At the same time, the analysisenabled us to refine our valuation approach to incorporate prepaymentassumptions specific to particular points of time in the life of the studentloans. We have used these refined prepayment assumptions to estimate the fairvalue of our residuals and structural advisory fees receivables at December 31,2005.

In addition, during the second quarter of fiscal 2006,we completed the development of a proprietary software program that allows fora detailed loan by loan simulation of projected trust cash flows. We believe thatthe implementation of this software program improves our methodology forestimating the fair value of our structural advisory fees and residualsreceivable.

In summary, during thesecond quarter of fiscal 2006, we changed the discount rate to be applied toadditional structural advisory fees to account for the change in the marketrate of 10-year U.S. Treasury Notes and refined our prepayment rate assumptionbased on the analysis discussed above. Except for these changes, we did notchange any loan performance assumptions regarding default rates, recovery ratesor discount rates in valuing projected trust cash flows during the first sixmonths of fiscal 2006 or fiscal 2005.

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*Sensitivityanalysis*

Increases in our estimates of defaults, prepaymentsand discount rates, increases in the spread between LIBOR and auction rates, aswell as decreases in default recovery rates and the multi-year forwardestimates of LIBOR would have a negative effect on the value of our additionalstructural advisory fees and residuals. Student loan prepayments include eitherfull or partial payments by a borrower in advance of the maturityschedule specified in the note, including payments as a result of loanconsolidation activity. Because essentially all credit defaults arereimbursable by third parties, increases in defaults generally have the sameeffect as increases in prepayments. If defaults increase beyond the level ofexpected third party reimbursement, then these changes will have an additionalnegative effect on the value of our additional structural advisory fees andresiduals. For purposes of this sensitivity analysis, we have assumed noamounts in excess of the pledge fund established at the time of eachsecuritization of private label loans are available to reimburse the trust fordefaults. Also, in the case of securitizations of GATE loans in which we haveinvested a portion of our up-front structural advisory fees, increases inestimates of defaults would reduce the value of our residual interests because amountsthat we would otherwise receive as residual interests would be applied to thedefaults. LIBOR is the reference rate for the loan assets and, we believe, areasonable index for borrowings of the trusts. Because the trusts’ student loanassets earn interest based on LIBOR and some trusts have outstanding securitiesthat pay interest based on the results of auction rates, changes in the spreadbetween LIBOR and the auction rate can affect the performance of the trust.

Thefollowing tables show the estimated change in our structural advisory fees andresiduals receivables balance at December 31, 2005 based on changes inthese loan performance assumptions:

| ** **                             | ** ** | **Percentage change in  assumptions** | ** ** | **Receivables**   | ** ** | **Percentage change in  assumptions** | ** ** |
|----------------------------------------|------------|-------------------------------------------------|------------|-------------------|------------|-------------------------------------------------|------------|
| **Structural advisory fees** | ** ** | ** **                                      | ** ** | **Down 20%** | ** ** | **Down 10%**                               | ** ** | **balance** | ** ** | **Up 10%** | ** ** | **Up 20%** | ** ** |
| ** **                             | ** ** | **(dollars in thousands)**            | ** ** |
| Default rate:                          |       |                                            |       |              |       |                                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Private label loan  trusts             |       |                                            | $          | 63,573            |       |                                            |       | $ | 63,346 |   |   |   | $ | 63,119 |   |   |   | $ | 62,894 |   |   | $ | 62,666 |   |
| GATE loan  trusts(1)                   |       |                                            | 6,681      |              |       |                                            | 6,575      |   |   |   | 6,470 |   |   |   | 6,365 |   |   | 6,258 |   |
| Total                                  |       |                                            | $          | 70,254            |       |                                            |       | $ | 69,921 |   |   |   | $ | 69,589 |   |   |   | $ | 69,259 |   |   | $ | 68,924 |   |
| Change in receivables balance:         |       |                                            | 0.96       | %                 |       |                                            | 0.48       | % |   |   |   |   |   |   | (0.47 | )% |   | (0.96 | )% |
| Default recovery  rate:                |       |                                            |       |              |       |                                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Private label loan  trusts             |       |                                            | $          | 63,119            |       |                                            |       | $ | 63,119 |   |   |   | $ | 63,119 |   |   |   | $ | 63,119 |   |   | $ | 63,119 |   |
| GATE loan  trusts(1)                   |       |                                            | 6,302      |              |       |                                            | 6,386      |   |   |   | 6,470 |   |   |   | 6,561 |   |   | 6,653 |   |
| Total                                  |       |                                            | $          | 69,421            |       |                                            |       | $ | 69,505 |   |   |   | $ | 69,589 |   |   |   | $ | 69,680 |   |   | $ | 69,772 |   |
| Change in receivables balance:         |       |                                            | (0.24      | )%                |       |                                            | (0.12      | )% |   |   |   |   |   |   | 0.13 | % |   | 0.26 | % |
| Annual prepayment  rate:               |       |                                            |       |              |       |                                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Private label loan  trusts             |       |                                            | $          | 66,209            |       |                                            |       | $ | 64,627 |   |   |   | $ | 63,119 |   |   |   | $ | 61,680 |   |   | $ | 60,300 |   |
| GATE loan  trusts(1)                   |       |                                            | 6,740      |              |       |                                            | 6,604      |   |   |   | 6,470 |   |   |   | 6,339 |   |   | 6,214 |   |
| Total                                  |       |                                            | $          | 72,949            |       |                                            |       | $ | 71,231 |   |   |   | $ | 69,589 |   |   |   | $ | 68,019 |   |   | $ | 66,514 |   |
| Change in receivables balance:         |       |                                            | 4.83       | %                 |       |                                            | 2.36       | % |   |   |   |   |   |   | (2.26 | )% |   | (4.42 | )% |
| Discount rate:                         |       |                                            |       |              |       |                                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Private label loan  trusts             |       |                                            | $          | 68,040            |       |                                            |       | $ | 65,519 |   |   |   | $ | 63,119 |   |   |   | $ | 60,834 |   |   | $ | 58,657 |   |
| GATE loan  trusts(1)                   |       |                                            | 6,971      |              |       |                                            | 6,714      |   |   |   | 6,470 |   |   |   | 6,236 |   |   | 6,007 |   |
| Total                                  |       |                                            | $          | 75,011            |       |                                            |       | $ | 72,233 |   |   |   | $ | 69,589 |   |   |   | $ | 67,070 |   |   | $ | 64,664 |   |
| Change in  receivables balance:        |       |                                            | 7.79       | %                 |       |                                            | 3.80       | % |   |   |   |   |   |   | (3.62 | )% |   | (7.08 | )% |
|                                        |            |                                                 |            |                   |            |                                                 |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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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:           |       |                                 |       |                                 |       |                               |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Private label  loan trusts      |       |                                 | $          | 58,726                               |       |                               |       | $ | 60,894 |   |   |   | $ | 63,119 |   |   |   | $ | 65,284 |   |   |   | $ | 67,537 |   |   |
| GATE loan  trusts(1)            |       |                                 | 6,051      |                                 |       |                               | 6,214      |   |   |   | 6,470 |   |   |   | 6,563 |   |   |   | 6,833 |   |   |
| Total                           |       |                                 | $          | 64,777                               |       |                               |       | $ | 67,108 |   |   |   | $ | 69,589 |   |   |   | $ | 71,847 |   |   |   | $ | 74,370 |   |   |
| Change in  receivables balance: |       |                                 | (6.91      | )%                                   |       |                               | (3.57      | )% |   |   |   |   |   |   | 3.24 | % |   |   | 6.87 | % |   |

----

(1)          GATEloan trusts include approximately $458 million of GATE loans and $36 million ofTERI-guaranteed loans.

| ** **                      | ** ** | **Percentage change in  assumptions** | ** ** | **Receivables**   | ** ** | **Percentage change in  assumptions** | ** ** |
|---------------------------------|------------|-------------------------------------------------|------------|-------------------|------------|-------------------------------------------------|------------|
| **Residuals**                   | ** ** | ** **                                      | ** ** | **Down 20%** | ** ** | **Down 10%**                               | ** ** | **balance** | ** ** | **Up 10%** | ** ** | **Up 20%** | ** ** |
| ** **                      | ** ** | **(dollars in thousands)**            | ** ** |
| Default rate:                   |       |                                            |       |              |       |                                            |       |   |   |   |   |   |   |   |   |
| Private label  loan trusts      |       | $                                               | 340,571    |              | $          | 337,940                                         |       |   | $ | 335,308 |   |   |   | $ | 332,686 |   |   | $ | 331,297 |   |
| GATE loan  trusts(1)            |       | 9,357                                           |       | 9,767             |       |                                            | 10,156     |   |   |   | 10,542 |   |   | 10,368 |   |
| Total                           |       | $                                               | 349,928    |              | $          | 347,707                                         |       |   | $ | 345,464 |   |   |   | $ | 343,228 |   |   | $ | 341,665 |   |
| Change in receivables balance:  |       | 1.29                                            | %          | 0.65              | %          |                                            |       |   |   |   | (0.65 | )% |   | (1.10 | )% |
| Default recovery  rate:         |       |                                            |       |              |       |                                            |       |   |   |   |   |   |   |   |   |
| Private label  loan trusts      |       | $                                               | 335,308    |              | $          | 335,308                                         |       |   | $ | 335,308 |   |   |   | $ | 335,308 |   |   | $ | 335,308 |   |
| GATE loan  trusts(1)            |       | 8,625                                           |       | 9,373             |       |                                            | 10,156     |   |   |   | 10,947 |   |   | 11,060 |   |
| Total                           |       | $                                               | 343,933    |              | $          | 344,681                                         |       |   | $ | 345,464 |   |   |   | $ | 346,255 |   |   | $ | 346,368 |   |
| Change in receivables balance:  |       | (0.44                                           | )%         | (0.23             | )%         |                                            |       |   |   |   | 0.23 | % |   | 0.26 | % |
| Annual prepayment  rate:        |       |                                            |       |              |       |                                            |       |   |   |   |   |   |   |   |   |
| Private label  loan trusts      |       | $                                               | 365,091    |              | $          | 349,888                                         |       |   | $ | 335,308 |   |   |   | $ | 321,319 |   |   | $ | 307,853 |   |
| GATE loan  trusts(1)            |       | 10,590                                          |       | 10,371            |       |                                            | 10,156     |   |   |   | 9,942 |   |   | 9,737 |   |
| Total                           |       | $                                               | 375,681    |              | $          | 360,259                                         |       |   | $ | 345,464 |   |   |   | $ | 331,261 |   |   | $ | 317,590 |   |
| Change in receivables balance:  |       | 8.75                                            | %          | 4.28              | %          |                                            |       |   |   |   | (4.11 | )% |   | (8.07 | )% |
| Discount rate:                  |       |                                            |       |              |       |                                            |       |   |   |   |   |   |   |   |   |
| Private label  loan trusts      |       | $                                               | 403,474    |              | $          | 367,511                                         |       |   | $ | 335,308 |   |   |   | $ | 306,409 |   |   | $ | 280,422 |   |
| GATE loan  trusts(1)            |       | 13,648                                          |       | 11,767            |       |                                            | 10,156     |   |   |   | 8,698 |   |   | 7,586 |   |
| Total                           |       | $                                               | 417,122    |              | $          | 379,278                                         |       |   | $ | 345,464 |   |   |   | $ | 315,107 |   |   | $ | 288,008 |   |
| Change in  receivables balance: |       | 20.74                                           | %          | 9.79              | %          |                                            |       |   |   |   | (8.79 | )% |   | (16.63 | )% |
|                                 |            |                                                 |            |                   |            |                                                 |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

