| You should carefully consider the risks and uncertainties described below in addition to the other information included in this annual report |
| If 21 ______________________________________________________________________ any of the following risks actually occurs, our business, financial condition or results of operations would likely suffer |
| In that case, the trading price of our common stock could fall |
| We derive a significant portion of our revenue and substantially all of our income from structuring securitization transactions; our financial results and future growth would be adversely affected if we are unable to structure securitizations |
| Securitization refers to the technique of pooling loans and selling them to a special purpose, bankruptcy remote entity, typically a trust, which issues securities to investors backed by those loans |
| As of the date of this annual report, we have provided structural advisory and other services for 31 loan securitizations since our formation in 1991 |
| In connection with securitizations, we receive compensation in the form of structural advisory fees, residuals and administrative fees for management of the trusts |
| The amount and timing of the fees we recognize are affected, in part, by the size and composition of loan pools to be securitized, the return expectations of investors and assumptions we make regarding loan portfolio performance, including defaults, recoveries, prepayments and the cost of funding |
| Revenue from new securitizations constituted 74prca of our total service revenue for fiscal 2006, 76prca of our total service revenue for fiscal 2005 and 78prca of our total service revenue for fiscal 2004 |
| Substantially all of our net income in those fiscal periods was attributable to securitization-related revenue |
| A number of factors, some of which are beyond our control, may adversely affect our securitization activities and thereby adversely affect our results of operations |
| Our financial performance and future growth depend in part on our continued success in structuring securitizations |
| Several factors may affect both our ability to structure securitizations and the revenue we generate for providing our structural advisory and other services, including the following: · degradation of the credit quality or performance of the loan portfolios of the trusts we structure, which could reduce or eliminate investor demand for future securitizations that we facilitate; · prolonged volatility in the capital markets generally or in the student loan sector specifically, which could restrict or delay our access to the capital markets; · unwillingness of financial guarantee providers to offer credit insurance in the securitizations that we structure or in student loan-backed securitizations generally; · adverse performance of, or other problems with, student loan-backed securitizations that other parties facilitate could impact pricing or demand for our securitizations; · challenges to the enforceability of student loans based on violations of federal or state consumer protection laws and related regulations, or imposition of penalties or liability on assignees of student loans for violation of such laws and regulations; and · any material downgrading or withdrawal of ratings given to securities previously issued in securitizations that we structured, or any occurrence of an event of default with respect to such securities, which could reduce demand for additional securitizations that we structure |
| A portion of the securities issued since 1998 in securitization transactions that we structured were sold to asset-backed commercial paper conduits |
| If these or similar asset-backed conduits cease to purchase securities in the securitizations that we structure, we may experience a delay in the timing of our securitizations as we seek to find alternate channels of distribution |
| Under the terms of some of our contracts with key lender clients, we have an obligation to securitize loans originated by those lenders periodically |
| We may agree with other lenders to securitize more frequently in the future |
| If we do not honor these obligations, we may be required to pay liquidated or other damages, which could adversely affect our results of operations |
| 22 ______________________________________________________________________ In connection with our recognition of revenue from securitization transactions, if the estimates we make, and the assumptions on which we rely, in preparing our financial statements prove inaccurate, our actual results may vary from those reflected in our financial statements |
| We receive structural advisory fees for our services in connection with securitization transactions |
| We receive an up-front portion of these structural advisory fees when the securitization trust purchases the loans or soon thereafter |
| We receive an additional portion of these structural advisory fees over time, based on the amount of loans outstanding in the trust from time to time over the life of the trust |
| We also have the right to receive a portion of the residual interests that the trust creates |
| As required under accounting principles generally accepted in the United States of America, or GAAP, we recognize as revenue an estimate of the fair value of the additional portion of the structural advisory fees and residuals at the time the securitization trust purchases the loans because these revenues are deemed to be earned before they are actually paid to us |
| We record additional structural advisory fees and residuals as receivables on our balance sheet at our estimate of their fair value |
| Accounting rules require that these receivables be recorded at fair value |
| We estimate the fair value both initially and in each subsequent quarter and reflect the change in our estimate of fair value in earnings for that period |
| Our key assumptions to estimate the fair value include prepayment and discount rates, interest rate trends, the spread between LIBOR and the auction rates on our senior auction rate notes, the expected credit losses from the underlying securitized loan portfolio, net of recoveries, and the expected timing of cash flows from the trusts’ underlying student loan assets |
| If the actual performance of some or all of the securitization trusts varies from the key assumptions we use, the actual additional structural advisory fees and residuals that we receive from the trusts could be significantly less than reflected in our current financial statements, and we may incur a material negative adjustment to our earnings in the period in which our assumptions change |
| For a discussion of the sensitivity of the additional structural advisory fees and residuals to variations in our assumptions and estimates, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Executive Summary—Application of Critical Accounting Policies and Estimates—Service Revenue and Receivables—Sensitivity Analysis |
| ” In particular, economic, regulatory, competitive and other factors affecting prepayment, default and recovery rates on the underlying securitized loan portfolio, including full or partial prepayments and prepayments as a result of loan consolidation activity, could cause or contribute to differences between the actual performance of the securitization trusts and our key assumptions |
| Our residuals and additional structural advisory fees in each securitization we have facilitated are subordinate to securities issued to investors in such securitizations and may fail to generate any cash flow for us if the securitized assets only generate enough cash flow to pay the debt holders |