27

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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:           |       |                                 |       |                                 |       |                               |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Private label  loan trusts      |       |                                 | $          | 316,131                              |       |                               |       | $ | 326,008 |   |   |   | $ | 335,308 |   |   |   | $ | 342,841 |   |   |   | $ | 349,974 |   |   |
| GATE loan  trusts(1)       |       |                                 | 9,241      |                                 |       |                               | 9,627      |   |   |   | 10,156 |   |   |   | 10,635 |   |   |   | 10,939 |   |   |
| Total                           |       |                                 | $          | 325,372                              |       |                               |       | $ | 335,635 |   |   |   | $ | 345,464 |   |   |   | $ | 353,476 |   |   |   | $ | 360,913 |   |   |
| Change in  receivables balance: |       |                                 | (5.82      | )%                                   |       |                               | (2.85      | )% |   |   |   |   |   |   | 2.32 | % |   |   | 4.47 | % |   |

 

| ** **                                                        | ** ** | **Change in assumption**     | ** ** | ** **                            | ** ** | **Change in assumption** | ** ** |
|-------------------------------------------------------------------|------------|----------------------------------------|------------|---------------------------------------|------------|------------------------------------|------------|
| ** **                                                        | ** ** | **Tighten 10  basis points** | ** ** | **Tighten 5  basis points** | ** ** | **Receivables  balance**           | ** ** | **Widen 5  basis points** | ** ** | **Widen 10  basis points** | ** ** |
| ** **                                                        | ** ** | **(dollars in thousands)**   | ** ** |
| Change in assumed spread  between LIBOR and auction rate indices: |       |                                   |       |                                  |       |                               |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Private label  loan trusts                                        |       |                                   | $          | 339,193                               |       |                               |       | $ | 337,251 |   |   |   | $ | 335,308 |   |   |   | $ | 333,365 |   |   |   | $ | 331,422 |   |   |
| GATE loan  trusts(1)                                              |       |                                   | 10,156     |                                  |       |                               | 10,156     |   |   |   | 10,156 |   |   |   | 10,156 |   |   |   | 10,156 |   |   |
| Total                                                             |       |                                   | $          | 349,349                               |       |                               |       | $ | 347,407 |   |   |   | $ | 345,464 |   |   |   | $ | 343,521 |   |   |   | $ | 341,578 |   |   |
| Change in receivables balance:                                    |       |                                   | 1.12       | %                                     |       |                               | 0.56       | % |   |   |   |   |   |   | (0.56 | )% |   |   | (1.12 | )% |   |

----

(1)          GATE loan trusts includeapproximately $458 million of GATE loans and $36 million of TERI-guaranteedloans.

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, the neteffect of simultaneous adverse changes in key assumptions may differ from thesum of the individual effects above.

***Consolidation***

Our consolidatedfinancial statements include the accounts of First Marblehead and itssubsidiaries, after eliminating inter-company accounts and transactions. Wehave not consolidated the financial results of the securitization trustspurchasing loans that we have facilitated. Prior to July 1, 2003, thisaccounting treatment was in accordance with various Emerging Issues Task Forceissues and related interpretations. We considered, among other things, thefollowing factors in assessing consolidation of the securitization trusts:

·  we did not have unilateral decision-makingabilities related to significant matters affecting the securitization trusts,such as asset acquisition, prepayment of debt, placement of debt obligationsand modification of trust documents;

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

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

28

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·  our continuing involvement in the trusts islimited to a passive residual interest and our role as an administrator for thetrust for which we receive market-based fees.

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

On December 24, 2003, the FASB issued FIN No. 46(revised December 2003), “Consolidation of Variable Interest Entities,” orFIN No. 46R, which addressed how a business enterprise should evaluatewhether it has a controlling interest in an entity through means other thanvoting rights and accordingly should consolidate the entity. FIN No. 46Rhas replaced FIN No. 46. At December 31, 2005, the securitizationtrusts created after January 31, 2003 have either met the criteria to be aqualified special-purpose entity, or QSPE, as defined in paragraph 35 ofFASB Statement No. 140, “Accounting for the Transfers and Servicing ofFinancial Assets and Extinguishments of Liabilities,” or we have determinedthat we are not the primary beneficiary of the securitization trusts, asdefined by FIN No. 46R. Accordingly, we did not consolidate these existingsecuritization trusts in our financial statements. In addition, thesecuritization trusts created prior to January 31, 2003 have been amendedin order for them to be considered QSPEs. The adoption of FIN No. 46R,which we began to apply in December 2003, did not have a material impacton our consolidated financial condition, results of operations, earnings pershare or cash flows.

The FASB has issuedexposure drafts that would amend FASB Statement No. 140. The proposedamendments would, among other things, change the requirements that an entitymust meet to be considered a QSPE. The FASB has announced that it expects toissue final guidance in the first or second calendar quarter of 2006. We aremonitoring the status of the exposure drafts to assess their impact, if any, onour financial statements.

**Results of Operations**

***Three and six months ended December 31, 2005 and2004***

***Revenue Related to Securitization Transactions***

The following tablesets forth for the first six months of fiscal 2006 and 2005:

·  the total volume of private label loanssecuritized;

·  the securitization-related service revenuecomponents, other than administrative and other fees, by dollar amount and as apercentage of the total volume of loans securitized; and

·  updates to reflect any fair value adjustmentto additional structural advisory fees and residuals for prior trusts.

29

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| **First six months   of fiscal year:** | ** ** | ** **                           | ** ** | **Total volume  of loans  securitized(1)** | ** ** | **Up front  structural   advisory fees** | ** ** | **Additional   structural  advisory fees** | ** ** | ** ** | ** ** | **Total   structural   advisory fees** | ** ** | **Residuals** |
|-----------------------------------------------------------------|------------|--------------------------------------|------------|------------------------------------------------------|------------|---------------------------------------------------------|------------|------------------------------------------------------|------------|------------|------------|-------------------------------------------------------|------------|---------------|
| ** **                                                      | ** ** | **(dollars in thousands)** |
| 2006                                                            |       |                                 |       |                                                 |       |                                                    |       |                                                 |       |       |       |                                                  |       |          |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Private label  loans                                            |       |                                 | $          | 1,265,387                                            |       |                                                    |       | $                                                    | 95,652     |       |       | 7.5                                                   | %          |          | $ | 14,778 |   |   | 1.2 | % |   | $ | 110,430 |   |   |   | $ | 78,216 |   |   | 6.2 | % |
| Trust updates(2)                                           |       |                                 | —     |                                                 |       |                                                    | —     |                                                 |       |       |       |                                                  | 1,440      |          |   |   |   |   | 1,440 |   |   |   | 19,973 |   |   |   |   |
| Other(3)                                                        |       |                                 | —     |                                                 |       |                                                    | 518        |                                                 |       |       |       |                                                  | —     |          |   |   |   |   | 518 |   |   |   | — |   |   |   |   |
| Total                                                           |       |                                 | $          | 1,265,387                                            |       |                                                    |       | $                                                    | 96,170     |       |       |                                                  |       |          | $ | 16,218 |   |   |   |   |   | $ | 112,388 |   |   |   | $ | 98,189 |   |   |   |   |
| 2005                                                            |       |                                 |       |                                                 |       |                                                    |       |                                                 |       |       |       |                                                  |       |          |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Private label  loans                                            |       |                                 | $          | 806,799                                              |       |                                                    |       | $                                                    | 65,050     |       |       | 8.1                                                   | %          |          | $ | 9,931 |   |   | 1.2 | % |   | $ | 74,981 |   |   |   | $ | 57,057 |   |   | 7.1 | % |
| Trust updates(2)                                                |       |                                 | —     |                                                 |       |                                                    | —     |                                                 |       |       |       |                                                  | 810        |          |   |   |   |   | 810 |   |   |   | 9,626 |   |   |   |   |
| Total                                                           |       |                                 | $          | 806,779                                              |       |                                                    |       | $                                                    | 65,050     |       |       |                                                  |       |          | $ | 10,741 |   |   |   |   |   | $ | 75,791 |   |   |   | $ | 66,683 |   |   |   |   |

----

(1)          Represents totalprincipal and accrued interest.

(2)          Trust updates reflectchanges resulting from the passage of time, which results in accretion of thediscounting inherent in the fair value estimates of additional structuraladvisory fees and residuals, as well as changes in the assumptions, if any,underlying our estimates of the fair value of these service revenue components.

(3)          Represents the receiptof funds from various trusts’ cost of issuance accounts once it is determinedthat the trust no longer needs such cost of issuance funds.

The principal balance of loans facilitated andavailable to us for later securitization totaled $773.0 million at December 31,2005.

Our private label loan products are marketed throughtwo marketing channels: direct to consumer, which generally refers to programsthat lenders, businesses, unions, affinity groups or other organizations marketdirectly to prospective borrowers, and school channel, which refers to programsthat lenders or third parties market directly to educational institutions. Ourestimates of the allocation by marketing channel of our securitization revenuesfor the first six months of fiscal 2006 and 2005, expressed as a percentage ofthe student loan balances securitized in each channel, are as follows:

30

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| ** **                                                               | ** ** | ** **             | ** ** | ** **                                    | ** ** | **Percentage yield**                         | ** ** |
|--------------------------------------------------------------------------|------------|------------------------|------------|-----------------------------------------------|------------|----------------------------------------------|------------|
| **Month and year of  private label  securitization** | ** ** | **Marketing  channel** | ** ** | **Volume of loans  securitized(1)** | ** ** | **Up-front  structural  advisory fees** | ** ** | **Additional  structural  advisory fees** | ** ** | **Residuals** | ** ** | **Total** | ** ** | ** ** |
| **Fiscal  2006**                                                         | ** ** | ** **             |       |                                          |       | ** **                                   |       |   | ** ** |   |   |   |   | ** ** |   |   | ** ** |   |   |   |   | ** ** |   |   |
| October 2005                                                        |       | Direct  to consumer    |       |                                          | $          | 921                                          | ** ** |   |   | 8.8 | % |   |   | 1.2 | % |   |   | 7.5 | % |   |   |   |   |   |   |
|                                                                     |       | School  channel        |       |                                          | 344        | ** **                                   |       |   | 4.1 |   |   |   | 1.2 |   |   |   | 2.6 |   |   |   |   |   |   |   |
|                                                                     |       | Total                  |       |                                          | $          | 1,265                                        | ** ** |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
|                                                                     |       | Blended  yield (2)     |       |                                          |       | ** **                                   |       |   | 7.5 | % |   |   | 1.2 | % |   |   | 6.2 | % |   |   | 14.9 | % |   |   |
| Total for first six months of fiscal 2006                                |       |                   |       |                                          | $          | 1,265                                        | ** ** |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
|                                                                     |       | Blended  yield (2)     |       |                                          |       | ** **                                   |       |   | 7.5 | % |   |   | 1.2 | % |   |   | 6.2 | % |   |   | 14.9 | % |   |   |
| **Fiscal  2005**                                                         |       |                   |       |                                          |       | ** **                                   |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| October 2004                                                        |       | Direct  to consumer    |       |                                          | $          | 744                                          | ** ** |   |   | 8.4 | % |   |   | 1.2 | % |   |   | 7.5 | % |   |   |   |   |   |   |
|                                                                     |       | School  channel        |       |                                          | 63         | ** **                                   |       |   | 4.3 |   |   |   | 1.0 |   |   |   | 2.2 |   |   |   |   |   |   |   |
|                                                                     |       | Total                  |       |                                          | $          | 807                                          | ** ** |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
|                                                                     |       | Blended  yield (2)     |       |                                          |       | ** **                                   |       |   | 8.1 | % |   |   | 1.2 | % |   |   | 7.1 | % |   |   | 16.4 | % |   |   |
| Total for first six months of fiscal 2005                                |       |                   |       |                                          | $          | 807                                          | ** ** |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
|                                                                     |       | Blended yield (2)      |       |                                          |       | ** **                                   |       |   | 8.1 | % |   |   | 1.2 | % |   |   | 7.1 | % |   |   | 16.4 | % |   |   |

----

(1)          Dollars in millions

(2)          Blended yield representssecuritization revenues as a percentage of the total principal and accruedinterest of loans securitized from all marketing channels.

Theseyields by marketing channel represent an allocation of revenues and costs basedon various estimates and assumptions regarding the relative profitability ofthese 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 the time of year that the loans are securitizedand the relative mix of loans from students with various expected terms tograduation, the structure of, and prevailing market conditions at the time of asecuritization, the marketing fees which our clients earn on loans wesecuritize for them, along with a number of other factors. Therefore, readersare cautioned that the blended yields and yields by marketing channel above maynot be indicative of yields that we may be able to achieve in futuresecuritizations.

*Structural advisoryfees*

Structural advisory fees increased to $112.4 millionfor the first six months of fiscal 2006 from $75.8 million for the first sixmonths of fiscal 2005. Structural advisory fees increased to $112.2 million inthe second quarter of fiscal 2006 from $75.2 million for the second quarter offiscal 2005. The increases in structural advisory fees in the 2006 periodscompared to the 2005 periods were primarily a result of an increase insecuritization volume.

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*Up-front structuraladvisory fees*

The up-front component of structural advisory feesincreased to $96.2 million for the first six months of fiscal 2006 and thesecond quarter of 2006 from $65.1 million for the first six months fiscal 2005and the second quarter of 2005. The increase in up-front structural advisoryfees between periods was primarily a result of an increase in loan facilitationvolume, which enabled us to securitize a greater amount of loans. A decrease inup-front structural advisory fees as a percentage of the loan volumesecuritized, or up-front structural advisory fee yield, partially offset theimpact of the increase in loan facilitation volume. The up-front structuraladvisory fee yield decreased because school channel loans comprised a largerproportion of the loans securitized in the 2006 period than in the 2005 period.School channel loans generally have a lower upfront structural advisory feeyield than direct-to-consumer loans.

Thefollowing table reflects the increases in up-front structural advisory feesattributable to the increases in securitization volume and changes in the feeyield and loan mix:

| ** **                                                                           | ** ** | **Up-front structural advisory fees** | ** ** |
|--------------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|
| **Fiscal year**                                                                 | ** ** | ** **                                           | ** ** | **Total volume  of loans  securitized** | ** ** | **Change attributable  to increased  securitization volume** | ** ** | **Change attributable to  change in fee yield  and loan mix** | ** ** | **Total increase** | ** ** |
| ** **                                                                           | ** ** | **(in thousands)**                              | ** ** |
| Six months ended  December 31, 2005 vs. six months ended December 31, 2004 |       |                                                 | $          | 1,265,387 |   |   |   | $ | 36,977 |   |   |   | $ | (5,857 | ) |   |   | $ | 31,120 |   |   |
|                                                                                      |            |                                                      |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

*Additionalstructural advisory fees*

The additional component of structural advisory feesincreased to $16.2 million for the first six months of fiscal 2006 from $10.7million for the first six months of fiscal 2005. Additional structural advisoryfees increased to $16.0 million for the second quarter of fiscal 2006 from$10.1 million for the second quarter of fiscal 2005.  The increases in additional structuraladvisory fees between periods were primarily a result of increases insecuritization volume.

Thefollowing table summarizes the changes in our estimate of the fair value of thestructural advisory fees receivable for the three and six months ended December 31,2005 and 2004:

| ** **                                     | ** ** | **Three months ended**

**December 31,** | ** ** |
|------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                     | ** ** | **2005**                                                | ** ** | **2004** | ** ** |
| ** **                                     | ** ** | **(in thousands)**                                 | ** ** |
| Fair value at  beginning of period             |       | $                                                       | 53,570     |   | $ | 24,703 |   |
| Additions from structuring new securitizations |       | 14,778                                                  |       | 9,931 |   |
| Fair value  adjustments                        |       |                                                    |       |   |   |
| Passage of time (present value accretion)      |       | 1,009                                                   |       | 479 |   |
| Other factors                                  |       | 232                                                     |       | (288 | ) |
| Total fair value adjustments                   |       | 1,241                                                   |       | 191 |   |
| Fair value at end of  period                   |       | $                                                       | 69,589     |   | $ | 34,825 |   |

 

32

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| ** **                                     | ** ** | **Six months ended  December 31,** | ** ** |
|------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                     | ** ** | **2005**                                          | ** ** | **2004** | ** ** |
| ** **                                     | ** ** | **(in thousands)**                           | ** ** |
| Fair value at beginning  of period             |       |                                              | $          | 53,371 |   |   | $ | 24,084 | (1) |
| Additions from structuring new securitizations |       |                                              | 14,778     |   |   | 9,931 |   |
| Fair value adjustments                         |       |                                              |       |   |   |   |   |
| Passage of time (present value accretion)      |       |                                              | 1,804      |   |   | 875 |   |
| Other factors                                  |       |                                              | (364       | ) |   | (65 | ) |
| Total fair value adjustments                   |       |                                              | 1,440      |   |   | 810 |   |
| Fair value at end of  period                   |       |                                              | $          | 69,589 |   |   | $ | 34,825 |   |

----

(1)          Excludes the $10.25 millionstructural advisory fee receivable from the December 2003 securitizationtransaction that we collected in July 2004.

During the first six months of fiscal 2006, ourestimate of the fair value of our additional structural advisory fees increasedapproximately $1.4 million. This increase was primarily due to the accretion ofthe discounting inherent in these fair value estimates and the impact of anincrease in the implied forward LIBOR curve during the period, offset by anincrease in the discount rate. During the first six months of fiscal 2005, ourestimate of the fair value of our additional structural advisory fees increasedapproximately $0.8 million. This increase was due to the accretion of thediscounting inherent in these fair value estimates and a decrease in the discountrate. During the three months ended December 31, 2005, our estimate of thefair value of our additional structural advisory fees increased approximately$1.2 million. The increase was primarily due to the discounting inherent inthese fair value estimates. During the three months ended December 31,2004, our estimate of the fair value of our additional structural advisory feesincreased approximately $0.2 million. The increase was primarily due to the discountinginherent in these fair value estimates.

On a quarterly basis, we update our estimate of thefair value of our additional structural advisory fees, which have an estimatedaverage life of approximately six to eight years. In doing so, we give effectto the passage of time, which results in the accretion of the discounting inherentin these fair value estimates, and we also adjust for any changes in thediscount rate and other assumptions that we use in estimating the fair value ofthese receivables. We monitor the performance of trust assets, includingdefault, recovery, prepayment and forward LIBOR rate 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 ouradditional structural advisory fees, see “—Executive Summary—Application ofCritical Accounting Policies—Service Revenue.”

We base the discount rate that we use to calculate thefair value of our additional structural advisory fees on the 10-year U.S.Treasury rate plus 200 basis points. The discount rate was 6.36% at December 31,2005, 6.33% at September 30, 2005, 5.96% at June 30, 2005, 6.22% at December 31,2004, 6.12% at September 30, 2004, and 6.58% at June 30, 2004. Adecrease in the 10-year U.S. Treasury rate has the effect of increasingthe fair value of our structural advisory fees receivable, while an increase inthe rate has the opposite effect on our estimate of their fair value.

We made no changes in ourassumptions regarding default rates and recovery rates for the private labelloan trusts or NCT trusts during either the first six months of fiscal 2006 orfiscal 2005. For a discussion of a refinement made to our prepayment rateassumption in the second quarter of fiscal 2006 see “—Executive Summary—Applicationof Critical Accounting Policies—Service Revenue”.

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*Residuals*

Residuals increased to $98.2 million for the first sixmonths of fiscal 2006 from $66.7 million for the first six months offiscal 2005, and increased to $90.7 million for the three months ended December 31,2005, compared to $63.2 million for the three months ended December 31,2004. The increases in residuals in the 2006 periods compared to the 2005periods were primarily a result of an increase in securitization volume. Inestimating the fair value of our residuals, we used a discount rate of 12%throughout the first six months of fiscal 2006 and all of fiscal 2005.

Thefollowing table reflects the increases in residuals attributable to theincrease in securitization volume and the change attributable to updates toprior trusts: 

| ** **                                                                           | ** ** | ** **                                        | ** ** | **Residuals**                                                                                               | ** ** |
|--------------------------------------------------------------------------------------|------------|---------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------|------------|
| ** **                                                                           | ** ** | **Total volume  of loans  securitized** | ** ** | **Change  attributable to  increased  securitization  volume and  change in loan  mix** | ** ** | **Change  attributable to  trust updates(1)** | ** ** | **Total increase** | ** ** |
| ** **                                                                           | ** ** | **(in thousands)**                           | ** ** |
| Six months ended  December 31, 2005 vs. six months ended December 31, 2004 |       | $                                                 | 1,265,387  |                                                                                                        |       | $ | 21,159 |   |   |   | $ | 10,347 |   |   |   | $ | 31,506 |   |   |
|                                                                                      |            |                                                   |            |                                                                                                             |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

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(1)          The change attributableto trust updates in fiscal 2006 and 2005 was primarily the result of thepassage of time and the resulting accretion of the discounting inherent inthese fair value estimates of residuals, rather than changes in ourassumptions.

Thefollowing tables summarize the changes in our estimate of the fair value of theresiduals receivable for the three and six months ended December 31, 2005and 2004: 

| ** **                                     | ** ** | **Three months ended  December 31,** | ** ** |
|------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                     | ** ** | **2005**                                            | ** ** | **2004** | ** ** |
| ** **                                     | ** ** | **(in thousands)**                             | ** ** |
| Fair value at  beginning of period             |       | $                                                   | 254,757    |   | $ | 111,955 |   |
| Additions from structuring new securitizations |       | 78,216                                              |       | 57,057 |   |
| Fair value  adjustments                        |       |                                                |       |   |   |
| Passage of time (present value accretion)      |       | 9,243                                               |       | 4,500 |   |
| Other factors                                  |       | 3,248                                               |       | 1,666 |   |
| Total fair value adjustments                   |       | 12,491                                              |       | 6,166 |   |
| Fair value at end of  period                   |       | $                                                   | 345,464    |   | $ | 175,178 |   |

 

| ** **                                     | ** ** | **Six months ended  December 31,** | ** ** |
|------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                     | ** ** | **2005**                                          | ** ** | **2004** | ** ** |
| ** **                                     | ** ** | **(in thousands)**                           | ** ** |
| Fair value at  beginning of period             |       | $                                                 | 247,275    |   | $ | 108,495 |   |
| Additions from structuring new securitizations |       | 78,216                                            |       | 57,057 |   |
| Fair value  adjustments                        |       |                                              |       |   |   |
| Passage of time (present value accretion)      |       | 16,661                                            |       | 7,755 |   |
| Other factors                                  |       | 3,312                                             |       | 1,871 |   |
| Total fair value adjustments                   |       | 19,973                                            |       | 9,626 |   |
| Fair value at end of  period                   |       | $                                                 | 345,464    |   | $ | 175,178 |   |

 

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During the first six months of fiscal 2006, ourestimate of the fair value of our residuals receivable increased approximately$20.0 million, and, during the first six months of fiscal 2005, our estimate ofthe fair value of our residuals receivable increased approximately $9.6million. During the second quarter of fiscal 2006, our estimate of the fairvalue of our residuals receivable increased approximately $12.5 million, and,during the second quarter of fiscal 2005, our estimate of the fair value of ourresiduals receivable increased approximately $6.2 million. These increases inthe 2006 periods compared to the 2005 periods were primarily due to the passageof time. The amount of these fair value adjustments also increased betweenperiods as the underlying receivables balance increased. We expect thatadjustments for the passage of time will continue to increase as we conductmore securitization transactions and thereby add to the residual revenues thatwe discount to fair value.