| Our financial results could be adversely affected if we were required to consolidate the financial results of the entities that we use for securitizations that we facilitate |
| We provide structural advisory and other services for loan securitizations undertaken through statutory trusts |
| We do not consolidate the financial results of the trusts with our own financial results |
| For a discussion of our decision not to consolidate, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Executive Summary—Application of Critical Accounting Policies and Estimates—Consolidation” included in this annual report |
| Some of the accounting rules relevant to this issue are in the process of being amended |
| If we were required to consolidate the financial results of one or more trusts with our own financial results as a result of amendments or changes in accounting rules, or if the SEC or other accounting authorities do not agree with our current approach, our financial results could be adversely affected, particularly in the early years of a trust when the trust typically experiences losses |
| 23 ______________________________________________________________________ If our relationships with key clients terminate, our revenue and results of operations would be adversely affected |
| We structure and support private student loan programs for commercial banks, including JPMorgan Chase Bank and Bank of America |
| Structural advisory fees and residuals from securitization of JPMorgan Chase Bank loans represented approximately 26prca of our total service revenue for fiscal 2006 and approximately 30prca of our total service revenue for fiscal 2005 |
| Structural advisory fees and residuals from securitization of Bank of America loans represented approximately 16prca of total service revenue for fiscal 2006 and approximately 18prca of total service revenue for fiscal 2005 |
| We also structure and support private student loan programs for companies such as CFS that assist lenders such as Charter One Bank, NA in marketing their programs to customers |
| Structural advisory fees and residuals from securitization of loans marketed by CFS represented approximately 10prca of our total service revenue for fiscal 2006 and approximately 17prca of our total service revenue for fiscal 2005 |
| JPMorgan Chase Bank acquired CFS in March 2006, and we entered into an agreement with JPMorgan Chase Bank in May 2006 that terminated our previous agreement with CFS Under our new agreement, JPMorgan Chase Bank agreed to increase its marketing expenditures in connection with its Education One loan program in an amount equal to CFS’s marketing commitment under its previous agreement with us, although we cannot assure you that the resulting loan volume will offset the loss of the loan volume derived from CFS We have agreements with lenders that govern the purchase of loans for securitization |
| Our agreement with JPMorgan Chase Bank is scheduled to terminate in March 2010 |
| Our agreements pursuant to which Charter One Bank serves as a program lender are generally scheduled to terminate in May 2007 |
| Our agreement with Bank of America governing the purchase of direct-to-consumer loans expires on May 31, 2008, provided that either party may terminate this agreement on or after June 1, 2007, upon 90 days notice |
| Our agreement with Bank of America governing the purchase of school channel loans can be terminated at any time upon 180 days notice |
| Our two agreements with Bank of America that govern the purchase of GATE loans expire on November 30, 2006 |
| In the absence of termination, both agreements will automatically renew for successive one-year terms, but can be terminated by either party with 90 days notice |
| Each client above has the right to terminate its agreement on short notice, generally 30 days or less, if we materially breach our agreement, including our failure to perform at service levels specified in those contracts |
| In addition, under the terms of our lender clients’ guaranty agreements with TERI, both the lender and TERI may propose modifications to loan program guidelines during the first calendar quarter of each year |
| If the parties are unable to agree on a proposed modification, such as an adjustment of the guarantee fees, the party proposing the modification has the option of terminating the guaranty agreement, effective as of May 1 of that calendar year |
| Under its master loan guaranty agreement with us, TERI may not propose a change to program guidelines without our consent |
| Similarly, under our agreements with lenders that have multi-year terms, the lender cannot change the program guidelines without our consent, which we cannot unreasonably withhold |
| A significant decline in services to JPMorgan Chase Bank or Bank of America, or the termination of guaranty agreements between those lenders and TERI, could reduce the overall volume of loans we facilitate, which could be difficult to replace through arrangements with other lenders |
| Our revenue, business and financial results could suffer as a result |
| The outsourcing services market for education lending is highly competitive and if we are not able to compete effectively, our revenue and results of operations may be adversely affected |
| We assist national and regional financial institutions and educational institutions, as well as businesses, education loan marketers and other enterprises, in structuring and supporting their private education loan programs |
| We receive fees for services we provide primarily in connection with the securitization of our clients’ loans |
| The outsourcing services market in which we operate includes a large number of service providers, some of which have greater financial, technical and marketing resources, larger customer bases, greater name recognition and more established relationships with their clients than 24 ______________________________________________________________________ we have |
| Larger competitors with greater financial resources may be better able than us to respond to the need for technological changes, compete for skilled professionals, build upon efficiencies based on a larger volume of loan transactions, fund internal growth and compete for market share generally |
| We may face competition from our clients if they choose, or acquire the ability, to provide directly the services that we provide |
| In March 2006, our client JPMorgan Chase Bank completed its acquisition of CFS, a marketer of education loans we facilitate |
| This acquisition could result in the emergence of a new competitor with the ability to offer outsourced services, including securitization services, for private student loans |
| In addition, we may face competition from third parties who decide to expand their services to include the suite of services that we provide |
| We are aware of two principal competitors, SLM Corporation, or Sallie Mae, and Servus Financial Corporation, an affiliate of Wells Fargo Company, that offer a similar range of services to lenders |
| Our business could also be adversely affected if Sallie Mae’s program to market private student loans directly to consumers continues to grow, if Sallie Mae seeks to market more aggressively to third parties the full range of services for private loan programs that we provide or if Sallie Mae’s recently announced private loan consolidation product results in increased consolidation of private student loans held by the securitization trusts we have facilitated |
| We are also aware of smaller privately held venture backed companies that are developing systems and expertise with plans to compete directly with us |
| If we are not able to compete effectively, our revenue and results of operations may be adversely affected |
| In addition, if third parties choose to provide the range of services that we provide, pricing for our services may become more competitive, which could lower our profitability |
| In addition, there has been significant consolidation within the banking industry |
| For example, in 2004 Charter One Financial, Inc, the publicly-traded parent company of Charter One Bank was acquired by Citizens Financial Group, Inc |
| and Bank One Corporation was acquired by JP Morgan Chase & Co |
| In addition, Sallie Mae acquired our client, Southwest Student Services Corporation, resulting in termination of our relationship with that client |
| The acquisition by JPMorgan Chase Bank of CFS could result in a reduction in our business with either or both of them |
| The merger may also negatively affect the volume of Charter One Bank loans that we process and securitize, because Charter One Bank no longer serves as a program lender for CFS loan programs that we facilitate |
| Further consolidation could result in a loss of business if one or more of our clients were acquired by a competitor or a lender that is not our client |
| Historically, lenders in the education loan market have focused their lending activities on federal loans because of the relative size of the federal loan market and because the federal government guarantees repayment of these loans, thereby significantly limiting the lenders’ credit risk |
| The demand for our services could decline if lenders place additional emphasis on the private education loan market and offer the services we provide |
| If our clients do not successfully market and sell student loans, our business will be adversely affected |
| We provide outsourcing services to lenders, loan marketers and educational institutions, as well as businesses and other organizations, in structuring and supporting their private education loan programs |
| We rely on our clients to market and sell education loans to student borrowers |
| If they do not devote sufficient time and resources to their marketing efforts, or if they are otherwise not successful in these efforts, then we may experience a reduction in the volume of loans that we process and securitize, and our business will be adversely affected |
| In addition, if the loans were marketed by our clients in a manner that is unfair or deceptive, or if the marketing, origination or servicing violated any applicable law, state unfair and deceptive practices acts could impose liability on a securitization trust holding the loan or create defenses to the enforceability of the loan |
| 25 ______________________________________________________________________ In structuring and facilitating securitizations of our clients’ loans and as holders of rights to receive residual cash flows in those trusts, we may incur liabilities to investors in the asset-backed securities those trusts issue |
| We have facilitated and structured a number of different special purpose trusts that have been used in securitizations to finance student loans that our clients originate |
| Under applicable state and federal securities laws, if investors incur losses as a result of purchasing asset-backed securities that those trusts issue, we could be deemed responsible and could be liable to those investors for damages |
| If we failed to cause the trusts to disclose adequately all material information regarding an investment in the asset-backed securities or if the trust made statements that were misleading in any material respect in information delivered to investors, it is possible that we could be held responsible for that information or omission |
| In addition, under various agreements entered into with underwriters or financial guarantee insurers of those asset-backed securities, we are contractually bound to indemnify those persons if investors are successful in seeking to recover losses from those parties and the trusts are found to have made materially misleading statements or to have omitted material information |
| If we are liable for losses investors incur in any of the securitizations that we facilitate or structure and any insurance that we may have does not cover this liability or proves to be insufficient, our profitability or financial position could be materially adversely affected |
| If our relationship with TERI terminates, our business could be adversely affected |
| In June 2001, we purchased the loan processing operations of TERI and entered into a series of agreements to govern future securitizations of TERI-guaranteed loans |
| TERI continues to provide private student loan guarantee, education information and counseling services for students, and is the exclusive third-party provider of borrower default guarantees for our clients’ private label loans |
| We have entered into an agreement to provide various services for TERI and received fees from TERI for services performed of dlra106dtta1 million, or 19prca of total service revenue, for fiscal 2006, and dlra78dtta2 million or 19prca of total service revenue, for fiscal 2005 |
| In addition, we have agreed to undertake on a best-efforts basis to arrange or facilitate securitizations for a limited category of TERI-guaranteed loans and have the right to receive structural advisory and other fees in connection with these securitizations |
| We also have entered into an agreement to receive from TERI updated information about the performance of the student loans it has guaranteed, to allow us to supplement our database |
| Each of these agreements with TERI had an initial term through June 2006 |
| In October 2004, we exercised our option to renew each agreement for 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 be adversely affected and the value of our intangible assets could be impaired for the following reasons: · we may not be able to offer our clients guarantee services from another guarantor and, accordingly, our access to loans and our opportunities to structure securitization transactions may diminish significantly; · we may not be successful in establishing an arrangement with a third-party to provide the warranties that TERI currently provides to lenders related to origination services |
| In such case, we may be required to provide such warranties; and · if TERI is unable to provide guarantee services, any financial guarantee insurance coverage we obtain in securitization transactions could be more costly, if it is available at all |
| In such events, demand for our services, including opportunities to structure and facilitate securitization transactions, could decline, which would adversely affect our business |
| In addition, the value of the loans in the securitization transactions we facilitate could decline and the value of our residuals could be reduced |
| 26 ______________________________________________________________________ Our business could be adversely affected if TERI’s ratings are downgraded |
| In its role as guarantor in the private education lending market, TERI agrees to reimburse lenders for unpaid principal and interest on defaulted loans |
| TERI is the exclusive provider of borrower default guarantees for our clients’ private label loans |
| As of June 30, 2006, TERI had a Baa3 counterparty rating from Moody’s Investors Service, which is the lowest investment grade rating, and an insurer financial strength rating of A+ from Fitch Ratings |
| If these ratings are lowered, our clients may not wish to enter into guarantee arrangements with TERI In addition, we may receive lower structural advisory fees because the costs of obtaining financial guarantee insurance for the asset-backed securitizations that we structure could increase |