As we do with our additional structural advisory fees,on a quarterly basis, we update our estimate of the fair value of ourresiduals. In doing so, we give effect for the passage of time, which resultsin the accretion of the discounting inherent in these fair value estimates, andwe also adjust for any change in the discount rate that we use in estimatingthe fair value of these receivables. We used a 12% discount factor during thefirst six months of fiscal 2006 and throughout fiscal 2005. We also monitor theperformance of trust assets, including default, recovery, prepayment andforward LIBOR rates experience, which we also consider in our estimates. We usean implied forward LIBOR curve to estimate trust cash flows. For a discussionof the assumptions we make in estimating our residuals, see “—Executive Summary—Applicationof Critical Accounting Policies and Estimates—Service Revenue.”

In determining anappropriate discount rate for valuing residuals, we review the rates used bystudent loan securitizers, as well as rates used in the much broader asset-backedsecurities, or ABS, market. We believe that the 12% discount rate we use isappropriate given the maximum 24-year life of the trust assets andresiduals.

*Processing feesfrom TERI*

Processing fees from TERIincreased to $51.2 million for the first six months of fiscal 2006 from$33.9 million for the first six months of fiscal 2005 and increased to$25.3 million for the second quarter of fiscal 2006 from $16.6 million for thesecond quarter of fiscal 2005. The increase reflects the additional reimbursedexpenses required to process the volume of private label loans that wefacilitated during the fiscal 2006 period, which increased to $1.83 billion forthe first six months of fiscal 2006 from $1.54 billion for the first six monthsof fiscal 2005 and to $618 million for the second quarter of fiscal 2006 from$530 million for the second quarter of fiscal 2005. We expect that ourprocessing fees from TERI will continue to increase as we devote additionalpersonnel and other resources to facilitate expected increases in private labelloan volumes. The increase was also due to the expansion of our loan processingfacilities which was partially reimbursed by TERI.

*Administrative andother fees*

Administrative and otherfees increased to $3.8 million for the first six months of fiscal 2006 from$1.8 million for the first six months of fiscal 2005 and increased to $2.3million for the second quarter of fiscal 2006 from $0.9 million for the secondquarter of fiscal 2005. The increases in the current year periods were primarilydue to fees we earned from the marketing services we provide to some of ourclients. To a lesser extent, the increase was due to increasing student loanbalances in the securitization trusts during the fiscal 2006 period compared tothe fiscal 2005 period.

***Operating Expenses***

Total operating expenses increased to $89.7 millionfor the first six months of fiscal 2006 from $61.5 million for the first sixmonths of fiscal 2005 and increased to $44.1 million in the second quarter offiscal 

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2006 from $29.7 million inthe second quarter of fiscal 2005. Compensation and benefits increased to $40.9million for the first six months of fiscal 2006 from $30.2 million for thefirst six months of fiscal 2005, and increased to $21.2 million in the secondquarter of fiscal 2006 from $15.3 million in the second quarter of fiscal 2005.General and administrative expenses increased to $48.8 million for the firstsix months of fiscal 2006 from $31.3 million for the first six months of fiscal2005, and increased to $22.9 million in the second quarter of fiscal 2006 from$14.4 million in the second quarter of fiscal 2005.

Compensation and benefits and general andadministrative expenses increased in the fiscal 2006 periods compared to thefiscal 2005 periods primarily as a result of an increase in personnel. Ouraverage total number of employees was 26% higher during the first six months offiscal 2006 than during the corresponding prior year period and 27% higherduring the second quarter of fiscal 2006 than during the second quarter offiscal 2005. We hired additional personnel to meet the operating andinformation systems requirements from our growing loan processing andsecuritization activities.

General and administrative expenses increased duringthe first six months of fiscal 2006 as compared to the first six months offiscal 2005 as a result of increases in several categories of expenses, offsetin part by a decrease in consulting fees. Marketing coordination expensesincreased from $0.9 million for the first six months of fiscal 2005 to $5.9million for the first six months of fiscal 2006. The increase in marketingcoordination expense was primarily due to our additional efforts to increaseloan facilitation volumes for our clients. Depreciation and amortizationexpense increased from $2.6 million for the first six months of fiscal 2005 to$6.9 million for the first six months of fiscal 2006. Occupancy costs increasedfrom $4.3 million for the first six months of fiscal 2005 to $7.0 million forthe first six months of fiscal 2006. The increase in depreciation and occupancyexpense is primarily due to the expansion of our loan processing operations andcorporate headquarters which resulted in increased office space under lease andadditional purchases of fixed assets. Equipment expenses increased from $2.2million for the first six months of fiscal 2005 to $5.5 million for the firstsix months of fiscal 2006. The increase in equipment expenses was primarily dueto an increase in software maintenance and license costs and an increase inleased equipment costs. Temporary employment expenses increased from $1.2million for the first six months of fiscal 2005 to $2.9 million for the firstsix months of fiscal 2006. External call center costs increased from $4.0million for the first six months of fiscal 2005 to $5.9 million for the firstsix months of fiscal 2006. The increases in temporary employment servicesexpense and external call center costs were primarily due to increases inpersonnel necessary to process the volume of loans facilitated during thefiscal 2006 period. Consulting fees decreased from $7.1 million for the firstsix months of fiscal 2005 to $5.9 million for the first six months of fiscal2006. This decrease was primarily due to a decrease in external consultantsinvolved in the evaluation and improvement of our loan facilitation systems.

General and administrative expenses increased duringthe second quarter of fiscal 2006 as compared to the second quarter of fiscal2005 as a result of increases in several categories of expenses. Marketingcoordination expenses increased from $0.2 million for the second quarter offiscal 2005 to $3.1 million for the second quarter of fiscal 2006. The increasein marketing coordination expense was primarily due to our additional effortsto increase loan facilitation volumes for our clients. Depreciation andamortization expense increased from $1.3 million for the second quarter offiscal 2005 to $4.0 million for the second quarter of fiscal 2006. Occupancycosts increased from $2.2 million for the second quarter of fiscal 2005 to $3.4million for the second quarter of fiscal 2006. The increase in depreciation andoccupancy expense was due to the expansion of our loan processing operationsand corporate headquarters which resulted in increased office space under leaseand additional purchases of fixed assets. Equipment expenses increased $1.1million for the second quarter of fiscal 2005 to $2.6 million for the secondquarter of fiscal 2006. The increase in equipment expenses was primarily due toan increase in software maintenance and license costs and an increase in leasedequipment costs.

We expect that our operating expenses will continue toincrease as we devote additional resources to the expected increasing loanvolumes facilitated for our existing and new clients.

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Thefollowing table summarizes the components of operating expenses, both thosereimbursed and not reimbursed by TERI, for the three and six months ended December 31,2005 and 2004:

 

| ** **                               | ** ** | **Operating expenses**                    | ** ** |
|------------------------------------------|------------|------------------------------------------------|------------|
| ** **                               | ** ** | **Expenses reimbursed by TERI** | ** ** | **Expenses not reimbursed by TERI** | ** ** | ** ** | ** ** |
| ** **                               | ** ** | **Compensation  and benefits**            | ** ** | **General and  administrative  expenses** | ** ** | **Subtotal  operating  expenses** | ** ** | **Compensation  and benefits** | ** ** | **General and  administrative  expenses** | ** ** | **Subtotal  operating  expenses** | ** ** | **Total  operating  expenses** | ** ** |
| ** **                               | ** ** | **(in thousands)**                        | ** ** |
| **Three months ended December 31,** |       |                                           |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| 2005                                     |       |                                           | $          | 13,079 |   |   |   | $ | 12,055 |   |   |   | $ | 25,134 |   |   |   | $ | 8,081 |   |   |   | $ | 10,836 |   |   |   | $ | 18,917 |   |   |   | $ | 44,051 |   |   |
| 2004                                     |       |                                           | 8,581      |   |   |   | 7,969 |   |   |   | 16,550 |   |   |   | 6,737 |   |   |   | 6,386 |   |   |   | 13,123 |   |   |   | 29,673 |   |   |
| **Six  months ended December 31,**  |       |                                           |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| 2005                                     |       |                                           | $          | 25,930 |   |   |   | $ | 25,001 |   |   |   | $ | 50,931 |   |   |   | $ | 14,972 |   |   |   | $ | 23,815 |   |   |   | $ | 38,787 |   |   |   | $ | 89,718 |   |   |
| 2004                                     |       |                                           | 17,140     |   |   |   | 16,737 |   |   |   | 33,877 |   |   |   | 13,058 |   |   |   | 14,577 |   |   |   | 27,635 |   |   |   | 61,512 |   |   |

 

***Other Income (Expense)***

*Interest income(expense), net*

Net interest income was$2.9 million for the first six months of fiscal 2006 as compared to netinterest income of $1.1 million for the first six months of fiscal 2005. Netinterest income was $1.6 million for the second quarter of fiscal 2006 ascompared to $0.8 million for the second quarter of fiscal 2005. Interestexpense was $0.4 million for the first six months of fiscal 2006 and $0.2million for the first six months of fiscal 2005. Interest expense was $0.2million for the second quarter of fiscal 2006 and $0.1 million for the secondquarter of fiscal 2005. Interest income was $3.3 million for the first sixmonths of fiscal 2006 and $1.4 million for the first six months of fiscal 2005.Interest income was $1.8 million for the second quarter of fiscal 2006 and $0.9million for the second quarter of fiscal 2005. The increases in interest incomewere due to greater cash available for investment in the current year periodsas well as increases in average yields on investments. Interest expense forboth periods is due primarily to our capital lease obligations and our notesissued to TERI in 2001 to finance our purchase of TERI’s loan processingoperations and loan database.

*Other*

During the second quarterof fiscal 2006, we realized a gain of $2.5 million upon the early terminationof an operating lease for a corporate aircraft. The terms of the lease allowedus the ability to benefit from the appreciation in value of the leased aircraftupon its termination.

***Income Tax Expense***

Income tax expenseincreased to $75.3 million for the first six months of fiscal 2006 fromapproximately $48.7 million for the first six months of fiscal 2005. Income taxexpense increased to $79.2 million for the second quarter of fiscal 2006 from$52.4 million for the second quarter of fiscal 2005. The increase in income taxexpense was primarily the result of an increase in the amount of income beforeincome tax expense between periods.

**FinancialCondition, Liquidity and Capital Resources**

Our liquidity requirementshave historically consisted, and we expect that they will continue to consist,of 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 and theproceeds of our initial public offering in November 2003, which resultedin net proceeds to us of approximately $115.1 million. We believe, based on ourcurrent operating plan, that our cash flows from operations and our currentcash and cash equivalents will be sufficient to meet our funding requirementsthrough at least fiscal 2007.

***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 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 delay or eliminate our quarterly cash dividends to our stockholders.