| Finally, the inability of TERI as student loan guarantor to meet its guaranty obligations could reduce the amount of principal or interest paid to the holders of asset-backed securities, which could adversely affect our residual interests in securitization trusts or harm our ability to structure securitizations in the future |
| In each such case, our business would be adversely affected |
| Our business could be adversely affected if PHEAA fails to provide adequate or timely services or if our relationship with PHEAA terminates |
| As of June 30, 2006, PHEAA serviced a majority of loans whose origination we suppport |
| This arrangement allows us to increase the volume of loans in our clients’ loan programs without incurring the overhead investment in servicing operations |
| Our reliance on an external service provider for loan servicing subjects us to risks associated with inadequate or untimely services, such as inadequate notice of developments in prepayments, delinquencies and defaults |
| A substantial increase in these rates could adversely affect our ability to access profitably the securitization markets for our clients’ loans and the value of our additional structural advisory fees and residuals receivable |
| In addition, if our relationship with PHEAA terminates, we would either need to expand or develop a relationship with another TERI-approved loan servicer, which could be time consuming and costly |
| In such event, our business could be adversely affected |
| Although we periodically review the costs associated with establishing servicing operations to service loans, we have no plans to establish and perform servicing operations at this time |
| The growth of our business could be adversely affected by changes in the annual or aggregate limitations under federal student loan programs or expansions in the population of students eligible for loans under federal student loan programs |
| We focus our business exclusively on the market for private education loans, and more than 90prca of our business is concentrated in loan programs for post-secondary education |
| The availability of loans that the federal government originates or guarantees affects the demand for private student loans because students and their families often rely on private loans to bridge the gap between available funds, including family savings, grants and federal and state loans, and the costs of post-secondary education |
| The federal government currently places both annual and aggregate limitations on the amount of federal loans that any student can receive and determines the criteria for student eligibility |
| These guidelines are adjusted in connection with funding authorizations from the United States Congress for programs under the Higher Education Act |
| During February 2006, Congress passed, and the President signed, the Deficit Reduction Act of 2005 |
| Although aggregate borrowing limits do not change, the Deficit Reduction Act of 2005 increases amounts that first and second year college students may borrow and makes Parent Loans for Undergraduate Students, or PLUS, loans available to graduate and professional students |
| Loans to fund graduate level education represented approximately 15prca during fiscal 2006 and 13prca during fiscal 2005 of our total loan facilitation volume |
| The loan limit increases take effect July 1, 2007 while most other provisions took effect July 1, 2006 |
| This recent legislation, as well as future legislation, could weaken the demand for private student loans, which could adversely affect the volume of private loans and the securitization transactions that we facilitate and structure and, as a result, the growth of our business |
| 27 ______________________________________________________________________ Access to alternative means of financing the costs of education may reduce demand for private student loans |
| The demand for private student loans could weaken if student borrowers use other vehicles to bridge the gap between available funds and costs of post-secondary education |
| These vehicles include, among others: · home equity loans, under which families borrow money based on the value of their real estate; · pre-paid tuition plans, which allow students to pay tuition at today’s rates to cover tuition costs in the future; · 529 plans, which are state-sponsored investment plans that allow a family to save funds for education expenses; and · education IRAs, now known as Coverdell Education Savings Accounts, under which a holder can make annual contributions for education savings |
| If demand for private student loans weakens, we would experience reduced demand for our services, which would seriously harm our financial results |
| The timing of our securitization activities and size of our securitization transactions will greatly affect our quarterly financial results |
| Our quarterly revenue, operating results and profitability have varied and may continue to vary significantly on a quarterly basis |
| In fiscal 2006, we recognized 6prca, 41prca, 26prca and 27prca of our total service revenue in the respective fiscal quarters of fiscal 2006 |
| In fiscal 2005, we recognized 5prca, 37prca, 29prca, and 29prca of our total service revenue in the respective fiscal quarters of fiscal 2005 |
| Our quarterly revenue varied primarily because of the timing of the securitizations that we structured |
| In fiscal 2006, we facilitated one securitization in the second quarter, one securitization in the third quarter, and two securitizations in the fourth quarter, but none in the first quarter |
| In fiscal 2005, we facilitated one securitization in the second quarter, one securitization in the third quarter, and three securitizations in the fourth quarter, but none in the first quarter |
| Unlike in previous fiscal years, we expect to facilitate one securitization in the first quarter of fiscal 2007 |
| Variations in the size of each securitization transaction will continue to result in variability of our operating results on a quarterly basis |
| The timing and size of our planned securitization activities may be affected by the seasonality of student loan applications and loan originations, as well as the other factors that could adversely affect our securitization activities |
| Origination of student loans is generally subject to seasonal trends, with the volume of loan applications increasing with the approach of tuition payment dates |
| In fiscal 2006, we processed 37prca of our total loan facilitation volume in the first quarter ended September 2005, and 19prca, 25prca and 19prca of our total loan facilitation volume in the respective successive quarters |
| In fiscal 2005, we processed 39prca of our total loan facilitation volume in the first quarter ended September 30, 2004, and 21prca, 24prca and 16prca of our total loan facilitation volume in the respective successive quarters |
| If competitors acquire or develop a student loan database or advanced loan information processing systems, our business could be adversely affected |
| We own a proprietary database of historical information on private student loan performance that we use to help us establish the pricing provisions of new loan programs on behalf of lenders, determine the terms of securitization transactions and establish the fair value of the structural advisory fees and residuals that we recognize as revenue |
| We also have developed a proprietary loan information processing system to enhance our application processing and loan origination capabilities |
| Our student loan database and loan information processing system provide us with a competitive advantage in offering our services |
| Third parties could create or acquire databases and systems such as ours |