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

·       ourfacilities expansion 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;

·       thetiming, size and composition of the loan pools of the securitizationtransactions that we structure; and

·               thecosts and timing of acquisitions of complementary businesses.

***Treasury Stock***

We had treasury stock of$121.5 million at December 31, 2005 and $55.7 million at June 30,2005. Our treasury stock balance was derived from the repurchases of our commonstock in open market transactions. Our board of directors approved therepurchase of 1,500,000 shares of our common stock in the fourth quarter offiscal 2005 and approved the repurchase of an additional 5,000,000 shares ofour common stock in the first quarter of fiscal 2006. As of December 31,2005, we had repurchased an aggregate of 3,846,800 shares at an average priceof $31.57 per share.

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***Cash and Cash Equivalents***

At December 31, 2005,we had $152.5 million in cash and cash equivalents and at June 30, 2005,we had $193.8 million in cash and cash equivalents. The decrease in cashand cash equivalents is primarily due to cash used to fund repurchases of ourcommon stock and the payment of cash dividends during the first six months offiscal 2006, offset by cash generated from our October 2005 securitizationtransaction. Cash and cash equivalents primarily include funds deposited in amoney market fund that invests in short-term obligations of the U.S. Treasuryand repurchase agreements fully collateralized by obligations of the U.S.Treasury.

***Service Receivables***

Our service receivables increased to $423.9 million atDecember 31, 2005 from $309.6 million at June 30, 2005,primarily as a result of the structural advisory fees and residuals generatedfrom the October 2005 securitization transaction. The increase in servicereceivables is also due to an increase in our estimate of the fair value of ourresiduals receivable of $20.0 million during the first six months of fiscal2006.

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***Property and Equipment, net***

During the first sixmonths of fiscal 2006, our property and equipment, net increased by $1.9million, as we spent $6.9 million on the expansion and improvement of our loanprocessing facilities and systems, offset by $6.1 million of depreciationexpense recorded during the period. During the first six months of fiscal 2006,we financed the acquisition of $1.1 million in property and equipment throughcapital leases.

***Prepaid Income Taxes***

We had no prepaid incometaxes at December 31, 2005 as compared to $2.6 million at June 30,2005. At June 30, 2005, this balance was primarily derived from a taxbenefit of $34.3 million from employee stock option exercises, principally inconnection with a stock option exercise at the time of our follow-on offeringin January 2005.

***Other Prepaid Expenses***

We had other prepaidexpenses of $7.0 million at December 31, 2005 compared to $4.2 million at June 30,2005. The increase in other prepaid expenses was primarily due to an increasein deferred marketing coordination expenses of approximately $1.2 million andan increase in prepaid insurance of approximately $1.6 million.

***Other Assets***

We had other assets of$5.0 million at December 31, 2005 and $3.2 million at June 30, 2005. Theincrease in other assets is primarily due to $1.2 million in up-frontstructural advisory fees due from the October 2005 private label loantrust. We agreed to delay the receipt of $1.2 million in up-front structuraladvisory fees at the closing of the October 2005 securitizationtransaction until the final reconciliation of the transaction was complete. We receivedthis remaining portion of the up-front structural advisory fee during the thirdquarter of fiscal 2006.

***Accounts Payable and Accrued Expenses***

We had accounts payableand accrued expenses of $23.1 million at December 31, 2005 and$33.3 million at June 30, 2005. Our accrued bonuses wereapproximately $6.8 million lower at December 31, 2005 as compared to June 30,2005, as we paid the performance-based compensation earned during fiscal 2005during the first quarter of fiscal 2006. Our accounts payable were $1.6 millionlower at December 31, 2005 as compared to June 30, 2005, primarilydue to the timing of the receipt and processing of invoices.

***Income Taxes Payable***

We had income taxespayable of $33.6 million at December 31, 2005. We had no income taxespayable at June 30, 2005. The increase in income taxes payable isprimarily due to the current tax expense generated by our income for the firstsix months of fiscal 2006.

***Net Deferred Income Tax Liability***

We have a net deferredincome tax liability primarily because, under GAAP, we recognize residuals infinancial statement income earlier than they are recognized for income taxpurposes. Our net deferred income tax liability increased primarily as a resultof the increase in residual revenue recognized during the first six months offiscal 2006, which more than offset the recognition of our share of taxableincome from the securitization trusts.

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***Capital Lease Obligations***

We had capital leaseobligations of $10.9 million at December 31, 2005 and $12.1 million at June 30,2005. The decrease in capital lease obligations was due to scheduled principalpayments made during the first fiscal six months of 2006.

***Notes Payable to TERI***

We had notes payable toTERI of $4.9 million at December 31, 2005 and $5.3 million at June 30,2005. The balance relates to two acquisition notes we issued to acquire TERI’sloan processing operations in 2001. The decrease in notes payable to TERI isdue to the scheduled principal payments made during the first six months of2006.

***Other Liabilities***

We had other liabilitiesof $3.6 million at December 31, 2005 and $1.7 million at June 30,2005. The balance at both period ends related primarily to deferred rentrelated to several operating leases for office space.

***Contractual Obligations***

During the first sixmonths of fiscal 2006, we terminated an operating lease for a corporateaircraft. As a result of this termination, we are no longer required to pay thebasic annual rent due under the lease of approximately $1.4 million per yearthrough 2009. Except for this change, our contractual obligations as ofDecember 31, 2005 had not changed materially from those described underManagement’s Discussion and Analysis of Financial Condition and Results ofOperations-Contractual Obligations” in our annual report on Form 10-Kfor the fiscal year ended June 30, 2005.

***Cash Flows***

Our net cash provided by operating activitiesincreased to $46.4 million for the first six months of fiscal 2006, compared to$44.5 million for the first six months of fiscal 2005. The increase of cashprovided by operations resulted primarily from our net income, an increase inaccounts payable, accrued expenses, income taxes payable and other liabilitiesand a decrease in prepaid income taxes, offset by increases in residualsreceivables, structural advisory fees receivables and other prepaid expenses.

We used $7.2 million of net cash in investingactivities during the first six months of fiscal 2006. The principal use of netcash was capital expenditures related to the expansion and improvement of ourloan processing facilities and systems and, to a lesser extent, payments forloan database updates from TERI.

We used net cash of $80.5 million in financingactivities during the first six months of 2006. Cash used in financingactivities was primarily for our repurchases of common stock and cash dividendspaid to common stockholders. We expect to make quarterly cash dividend paymentsto our stockholders in future periods.

We expect that our capitalexpenditure requirements for the final six months of fiscal 2006 will beapproximately $13.2 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, we issued two acquisition notes toTERI totaling $7.9 million to acquire TERI’s loan processing operations aswell as its workforce-in-place. Principal and interest at an annual rate of 6%is payable on these notes in 120 monthly payments of $87,706 commencing onJuly 20, 2001 and ending on 

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June 20, 2011. At December 31,2005, outstanding principal on these notes totaled $4.9 million as compared to$5.3 million at June 30, 2005.

In August 2003, weentered into a $10 million revolving credit facility with Fleet NationalBank. Fleet National Bank was subsequently acquired by Bank of America, and ouragreement related to this facility was assigned to Bank of America. Therevolving credit facility matured on August 28, 2005, and we did notextend it. The revolving credit line contained certain financial covenants withwhich we complied throughout the terms of the facility.

**Off-BalanceSheet Transactions**

We offer outsourcingservices in connection with the lifecycle of a private student loan, fromprogram design and marketing through loan administration and, ultimately, tothe sale and securitization of the loans. We also structure and facilitate thesecuritization of loans for our clients through a series of bankruptcy remote,qualified special purpose trusts.

We do not utilize thesetrusts as a means to transfer assets or liabilities from our balance sheet tothose of the trusts because we are not the originator of the securitizedstudent loans or the issuer of the related debt. We do not serve as lender,guarantor or loan servicer. Specifically, these trusts purchase such studentloans from third-party financial institutions, the financing of which isprovided through the issuance of asset-backed securities.

Theprincipal uses of these trusts are to:

•     generate sources of liquidityfor our clients’ assets sold into such trusts and to reduce their credit risk;

•     make available more funds tostudents and colleges; and

•     leverage the capital marketsto 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.

**FactorsThat May Affect Future Results**

This quarterly report on Form 10-Qincludes forward-looking statements within the meaning of Section 21E ofthe Securities Exchange Act of 1934, as amended, or the Exchange Act. For thispurpose, any statements contained herein regarding our strategy, futureoperations, financial position, future revenues, projected costs, prospects,plans and objectives of management, other than statements of historical facts,are forward-looking statements. The words “anticipates,” “believes,” “estimates,”“expects,” “intends,” “may,” “plans,” “projects,” “will,” “would” and similarexpressions are intended to identify forward-looking statements, although notall forward-looking statements contain these identifying words. We cannotprovide any assurance that we actually will achieve the plans, intentions orexpectations expressed or implied in our forward-looking statements. There area number of important factors that could cause actual results, levels ofactivity, performance or events to differ materially from those expressed orimplied in the forward-looking statements we make. These important factorsinclude our “critical accounting estimates” and the risk factors set forthbelow under Item 1A of Part II. Although we may elect to updateforward-looking statements in the future, we specifically disclaim anyobligation to do so, even if our estimates change, and readers should not relyon those forward-looking statements as representing our views as of any datesubsequent to the date of this quarterly report.

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**Item 3—Quantitative and Qualitative Disclosures aboutMarket Risk**

***General***

Market risk is the risk ofchange in fair value of a financial instrument due to changes in interestrates, equity prices, creditworthiness, foreign exchange rates or otherfactors. We manage our market risk through a conservative investment policy,the primary objective of which is preservation of capital. At December 31,2005, cash and cash equivalents consisted primarily of balances in money marketfunds. As a result, we do not believe a change in interest rates would have amaterial impact on the fair value of cash and cash equivalents.

***Market Risks Related to Structural Advisory Fees andResiduals***

Because there are noquoted market prices for our additional structural advisory fees and residualsreceivables, we use assumptions to estimate their values. We base theseestimates on our proprietary historical data, third party data and our industryexperience, adjusting for specific program and borrower characteristics such asloan type and borrower creditworthiness. Increases in our estimates ofdefaults, prepayments and discount rates, increases in the spread between LIBORand auction rate indices as well as decreases in default recovery rates and themulti-year forward estimates of the LIBOR rate, which is the reference rate forthe loan assets and borrowings of the securitization trusts, would have anegative effect on the value of our additional structural advisory fees andresiduals. For an analysis of the estimated change in our structural advisoryfees and residuals receivables balance at December 31, 2005 based onchanges in these loan performance assumptions, see “Management’s Discussion andAnalysis of Financial Conditions and Results of Operations—Executive Summary—Applicationof Critical Accounting Policies and Estimates—Service Revenue—SensitivityAnalysis.”

**Item 4—Controls and Procedures**

Our management, with the participation of our chiefexecutive officer and chief financial officer, evaluated the effectiveness ofour disclosure controls and procedures as of December 31, 2005. The term “disclosurecontrols and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) underthe Exchange Act, means controls and other procedures of a company that aredesigned to ensure that information required to be disclosed by us in thereports that we file or submit under the Exchange Act is recorded, processed,summarized and reported, within the time periods specified in the SEC’s rules andforms. Disclosure controls and procedures include, without limitation, controlsand procedures designed to ensure that information required to be disclosed bya company in the reports that it files or submits under the Exchange Act isaccumulated and communicated to the company’s management, including itsprincipal executive and principal financial officers, as appropriate to allowtimely decisions regarding required disclosure. Management recognizes that anycontrols and procedures, no matter how well designed and operated, can provideonly reasonable assurance of achieving their objectives and managementnecessarily applies its judgment in evaluating the cost-benefit relationship ofpossible controls and procedures. Based on the evaluation of our disclosurecontrols and procedures as of December 31, 2005, our chief executiveofficer and chief financial officer concluded that, as of such date, ourdisclosure controls and procedures were effective at the reasonable assurancelevel.