| For example, as lenders and other organizations in the student loan market originate or service loans, they compile over time information for 28 ______________________________________________________________________ their own student loan performance database |
| If a third party creates or acquires a student loan database or develops a loan information processing system, our competitive positioning, ability to attract new clients and business could be adversely affected |
| Changes in interest rates could affect the value of our additional structural advisory fees and residuals receivables, as well as demand for private student loans and our services |
| Student loans typically carry floating interest rates |
| Higher interest rates would increase the cost of the loan to the borrower, which in turn, could cause an increase in default rates for outstanding student loans |
| In addition, higher interest rates, or the perception that interest rates could increase in the future, could cause an increase in prepayments, including full or partial prepayments or prepayments as a result of loan consolidation activity |
| If the prepayment or default rates increased for the student loans held by the securitization trusts, we may experience a decline in the value of our additional structural advisory fees and residuals receivable, and future securitization transactions may be less profitable for us |
| In addition, most of the student loans that our clients originate carry floating rates of interest tied to prevailing short-term interest rates |
| An increase in interest rates could reduce borrowing for education generally, which, in turn, could cause the overall demand for our services to decline |
| If we are unable to protect the confidentiality of our proprietary database and information systems and processes, the value of our services and technology will be adversely affected |
| We rely on trade secret laws and restrictions on disclosure to protect our proprietary database and information systems and processes |
| We have entered into confidentiality agreements with third parties and with some of our employees to maintain the confidentiality of our trade secrets and proprietary information |
| These methods may neither effectively prevent disclosure of our confidential information nor provide meaningful protection for our confidential information if there is unauthorized use or disclosure |
| We own no patents and have filed no patent applications with respect to our proprietary database or loan information processing systems |
| Accordingly, our technology is not covered by patents that would preclude or inhibit competitors from entering our market |
| Monitoring unauthorized use of the systems and processes that we developed is difficult, and we cannot be certain that the steps that we have taken will prevent unauthorized use of our technology |
| Furthermore, others may independently develop substantially equivalent proprietary information and techniques or otherwise gain access to our proprietary information |
| If we are unable to protect the confidentiality of our proprietary information and know-how, the value of our technology and services will be adversely affected |
| An interruption in or breach of our information systems may result in lost business |
| We rely heavily upon communications and information systems to conduct our business |
| As we implement our growth strategy and increase our volume of business, that reliance will increase |
| Our systems and operations are potentially vulnerable to damage or interruption from network failure, hardware failure, software failure, power or telecommunications failures, computer viruses and worms, penetration of our network by hackers or other unauthorized users and natural disasters |
| Any failure or interruption, or breach in security, of our information systems or the third-party information systems on which we rely could cause underwriting or other delays and could result in fewer loan applications being received, slower processing of applications and reduced efficiency in loan processing |
| A failure, interruption or breach in security could also result in an obligation to notify clients in states such as California that require such notification, with possible civil liability resulting from such failure, interruption or breach |
| We cannot assure you that such failures, interruptions or breaches will not occur, or if they do occur that we or the third parties on whom we rely will adequately address them |
| The precautionary measures that we have implemented to avoid systems outages and to minimize the effects of any data or telephone systems interruptions may not be adequate, and we may not have anticipated or addressed all of 29 ______________________________________________________________________ the potential events that could threaten or undermine our information systems |
| In addition, we have not instituted redundancy for key systems |
| The occurrence of any failure, interruption or breach could significantly impair the reputation of our brand, diminish the attractiveness of our services and harm our business |
| If we experience a data security breach and confidential customer information is disclosed, we may be subject to penalties imposed by regulators, civil actions for damages and negative publicity, which could affect our customer relationships and have a material adverse effect on our business |
| In addition, current state and federal legislative proposals, if enacted, may impose additional requirements on us to safeguard confidential customer information, which may result in increased compliance costs |
| Recently, data security breaches suffered by well-known companies and institutions have attracted a substantial amount of media attention, prompting state and federal legislative proposals addressing data privacy and security |
| If some of the current proposals are adopted, we may be subject to more extensive requirements to protect the borrower information that we process in connection with the loans |
| Implementation of systems and procedures to address these requirements would increase our compliance costs |
| If we were to experience a data security breach, or if we or the securitization trusts that we administer otherwise improperly disclose confidential customer information, such breach or other disclosure could generate negative publicity about us and could adversely affect our relationships with our clients, including the lenders and educational institutions with which we do business |
| In addition, pending legislative proposals, if adopted, likely would result in substantial penalties for unauthorized disclosure of confidential consumer information |
| The loan origination process is becoming increasingly dependent upon technological advancement, and we could lose clients and market share if we are not able to keep pace with rapid changes in technology |
| Our ability to handle an increasing volume of transactions is based in large part on the advanced systems and processes we have implemented and developed |
| The loan origination process is becoming increasingly dependent upon technological advancement such as the ability to process loans over the Internet, accept electronic signatures and provide process updates instantly |
| Our future success depends in part on our ability to develop and implement technology solutions that anticipate and keep pace with these and other continuing changes in technology, industry standards and client preferences |
| We may not be successful in anticipating or responding to these developments on a timely basis |
| If competitors introduce products, services, systems and processes that are better than ours or that gain greater market acceptance, those that we offer or use may become obsolete or noncompetitive |
| Any one of these circumstances could have a material adverse effect on our ability to obtain and retain key clients |
| We may be required to expend significant funds to develop or acquire new technologies |
| If we cannot offer new technologies as quickly as our competitors, we could lose clients and market share |
| We also could lose market share if our competitors develop more cost effective technologies than those we offer or develop |
| We have expanded our operations rapidly in recent years, and if we fail to manage effectively our growth, our financial results could be adversely affected |
| The number of our employees increased to 917 full-time and 15 part-time employees as of June 30, 2006 from 842 full-time, 11 part-time and 36 seasonal employees as of June 30, 2005 |
| Our revenue increased to dlra563dtta6 million for fiscal 2006 from dlra418dtta0 million for fiscal 2005 and dlra199dtta3 million for fiscal 2004 |
| Our growth may place a strain on our management, systems and resources |
| We must continue to refine and expand our 30 ______________________________________________________________________ business development capabilities, our systems and processes and our access to financing sources |
| As we grow, we must continue to hire, train, supervise and manage new employees |
| We have recently begun to co-source some borrower service functions, including some call center operations, in an effort to reduce costs and enhance our ability to process an increasing volume of loans |
| We have limited experience with our co-sourcing vendor and rely on the vendor to provide a high level of customer service |
| Our reliance on this external service provider subjects us to risks associated with inadequate or untimely services, and could result in a lower number of loans than we would experience if we performed the service function in-house |
| We have applied to the Office of Thrift Supervision to acquire Union Federal Savings Bank, North Providence, Rhode Island, and if the acquisition is approved, we may face challenges in integrating our products, services and employees |
| We cannot assure you that we will be able to: · expand our systems effectively; · allocate our human resources optimally; · identify and hire qualified employees or vendors; or · incorporate effectively the components of any business that we may acquire in our effort to achieve growth |
| If we are unable to manage our growth, our operations and our financial results could be adversely affected |
| We may be subject to state registration or licensing requirements in jurisdictions where we are not currently registered or licensed |
| If we determine that we are subject to the registration or licensing requirements of any jurisdiction, our compliance costs could increase significantly and other adverse consequences may result |
| Based on the advice of counsel and, in some states, additional informal advice from state regulators, we have been operating on the basis that no registrations or licenses for loan brokers and loan arrangers are required of us |
| Although we believe that our prior consultations with national and local counsel identified all material registration, licensing and other regulatory requirements then applicable, we are currently analyzing the preliminary results of a nationwide review of state registration and licensing requirements that may be applicable to us now, in view of the expansion of the scope of the services we provide, our plans for future activities and the time that has elapsed since our prior review |
| As a result of this current review, we may determine that registration or licensing is required in jurisdictions where we are not currently registered or licensed |
| Even if we are not physically present in a state, its regulators may take the position that registration or licensing is required because we provide services by mail, telephone, the Internet or other remote means |
| If we identify any states in which registration or licensing is required, we will proceed with registration or licensing in the affected state |
| If any state asserts jurisdiction over our business, we will consider whether to challenge the assertion or proceed with registration or licensing in the affected state |
| Compliance with such requirements could involve additional costs, which could have a material adverse effect on our business |
| Our failure to comply with these laws could lead to, among other things: · curtailment of our ability to continue to conduct business in the relevant jurisdiction, pending processing of registration or a license application; · administrative enforcement actions; · class action lawsuits; 31 ______________________________________________________________________ · the assertion of legal defenses delaying or otherwise affecting the enforcement of loans; and · criminal as well as civil liability |
| If the regulatory exemptions or rulings that allow us to conduct our business without registration or licensing are modified or revoked, or the statutory and regulatory requirements change in the future, our compliance costs could increase substantially |
| The Massachusetts Division of Banks ruled that our business with TERI is not subject to licensing because, as a provider of loan origination outsourcing services, we do not conduct a lending business with consumers in our own name and our processing centers are not generally open to the public |
| The Massachusetts Small Loan Act requires any person that is engaged, for compensation, in the business of making small loans, or in aiding or assisting the borrower or the lender in procuring or making such loans, to obtain a license |
| The TERI-guaranteed loans that we facilitate, as well as GATE loans we support, include amounts as small as dlra1cmam000, and a small portion of those loans have combined interest rates and fees exceeding 12prca |
| We could therefore become subject to the Small Loan Act with respect to these loans if the Massachusetts Division of Banks revokes its previous determination that our operations are exempt or determines that our activities exceed the scope of the determination |
| We could also become subject to registration or licensing requirements due to changes in existing federal and state laws and regulations |
| The Massachusetts legislature could, for example, modify the statutory requirements under the Small Loan Act |
| If the Massachusetts legislature, or any other state or federal regulatory authority, changes existing laws and rules, or enacts new laws or rules, we could be forced to make changes in our relationships with lenders, educational institutions, guarantors, servicers or the trusts involved in the securitizations that we facilitate |
| Specifically, changes in existing laws and rules could also require us to implement additional or different programs and information technology systems and could impose licensing, capital and reserve requirements and additional costs, including administrative, compliance and third-party service costs |
| We may be exposed to liability for failures of third parties with which we do business to comply with the registration, licensing and other requirements that apply to them |
| Third parties with which we do business, including federal and state chartered financial institutions as well as TERI, are subject to registration, licensing and extensive governmental regulations, including Truth-in-Lending laws and other consumer protection laws and regulations |