No change in our internalcontrol over financial reporting occurred during the fiscal quarter ended December 31,2005 that has materially affected, or is reasonably likely to materiallyaffect, our internal control over financial reporting.

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**Part II.   Other Information**

**Item 1A.—Risk Factors**

***We derive a significant portionof our revenue and substantially all of our income from structuringsecuritization transactions; our financial results and future growth would beadversely affected if we are unable to structure securitizations.***

Securitization refers tothe technique of pooling loans and selling them to a special purpose, bankruptcyremote entity, typically a trust, which issues securities to investors backedby those loans. As of the date of this quarterly report, we have providedstructural advisory and other services for 28 loan securitizations since ourformation in 1991, and we receive fees for these services. In connection withsecuritizations, we receive compensation in the form of structural advisoryfees, residuals and administrative fees for management of the trusts. Theamount and timing of the fees we recognize are affected, in part, by the sizeand composition 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 71% of our total service revenue for thefirst six months of fiscal 2006, 75% of our total service revenue for the firstsix months of fiscal 2005 and 78% of our total service revenue for the firstsix months of fiscal 2004. Substantially all of our net income in those fiscalperiods was attributable to securitization-related revenue.

***The timing of our securitization activities willgreatly affect our quarterly financial results.***

Our quarterly revenue,operating results and profitability have varied and are expected to continue tovary significantly on a quarterly basis. In fiscal 2005, we recognized 5%, 37%,29% and 29% of our total service revenue in the respective fiscal quarters offiscal 2005. Our quarterly revenue varies primarily because of the timing ofthe securitizations that we structure. In fiscal 2005, we facilitated onesecuritization in the second quarter, one securitization in the third quarter,and three securitizations in the fourth quarter, but none in the first quarter.Thus far in fiscal 2006, we have facilitated one securitization in the secondquarter. The timing of our securitization activities is affected to some degreeby the seasonality of student loan applications and loan originations. Originationof student loans is generally subject to seasonal trends, with the volume ofloan applications increasing with the approach of tuition payment dates. Infiscal 2005, we processed 39% of our total loan facilitation volume in thefirst quarter ended September 30, 2004, and 21%, 24% and 17% of our totalloan facilitation volume in the respective successive quarters.

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

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

•     degradation of the creditquality and performance in the loan portfolios of the trusts we structure couldreduce or eliminate investor demand for securitizations that we facilitate inthe future;

•     prolonged volatility in thecapital markets generally or in the student loan sector specifically, whichcould restrict or delay our access to the capital markets;

•     unwillingness of financialguarantee providers to offer credit insurance in the securitizations that westructure or in student loan-backed securitizations generally;

•     adverse performance of, orother problems with, student loan-backed securitizations that other partiesfacilitate could impact pricing or demand for our securitizations; and

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•     any material downgrading orwithdrawal of ratings given to securities previously issued in securitizationsthat we structured could reduce demand for additional securitizations that westructure.

A portion of the securities issued since 1998 insecuritization transactions that we structured were sold to asset-backedcommercial paper conduits. If these or similar asset-backed conduits cease topurchase securities in the securitizations that we structure, we may experiencea delay in the timing of our securitizations as we seek to find alternatechannels of distribution.

Under the terms of some of our contracts with keylender clients, we have an obligation to securitize loans originated by thoselenders periodically, typically twice per year. We may agree with other lendersto securitize more frequently in the future. If we do not honor theseobligations, we may be required to pay liquidated or other damages, which couldadversely affect our results of operations.

***In connection with our recognitionof revenue from securitization transactions, if the estimates we make, and theassumptions on which we rely, in preparing our financial statements proveinaccurate, our actual results may vary 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 the residual interests that the trust creates. As required underGAAP, we recognize as revenue an estimate of the fair value of the additionalportion of the structural advisory fees and residuals at the time thesecuritization trust purchases the loans because these revenues are deemed tobe earned before they are actually paid to us. We record additional structuraladvisory fees and residuals as receivables on our balance sheet at our estimateof their fair value. Accounting rules require that these receivables bemarked-to-market. We estimate the fair value both initially and in eachsubsequent quarter and reflect the change in our estimate of fair value inearnings for that period. Our key assumptions to estimate the value includeprepayment and discount rates, interest rate trends, the spread between LIBORand the auction rates on our senior auction rate notes, the expected creditlosses from the underlying securitized loan portfolio, net of recoveries, andthe expected timing of cash flows from the trusts’ underlying student loanassets. If our assumptions are wrong, the additional structural advisory feesand residuals that we receive from the trusts could be significantly less thanreflected in our current financial statements, and we may incur a materialnegative adjustment to our earnings in the period in which our assumptionschange. For a discussion of the sensitivity of the additional structuraladvisory fees and residuals to variations in our assumptions and estimates, see“Management’s Discussion and Analysis of Financial Condition and Results ofOperations—Executive Summary—Application of Critical Accounting Policies andEstimates—Service Revenue—Sensitivity Analysis.”

Our residuals in eachsecuritization we have facilitated are subordinate to securities issued toinvestors in such securitizations and may fail to generate any cash flow for usif the securitized assets only generate enough cash flow to pay the investors.

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

We provide structuraladvisory and other services for loan securitizations undertaken throughstatutory trusts. We do not consolidate the financial results of the trustswith our own financial results. For a discussion of our decision not toconsolidate, see “Management’s Discussion and Analysis of Financial Conditionand Results of Operations—Executive Summary—Application of Critical AccountingPolicies and Estimates—Consolidation” included in this quarterly report. Someof the accounting rules relevant to this issue are in the process of beingamended. If we were required to consolidate the financial results of 

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one ormore trusts with our own financial results as a result of amendments or changesin accounting rules, or if the SEC or other accounting authorities do not agreewith our current approach, our financial results could be adversely affected,particularly in the early years of a trust when the trust typically experienceslosses.

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

We structure and support private student loan programsfor commercial banks, including JPMorgan Chase Bank, N.A. and Bank of America,N.A. We also structure and support private student loan programs for marketingpartners that refer their borrowers to a particular lending source, such asCharter One Bank, N.A. We refer to these lenders as referral lenders.Structural advisory fees and residuals from securitization of JPMorgan ChaseBank private label loans represented approximately 30% of our total servicerevenue for fiscal 2005 and approximately 44% of our total service revenue forfiscal 2004. Structural advisory fees and residuals from securitization of Bankof America private label loans represented approximately 15% of total servicerevenue for fiscal 2005 and approximately 8% of total service revenue forfiscal 2004. In addition, Bank of America is currently the lender for our GATEprogram clients. Our GATE programs contributed 3% of our total service revenuein fiscal 2005 and 4% of our total service revenue in fiscal 2004.Structural advisory fees and residuals from securitization of private labelloans funded by Charter One Bank represented approximately 22% of our totalservice revenue for fiscal 2005 and approximately 16% of our total servicerevenue in fiscal 2004.

We have agreements with these commercial banks thatgovern the purchase of loans for securitization. Our agreement with JPMorganChase Bank is scheduled to terminate in March 2010. Our agreements withCharter One Bank are generally scheduled to terminate in May 2007, exceptwith respect to loans marketed by Collegiate Funding Services, L.L.C. andfunded by Charter One Bank, in which case our agreement has a term through July 2007.Our agreement with Bank of America governing the purchase of school channelloans can be terminated at any time upon 180 days notice. Our two agreementswith Bank of America that govern the purchase of GATE loans extend through November 30,2006. In the absence of termination, both agreements will automatically renewfor successive one-year terms, but can be terminated by either party with 90days notice after June 1, 2006. Our agreement with Bank of Americagoverning the purchase of direct-to-consumer loans expires in May 2006. OnNovember 2, 2005, we received notice that Bank of America opted out ofautomatic renewal of this agreement. We cannot assure you that we willsuccessfully negotiate a continuation of the agreement. Unless we agree withBank of America on terms for such a continuation, the agreement will expire on May 1,2006. Each client above has the right to terminate their agreement on shortnotice, generally 30 days or less, if we materially breach our agreement,including our failure to perform at service levels specified in thosecontracts. In addition, under the terms of our lender clients’ guarantyagreements with TERI, both the lender and TERI may propose modifications toloan program guidelines during the first calendar quarter of each year. If theparties are unable to agree on a proposed modification, such as an adjustmentof the guarantee fees, the party proposing the modification has the option ofterminating the guaranty agreement, effective as of May 1 of that calendaryear. Under its master loan guaranty agreement with us, TERI may not propose achange to program guidelines without our consent. Similarly, under ouragreements with lenders that have multi-year terms, the lender cannot changethe program guidelines without our consent, which we cannot unreasonablywithhold.

A significant decline inservices to JP Morgan Chase, 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.

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

We assist national and regional financial institutionsand educational institutions, as well as businesses and other enterprises, instructuring and supporting their private education loan programs. In providingour services, we receive fees for services we provide primarily in connectionwith the securitization of our clients’ loans. The outsourcing services marketin which we operate includes a large number of service providers, some of whichhave greater financial, technical and marketing resources, larger customerbases, greater name recognition and more established relationships with theirclients than we have. Larger competitors with greater financial resources maybe better able to respond to the need for technological changes, compete forskilled professionals, build upon efficiencies based on a larger volume of loantransactions, fund internal growth and compete for market share generally. Wemay face competition from our clients if they choose, or acquire the ability,to provide directly the services that we provide. In December 2005, ourclient J.P. Morgan Chase announced that it had signed a definitive agreement topurchase Collegiate Funding Service, Inc., a marketer of education loanswe facilitate. This acquisition could result in the emergence of a newcompetitor with the ability to offer outsourced services, includingsecuritization services, for private student loans. In addition, we may facecompetition  from third parties whodecide to expand their services to include the suite of services that weprovide. We are aware of two principal competitors, SLM Corporation, or SallieMae, and Servus Financial Corporation, an affiliate of Wells Fargo Company,that offer 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 or if Sallie Mae seeks to market moreaggressively to third parties the full range of services for private loanprograms that we provide. If we are not able to compete effectively, ourrevenue and results of operations may be adversely affected. In addition, ifthird parties choose to provide the range of services that we provide, pricingfor our services may become more competitive, which could lower ourprofitability.

In addition, there has been significant consolidationwithin the banking industry. For example, Charter One Financial, Inc., thepublicly traded parent company of Charter One Bank was acquired by CitizensFinancial Group, Inc., and Bank One Corporation was acquired by J.P.Morgan Chase & Co. In addition, Sallie Mae acquired our client,Southwest Student Services Corporation, resulting in termination of ourrelationship with that client. The merger between JPMorgan Chase Bank andCollegiate Funding Service, Inc. could result in the loss of theseclients, or a reduction in our business with them. Further consolidation couldresult in a loss of business if one or more of our clients were acquired by acompetitor or a lender that is not our client.

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

***If our clients do not successfully market and sellstudent loans, our business will be adversely affected.***

We provide outsourcingservices to lenders, marketing partners and educational institutions, as wellas businesses and other organizations, in structuring and supporting theirprivate education loan programs. We rely on our clients to market and selleducation loans to student borrowers. If they do not devote sufficient time andresources to their marketing efforts, or if they are otherwise not successfulin these efforts, then we may experience a reduction in the volume of loansthat we process and securitize, and our business will be adversely affected.

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

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

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

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

In June 2001,we purchased the loan processing operations of TERI and entered into a seriesof agreements to govern future securitizations of TERI-guaranteed loans. TERIcontinues to provide private student loan guarantee, education information andcounseling services for students, and is the exclusive third party provider ofborrower default guarantees for our clients’ private label loans. We haveentered into an agreement to provide various services for TERI and receivedfees from TERI for services performed of $51.2 million, or 19% of total servicerevenue, for the first six months of fiscal 2006, and $33.9 million or 19% oftotal service revenue for the first six month of fiscal 2005. In addition, wehave agreed to undertake on a best-efforts basis to arrange or facilitatesecuritizations for a limited category of TERI-guaranteed loans and have theright to receive structural advisory and other fees in connection with thesesecuritizations. We also have entered into an agreement to receive from TERIupdated 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:

•     we may not be able to offerour clients guarantee services from another guarantor and, accordingly, ouraccess to loans and our opportunities to structure securitization transactionsmay diminish significantly;

•     we may not be successful inestablishing an arrangement with a third party to provide the warranties thatTERI currently provides to lenders related to origination services. In suchcase, we may be required to provide such warranties; and

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

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

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***Our business could be adversely affected if TERI’sratings are downgraded.***

In its role as guarantorin the private education lending market, TERI agrees to reimburse lenders forunpaid principal and interest on defaulted loans. TERI is the exclusiveprovider of borrower default guarantees for our clients’ private label loans.As of December 31, 2005, TERI had a Baa3 counterparty rating from Moody’sInvestors Service, which is the lowest investment grade rating, and an insurerfinancial strength rating of A+ from Fitch Ratings. If these ratings arelowered, our clients may not wish to enter into guarantee arrangements withTERI. In addition, we may receive lower structural advisory fees because thecosts of obtaining financial guarantee insurance for the asset-backedsecuritizations that we structure could increase. In such case, our businesswould be adversely affected.

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

As of December 31,2005, PHEAA serviced a majority of loans whose origination we facilitate. Thisarrangement allows us to increase the volume of loans in our clients’ loanprograms without incurring the overhead investment in servicing operations. Aswith any external service provider, there are risks associated with inadequateor untimely services. We regularly monitor the servicing portfolio reports,including delinquencies and defaults. A substantial increase in the delinquencyrate could adversely affect our ability to access profitably the securitizationmarkets for our clients’ loans. In addition, if our relationship with PHEAAterminates, we would either need to expand or develop a relationship withanother TERI-approved loan servicer, which could be time consuming and costly.In such event, our business could be adversely affected. Although weperiodically review the costs associated with establishing servicing operationsto service loans, we have no plans to establish and perform servicingoperations at this time.

***The growth of ourbusiness could be adversely affected by changes in the annual or aggregatelimitations under federal student loan programs or expansions in the populationof students eligible for loans under federal student loan programs.***

We focus our businessexclusively on the market for private education loans, and more than 90% of ourbusiness is concentrated in loan programs for post-secondary education. Theavailability of loans that the federal government originates or guaranteesaffects the demand for private student loans because students and their familiesoften rely on private loans to bridge the gap between available funds,including family savings, grants and federal and state loans, and the costs ofpost-secondary education. The federal government currently places both annualand aggregate limitations on the amount of federal loans that any student canreceive and determines the criteria for student eligibility. These guidelinesare adjusted in connection with funding authorizations from the United StatesCongress for programs under the Higher Education Act. On February 1, 2006,Congress passed the Deficit Reduction Act of 2005. The Deficit Reduction Act of2005 includes several changes to federal student loan programs. Althoughaggregate borrowing limits would not change, the Deficit Reduction Act of 2005would increase amounts that first and second year college students may borrow andwould make Parent Loans for Undergraduate Students, or PLUS loans, available tograduate and professional students. If signed by the President, the loan limitincreases would take effect July 1, 2007 while most other provisions wouldtake affect July 1, 2006. These recent changes approved by Congress, aswell as future changes Congress may approve, could weaken the demand forprivate student loans, which could adversely affect the volume of private loansand the securitization transactions that we facilitate and structure and, as aresult, the growth of our business.

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

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

•     home equity loans, underwhich families borrow money based on the value of their real estate;

•     pre-paid tuition plans, whichallow students to pay tuition at today’s rates to cover tuition costs in thefuture;

•     529 plans, which arestate-sponsored investment plans that allow a family to save funds foreducation expenses; and

•     education IRAs, now known asCoverdell Education Savings Accounts, under which a holder can make annualcontributions for education savings.

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

***If competitorsacquire or develop a student loan database or advanced loan informationprocessing systems, our business could be adversely affected.***

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

***Changes in interestrates could affect the value of our additional structural advisory fees andresiduals receivables, 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 lessen demand for our servicesand cause an increase in prepayment and default rates for outstanding studentloans. If this occurs, we may experience a decline in the value of ouradditional structural advisory fees and residuals receivables in connectionwith the securitizations that we facilitate. In addition, most of the studentloans that our clients originate carry floating rates of interest tied toprevailing short-term interest rates. An increase in interest rates couldreduce borrowing for education generally, which, in turn, could cause theoverall demand for our services to decline.

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

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

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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 and techniquesor otherwise gain access to our proprietary information. If we are unable toprotect the confidentiality of our proprietary information and know-how, thevalue 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 upon communications and informationsystems to conduct our business. As we implement our growth strategy andincrease our volume of business, that reliance will increase. Any failure orinterruption, or breach in security, of our information systems or the thirdparty information systems on which we rely could cause underwriting or otherdelays and could result in fewer loan applications being received, slowerprocessing 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. We have implemented precautionary measures toavoid systems outages and to minimize the effects of any data or telephonesystems interruptions, but we have not instituted redundancy for key systems.The occurrence of any failure, interruption or breach could significantly harmour business.

***If we experience a data securitybreach and confidential customer information is disclosed, we may be subject topenalties imposed by regulators, civil actions for damages and negativepublicity, which could affect our customer relationships and have a material adverseeffect on our business. In addition, current state and federal legislativeproposals, if enacted, may impose additional requirements on us to safeguardconfidential customer information, which may result in increased compliancecosts.***

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

***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 advanced systems and processes wehave implemented 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 provide processupdates instantly. Our future success depends in part on our ability to developand implement technology solutions that anticipate and keep pace with these andother continuing changes in technology, industry standards and clientpreferences. We may not be successful in anticipating or responding to thesedevelopments on a timely basis. If competitors introduce products, services,systems and processes that are better than ours or that gain greater marketacceptance, 

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those that we offer or usemay become obsolete or noncompetitive. Any one of these circumstances couldhave a material adverse effect on our ability to obtain and retain key clients.

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

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

The number of our employees increased to 919 regularemployees as of December 31, 2005 from 655 regular employees and 107seasonal employees as of December 31, 2004. Many of these employees havevery limited experience with us and a limited understanding of our systems andcontrols. From our inception to December 31, 2005, our assets have grownto $634.8 million. Our revenue increased to $265.6 million for the first sixmonths of fiscal 2006 from $178.2 million for the first six months of fiscal2005, and $87.0 million for the first six months of fiscal 2004. Ourgrowth may place a strain on our management, systems and resources. We mustcontinue to refine and expand our business development capabilities, oursystems and processes and our access to financing sources. As we grow, we mustcontinue to hire, train, supervise and manage new employees.

We cannot assureyou that we will be able to:

•     expand our systemseffectively;

•     allocate our human resourcesoptimally;

•     identify and hire qualifiedemployees; or

•     incorporate effectively thecomponents of any business that we may acquire in our effort to achieve 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 advice ofcounsel and, in some states, additional informal advice from state regulators,we have been operating on the basis that no registrations or licenses for loanbrokers and loan arrangers are required of us. Although we believe that ourprior consultations with national and local counsel identified all materialregistration, licensing and other regulatory requirements then applicable, weare conducting a nationwide review of state registration and licensingrequirements that may be applicable to us now, based on the expansion of thescope of the services we provide and the time that has elapsed since our priorreview. As a result of this current review, we may determine that registrationor licensing is required in jurisdictions where we are not currently registeredor licensed. Even if we are not physically present in a state, its regulators maytake the position that registration or licensing is required because we provideservices by mail, telephone, the Internet or other remote means. If we identifyany states in which registration or licensing is required, we will proceed withregistration or licensing in the affected state. If any state assertsjurisdiction over our business, we will consider whether to challenge theassertion or proceed with registration or licensing in the affected state.Compliance with such requirements could involve additional costs, which couldhave a material adverse effect on our business. Our failure to comply withthese laws could lead to, among other things: (a) curtailment of ourability to continue to conduct 

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businessin the relevant jurisdiction, pending processing of registration or a licenseapplication, (b) administrative enforcement actions, (c) class actionlawsuits, (d) the assertion of legal defenses delaying or otherwiseaffecting the enforcement of loans, and (e) criminal as well as civilliability. This could have a material adverse effect on our business.

***If the regulatoryexemptions or rulings that allow us to conduct our business withoutregistration or licensing are modified or revoked, or the statutory andregulatory requirements change in the future, our compliance costs couldincrease substantially.***

The Massachusetts Division of Banks ruled that ourbusiness with TERI is not subject to licensing because, as a provider of loanorigination outsourcing services, we do not conduct a lending business withconsumers in our own name and our processing centers are not generally open tothe public. The Massachusetts Small Loan Act requires any person that isengaged, for compensation, in the business of making small loans, or in aidingor assisting the borrower or the lender in procuring or making such loans, toobtain a license. Under the statute, the business of making small loansincludes the making of loans of $6,000 or less with interest rates and expensesof more than 12% per year. The TERI-guaranteed loans that we facilitate includeamounts as small as $1,000, and a small portion of those loans have combinedinterest rates and fees exceeding 12%. We could therefore become subject to theSmall Loan Act with respect to these loans if the Massachusetts Division ofBanks revokes its previous determination that our operations are exempt ordetermines that our activities 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 and rules couldalso require us to implement additional or different programs and informationtechnology systems and could impose licensing, capital and reserve requirementsand additional costs, including administrative, compliance and third-party servicecosts.

***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 aswell as TERI, are subject to registration, licensing and extensive governmentalregulations, including Truth-in-Lending laws and other consumer protection lawsand regulations. For example, some of the third party marketers with which wedo business may be subject to state registration or licensing requirements andlaws and regulations, including those relating to small loans, loan brokers andcredit services organizations. As a result of the activities that we conduct forour clients, it may be asserted that we have some responsibility for complianceby third parties, with which we do business, with the laws and regulationsapplicable to them, whether on contractual or other grounds. If it isdetermined that we have failed to comply with our obligations with respect tothese third parties, we could be subject to civil or criminal liability.

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

We are in the process ofexpanding the scope of the services we provide on behalf of lenders to includecertain advertising and marketing functions. As a result of this expansion ofour services, or if we expand our services in the future to include, amongothers, loan guarantees, our current exemption from the Massachusetts SmallLoan Act could be invalidated, and consequently, we may need to obtain alicense 

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from theMassachusetts Division of Banks. In addition, we may become subject to the lawsand regulations of other states governing such expanded services. We may alsobecome subject to state regulatory requirements if the extent of the activitiesthat we conduct in a particular state expands. Compliance with suchrequirements could involve additional costs, which could have a materialadverse effect on our business.