| For example, some of the third-party marketers with which we do business may be subject to state registration or licensing requirements and laws and regulations, including those relating to small loans, loan brokers and credit services organizations |
| As a result of the activities that we conduct for our clients, it may be asserted that we have some responsibility for compliance by third parties with which we do business with the laws and regulations applicable to them, whether on contractual or other grounds |
| If it is determined that we have failed to comply with our obligations with respect to these third parties, we could be subject to civil or criminal liability |
| We could also become subject to registration or licensing and other regulatory requirements in Massachusetts and other states by expanding the scope or extent of our services |
| We are in the process of expanding the scope of the services we provide on behalf of lenders to include certain advertising and marketing functions |
| As a result of this expansion of our services, or if we expand our services in the future to include, among others, loan guarantees, our current exemption from the Massachusetts Small Loan Act could be invalidated, and consequently, we may need to obtain a license 32 ______________________________________________________________________ from the Massachusetts Division of Banks |
| In addition, we may become subject to the laws and regulations of other states governing such expanded services |
| We may also become subject to state regulatory requirements if the extent of the activities that we conduct in a particular state expands |
| Compliance with such requirements could involve additional costs, which could have a material adverse effect on our business |
| The federal government and state governments regulate extensively the financial institutions and other entities that originate loans in the student loan market |
| These regulations include bankruptcy, tax, usury, disclosure, credit reporting, identity theft, privacy, fraud and abuse and other laws to protect borrowers |
| Changes in consumer protection laws or related regulations, or in the prevailing interpretations thereof, may expose us to litigation, adversely affect the collection of balances due on the loan assets held by securitization trusts or otherwise adversely affect our business |
| Moreover, changes in the consumer protection laws and related regulations, or in the prevailing interpretations thereof, could invalidate or call into question the legality of certain of our services and business practices |
| Recent or future changes in federal and state bankruptcy and debtor relief laws may increase credit losses on the loans held by securitization trusts and related administrative expenses |
| Violations of the laws or regulations governing our operations, or the operations of TERI or our other clients, could result in the imposition of civil or criminal penalties, the cancellation of our contracts to provide services or our exclusion from participating in education loan programs |
| These penalties or exclusions, were they to occur, would negatively impair our ability to operate our business |
| In addition, the loan assets held by securitization trusts that we have structured could be adversely impacted by violation of tax or consumer protection laws |
| In such event, the value of our residual interests could also be adversely impacted |
| In some cases, such violations may render the loan assets unenforceable |
| Recent litigation has sought to re-characterize “payday loan” marketers and other originators as lenders; if litigation on similar theories were successful against us or any third-party marketer, the loans that we securitize would be subject to individual state consumer protection laws |
| We provide financial and educational institutions, as well as other organizations, with an integrated suite of services in support of private student loan programs |
| All of the lenders with which we work are federally-insured banks and credit unions and, therefore, are not subject to many state consumer protection laws, including limitations on certain interest rates, fees and other charges |
| In providing our services, we do not act as a lender, guarantor or loan servicer, and the terms of the loans that we securitize are regulated in accordance with the laws and regulations applicable to the lenders |
| The association between loan marketers and out-of-state national banks has come under recent scrutiny, specifically in the context of high-interest “payday loans” |
| Recent litigation asserts that payday loan marketers use out-of-state lenders in order to evade the usury and interest rate caps, and other consumer protection laws, imposed by the states where they do business |
| Such litigation has sought, successfully in some instances, to re-characterize the loan marketer as the lender for purposes of state consumer protection law restrictions |
| Similar civil actions have been brought in the context of gift cards |
| We believe that our activities, and the activities of third parties whose marketing on behalf of lenders is coordinated by 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 and under the control and supervision of lenders, additional state consumer protection laws would be applicable to the loans if we, or any third-party loan marketer whose activities we coordinate, were re-characterized as a lender, and the loans (or the provisions governing interest rates, fees and other charges) could be unenforceable |
| In addition, we could be subject to claims by consumers, as well as 33 ______________________________________________________________________ enforcement actions by regulators |
| Even if we were not required to cease doing business with residents of certain states or to change our business practices to comply with applicable laws and regulations, we could be required to register or obtain licenses or regulatory approvals that could impose a substantial cost on us |
| To date, there have been no actions taken or threatened against us on the theory that we have engaged in unauthorized lending |
| However, such actions could have a material adverse effect on our business |
| The price of our common stock may be volatile |
| The trading price of our common stock may fluctuate substantially, depending on many factors, some of which are beyond our control and may not be related to our operating performance |
| These fluctuations could cause you to lose part or all of your investment in our shares of common stock |
| Those factors that could cause fluctuations include, but are not limited to, the following: · actual or anticipated changes in our earnings or fluctuations in our operating results or in the expectations of securities analysts; · difficulties we may encounter in the securitizations that we structure or the loss of opportunities to structure securitization transactions; · announcement by us, our competitors or our potential competitors of acquisitions, new products or services, significant contracts, commercial relationships or capital commitments; · price and volume fluctuations in the overall stock market from time to time; · significant volatility in the market price and trading volume of financial services and process outsourcing companies; · general economic conditions and trends; · negative publicity about the student loan market generally or us specifically; · major catastrophic events; · loss of a significant client or clients; · purchases or sales of large blocks of our stock; or · departures of key personnel |
| In the past, following periods of volatility in the market price of a company’s securities, securities class action litigation has often been brought against that company |