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

The federal government andstate governments regulate extensively the financial institutions and otherentities that originate loans in the student loan market. These regulationsinclude bankruptcy, tax, usury, disclosure, credit reporting, identity theft,privacy, fraud and abuse and other laws to protect borrowers. Changes inconsumer protection laws or related regulations, or in the prevailinginterpretations thereof, may expose us to litigation, adversely affect thecollection of balances due on the loan assets held by securitization trusts orotherwise adversely affect our business. Moreover, changes in the consumerprotection laws and related regulations, or in the prevailing interpretationsthereof, could invalidate or call into question the legality of certain of ourservices and business practices. 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 assetsunenforceable.

***Recent litigationhas sought to re-characterize “payday loan” and other originators as lenders;if litigation on similar theories were successful against us or any third partymarketer, the loans that we securitize would be subject to individual stateconsumer protection laws.***

We provide financial and educational institutions, aswell as other organizations, with an integrated suite of services in support ofprivate student loan programs. The lenders with which we work arefederally-insured banks and, therefore, are not subject to many state consumerprotection laws, including limitations on interest rates, fees and othercharges. In providing our services, we do not act as a lender, guarantor orloan servicer, and the terms of the loans that we securitize are regulated inaccordance with the laws and regulations applicable to the lenders.

The association between loan marketers andout-of-state national banks has come under recent scrutiny, specifically in thecontext of high-interest “payday loans”. Recent litigation asserts that paydayloan marketers use out-of-state lenders in order to evade the usury andinterest rate caps, and other consumer protection laws, imposed by the stateswhere they do business. Such litigation has sought, successfully in someinstances, to re-characterize the loan marketer as the lender for purposes ofstate consumer protection law restrictions. Similar civil actions have beenbrought in the context of gift cards. We believe that our activities, and theactivities of third parties whose marketing on behalf of lenders is coordinatedby us, are distinguishable from the activities involved in these cases.

Although we do not make,guarantee or service the loans and our activities are done in the name of andunder the control and supervision of lenders, additional state consumerprotection laws would be applicable to the loans if we, or any third party loanmarketer whose activities we coordinate, were re-characterized as a lender, andthe loans (or the provisions governing interest rates, fees and other charges)could be unenforceable. In addition, we could be subject to claims byconsumers, as well as enforcement 

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actionsby regulators. Even if we were not required to cease doing business withresidents of certain states or to change our business practices to comply withapplicable laws and regulations, we could be required to register or obtainlicenses or regulatory approvals that could impose a substantial cost on us. Todate, there have been no actions taken or threatened against us on the theorythat we have engaged in unauthorized lending. However, such actions could havea material adverse effect on our business.

***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:

•     difficulties we may encounterin the securitizations that we structure or the loss of opportunities tostructure securitization transactions;

•     price and volume fluctuationsin the overall stock market from time to time;

•     significant volatility in themarket price and trading volume of financial services and process outsourcingcompanies;

•     actual or anticipated changesin our earnings or fluctuations in our operating results or in the expectationsof securities analysts;

•     general economic conditionsand trends;

•     negative publicity about thestudent loan market generally or us specifically;

•     major catastrophic events;

•     loss of a significant clientor clients;

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

•     sales of large blocks of ourstock; or

•     departures of key personnel.

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

***If a substantialnumber of shares become available for sale and are sold in a short period oftime, the market price of our common stock could decline.***

Future sales of asubstantial number of shares of our common stock in the public market, or theperception that such sales may occur, could adversely affect thethen-prevailing market price of our common stock. As of January 31, 2006,we had 62,822,660 shares of common stock outstanding. Subject to limitationsunder federal securities laws, including in some cases the holding periodrequirements and volume limitations of Rule 144, these shares are eligiblefor sale in the public market. The market price of shares of our common stockmay drop significantly if our existing stockholders sell a substantial numberof shares. A decline in the price of shares of our common stock might impedeour ability to raise capital through the issuance of additional shares of ourcommon stock or other equity securities.

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

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

***Some provisions in our certificate of incorporationand by-laws may deter third parties from acquiring us.***

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

•     only our board of directors,the chairman of our board of directors or our president may call specialmeetings of our stockholders;

•     our stockholders may takeaction only at a meeting of our stockholders and not by written consent;

•     we have authorizedundesignated preferred stock, the terms of which may be established and sharesof which may be issued without stockholder approval;

•     our directors may be removedonly for cause by the affirmative vote of a majority of the directors presentat a meeting duly held at which a quorum is present, or the holders of 75% ofthe votes that all stockholders would be entitled to cast in the election ofdirectors; and

•     we impose advance noticerequirements for stockholder proposals.

These anti-takeover defensescould discourage, delay or prevent a transaction involving a change in controlof our company. These provisions could also discourage proxy contests and makeit more difficult for you and other stockholders to elect directors of yourchoosing and cause us to take other corporate actions you desire.

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

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

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**Item 2—Unregistered Sales of Equity Securities and Useof Proceeds**

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

***None.***

***(b) Use of Proceeds from Registered Securities***

In our initial public offering, or IPO, we sold7,906,250 shares of common stock, including an over-allotment option of1,031,750 shares, pursuant to a registration statement on Form S-1(File No. 333-108531) that was declared effective by the SEC on October 30,2003. We received in aggregate net proceeds of approximately $115.1 million,after deducting underwriting discounts and commissions of approximately $8.9million and expenses of the offering of approximately $2.5 million. From theeffective date of the registration statement through December 31, 2005, wehave not spent any of the net proceeds from the IPO, which have been investedin cash and cash equivalents. 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 outaffiliates.

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

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

| **Period**                                       | ** ** | **Total number  of shares  purchased (1)** | ** ** | **Average price  paid per share  (2)** | ** ** | **Total number of  shares purchased  as part of  publicly  announced plans  or programs (1)** | ** ** | **Maximum number  of shares that may  yet be purchased  under the plans or  programs** | ** ** |
|--------------------------------------------------|------------|-----------------------------------------------------------|------------|-------------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------|------------|
| October 1,  2005 to October 31, 2005   |       |                                                      | 51,000     |                                                  |       |                                                                                                                                  | $          | 29.20                                                                                                                               |       |   |   | 51,000 |   |   |   | 4,949,000 | (1) |   |
| November 1,  2005 to November 30, 2005 |       |                                                      | 2,065,200  |                                                  |       |                                                                                                                                  | 27.49      |                                                                                                                                |       |   | 2,065,200 |   |   |   | 2,883,800 | (1) |   |
| December 1,  2005 to December 31, 2005 |       |                                                      | 230,600    |                                                  |       |                                                                                                                                  | 28.59      |                                                                                                                                |       |   | 230,600 |   |   |   | 2,653,200 | (1) |   |
| Total                                            |       |                                                      | 2,346,800  |                                                  |       |                                                                                                                                  | $          | 27.64                                                                                                                               |       |   |   | 2,346,800 |   |   |   | 2,653,200 | (1) |   |

 

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(1)          On September 29,2005, we announced a repurchase program of up to 5,000,000 shares of our commonstock. This repurchase program does not have a fixed expiration date. Prior to October 1,2005, we repurchased an aggregate of 1,500,000 shares of our common stockpursuant to repurchase programs announced on April 29, 2005 and June 2,2005.

(2)          Averageprice paid per share excludes commissions that we paid to the brokers thateffected these repurchases.

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**Item 4—Submission of Matters to a Vote of SecurityHolders**

On October 27,2005 the following proposals were voted on at our 2005 annual meeting ofstockholders:

| **Proposal**                                                                                                                                                                                                                                   | ** ** | **For**    | ** ** | **Against/Withheld** | ** ** | **Abstentions** | ** ** | **Broker  Non-Votes** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------|------------|----------------------|------------|-----------------|------------|-----------------------|------------|
| To elect the  following eight persons to serve as directors until the next annual meeting  of stockholders and until their successors are duly elected and qualified  (subject to such director’s earlier death, resignation or removal): |       |       |       |                 |       |            |       |                  |       |   |   |   |   |
| Peter B. Tarr                                                                                                                                                                                                                                  |       | 53,216,600 |       |                 | 7,299,313  |            |       |                  | N/A        |   |   | N/A |   |
| Stephen E.  Anbinder                                                                                                                                                                                                                           |       | 53,233,911 |       |                 | 7,282,002  |            |       |                  | N/A        |   |   | N/A |   |
| Leslie L.  Alexander                                                                                                                                                                                                                           |       | 53,008,470 |       |                 | 7,507,443  |            |       |                  | N/A        |   |   | N/A |   |
| William R.  Berkley                                                                                                                                                                                                                            |       | 52,630,496 |       |                 | 7,885,417  |            |       |                  | N/A        |   |   | N/A |   |
| Dort A. Cameron  III                                                                                                                                                                                                                           |       | 52,699,014 |       |                 | 7,816,899  |            |       |                  | N/A        |   |   | N/A |   |
| George G. Daly                                                                                                                                                                                                                                 |       | 53,415,682 |       |                 | 7,100,231  |            |       |                  | N/A        |   |   | N/A |   |
| Peter S. Drotch                                                                                                                                                                                                                                |       | 53,457,696 |       |                 | 7,058,217  |            |       |                  | N/A        |   |   | N/A |   |
| William D. Hansen                                                                                                                                                                                                                              |       | 53,534,957 |       |                 | 6,980,956  |            |       |                  | N/A        |   |   | N/A |   |
| To approve an amendment to the 2003 Stock Incentive  Plan increasing from 1,200,000 to 2,700,000 the number of shares of common  stock reserved for issuance under the plan                                                                    |       | 39,264,380 |       |                 | 11,936,632 |            |       |                  | 13,326     |   |   | 9,301,575 |   |

 

**Item 6—Exhibits**

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

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**SIGNATURES**

Pursuantto the requirements of the Securities Exchange Act of 1934, the Registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.
|                              | **THE FIRST MARBLEHEAD CORPORATION** |
|------------------------------|--------------------------------------|
| Date: February 8,  2006 | By:                                  | /s/ Donald R. Peck |
|                         |                                 | Donald R. Peck |
|                         | * *                             | *Executive Vice President, Chief Financial  Officer, Treasurer and Secretary* |
|                         | * *                             | *(Duly authorized officer and principal financial  officer)* |

 

 

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**EXHIBIT INDEX**

| Exhibit  Number | ** ** | **Description**                                                                                                                                                                                                                                         |
|-----------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|            |       |                                                                                                                                                                                                                                                    |
| 10.1            | †     | Eleventh Amendment to Gate Student Umbrella  Agreement and Second Amendment to Gate Universal Umbrella Agreement, dated  November 29, 2005, by and among the Registrant, Bank of America,  National Association, and The National Collegiate Trust |
| 31.1            |       | Chief Executive Officer—Certification pursuant to  Rule 13a-14(a) of the Securities Exchange Act of 1934, as  adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002                                                     |
| 31.2            |       | Chief Financial Officer—Certification pursuant to  Rule 13a-14(a) of the Securities Exchange Act of 1934, as  adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002                                                     |
| 32.1            |       | Chief Executive Officer—Certification pursuant to  Rule 13a-14(b) of the Securities Exchange Act of 1934 and 18  U.S.C. Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002                    |
| 32.2            |       | Chief Financial Officer—Certification pursuant to  Rule 13a-14(b) of the Securities Exchange Act of 1934 and 18  U.S.C. Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002.                   |

 

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†                    Confidentialtreatment has been requested as to certain portions, which portions have beenseparately filed with the Securities and Exchange Commission.

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