| Due to the potential volatility of our stock price, we may therefore be the target of securities litigation in the future |
| Securities litigation could result in substantial costs and divert management’s attention and resources from our business |
| Future sales of a substantial number of shares of our common stock in the public market, or the perception that such sales may occur, could adversely affect the then-prevailing market price of our common stock |
| As of July 31, 2006, we had 62cmam805cmam814 shares of common stock outstanding |
| Subject to limitations under federal securities laws, including in some cases the volume limitations of Rule 144, these shares are eligible for sale in the public market |
| The market price of shares of our common stock may drop significantly if our existing stockholders sell a substantial number of shares |
| A decline in the price of shares of our common stock might impede our ability to raise capital through the issuance of additional shares of our common stock or other equity securities |
| 34 ______________________________________________________________________ Insiders have substantial control over us and could limit your ability to influence the outcome of key transactions, including a change of control |
| Our directors and executive officers, and entities affiliated with them, beneficially own approximately 39prca of the outstanding shares of our common stock |
| As a result, these stockholders, if acting together, could substantially influence matters requiring approval by our stockholders, including the election of directors and the approval of mergers or other extraordinary transactions |
| They may also have interests that differ from yours and may vote in a way with which you disagree and which may be adverse to your interests |
| The concentration of ownership may have the effect of delaying, preventing or deterring a change of control of our company, could deprive our stockholders of an opportunity to receive a premium for their common stock as part of a sale of our company and might ultimately affect the market price of our common stock |
| We may not receive approval from the Office of Thrift Supervision to acquire Union Federal Savings Bank |
| In July 2006, we submitted an application to the OTS for approval to acquire Union Federal Savings Bank in North Providence, Rhode Island, from Union Bank, a Rhode Island banking corporation |
| We cannot assure you that we will receive OTS approval, which is based on a number of factors, including an assessment of the financial and managerial resources and future prospects of First Marblehead and Union Federal, and the impact of the acquisition on competition in the parties’ respective markets |
| Moreover, as a condition to approving the acquisition, the OTS may impose restrictions on us and may require prior approval of any future material changes to Union Federal’s business plans |
| We have already spent significant time and resources on this proposed acquisition and the OTS application, and the OTS review process could further divert the attention of senior management from our business operations |
| If the OTS does not approve our acquisition of Union Federal, our growth strategy and business prospects could be materially adversely affected |
| We do not have experience with being regulated as a savings and loan holding company |
| We are not currently regulated as a savings and loan holding company or bank holding company, and do not control any FDIC-insured institution |
| If we receive OTS approval, upon acquiring control of Union Federal, we would become subject to regulation as a savings and loan holding company and would be limited to activities that are financial in nature and certain real-estate related activities |
| We would also be required to register with the OTS and file periodic reports, and would be subject to examination by the OTS The OTS would also have certain types of enforcement powers over us, including the ability to issue cease-and-desist orders, force divestiture of Union Federal and impose civil and monetary penalties for violations of federal banking laws and regulations or for unsafe or unsound banking practices |
| In addition, savings banks such as Union Federal are subject to extensive regulation, supervision and examination by the OTS and the Federal Deposit Insurance Corporation |
| Such regulation covers all banking business, including activities and investments, lending practices, safeguarding deposits, capitalization, risk management policies and procedures, relationships with affiliated companies, recordkeeping and conduct and qualifications of personnel |
| In particular, the failure of a savings bank to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary, actions by regulators that, if undertaken, could have a direct material adverse effect on a saving bank’s operations and financial statements |
| There is a risk that we could incur additional costs in complying with regulations applicable to savings and loan holding companies and savings banks, or significant penalties if we fail to comply |
| Our ability to comply with all applicable laws and rules will depend largely on our establishment and maintenance of a system to ensure such compliance, as well as our ability to attract and retain qualified compliance personnel |
| We could be subject to disciplinary or other actions due to claimed noncompliance in the future, which could have an adverse effect on our business, financial condition and operating results |
| 35 ______________________________________________________________________ Some provisions in our restated certificate of incorporation and amended and restated by-laws may deter third-parties from acquiring us |
| Our restated certificate of incorporation and amended and restated by-laws contain provisions that may make the acquisition of our 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 special meetings of our stockholders; · our stockholders may take action only at a meeting of our stockholders and not by written consent; · we have authorized undesignated preferred stock, the terms of which may be established and shares of which may be issued without stockholder approval; · our directors may be removed only for cause by the affirmative vote of a majority of the directors present at a meeting duly held at which a quorum is present, or the holders of 75prca of the votes that all stockholders would be entitled to cast in the election of directors; and · we impose advance notice requirements for stockholder proposals |
| These anti-takeover defenses could discourage, delay or prevent a transaction involving a change in control of our company |
| These provisions could also discourage proxy contests and make it more difficult for you and other stockholders to elect directors of your choosing and cause us to take other corporate actions you desire |
| Section 203 of the Delaware General Corporation Law may delay, defer or prevent a change in control that our stockholders might consider to be in their best interests |
| We are subject to Section 203 of the Delaware General Corporation Law which, subject to certain exceptions, prohibits “business combinations” between a Delaware corporation and an “interested stockholder,” which is generally defined as a stockholder who becomes a beneficial owner of 15prca or more of a Delaware corporation’s voting stock, for a three-year period following the date that such stockholder became an interested stockholder |
| Section 203 could have the effect of delaying, deferring or preventing a change in control that our stockholders might consider to be in their best interests |