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No. of Recommendations: 58
Looking at FMD by quarters from Q1 FY 2004(calendar start Sept 2003) the company was not securitizing loans every quarter until FY 2007(starts July 2006). In FY 2004 FMD securitized loans in Q2 and Q4. They have since increased that to a securitization every quarter in FY 2007(Q1 started September 2006). In FY 2005 and FY 2006, the company facilitated three securitizations. In FY 2007, there were 4 securitizations. Volume has increased by roughly $1 billion every FY.Until the December 2007 no show(FY 2008), if past increases were any guide, FMD would have been expected to securitize nearly $6 billion in FY 2008. With the ABS market struggling, FY 2008 is stuck at $2043 million with nearly $4 billion to go if FMD was to grow at past rates.

How did the company survive past years where there were no securitizations every quarter? Was FMD facing a looming bankruptcy? What happens when there are no upfront advisory fees?

* No surprise--cash burn increased in quarters where no upfront advisory fees were paid -- quite a bit.

* Expenses as a percentage of nonresidual revenue went over 100%--again no surprise

*CFFO went in to the red

* Income from operations goes red**

The company has not had 2 consecutive quarters without a securitization [starting FY 2004] and it began to look with the December no show and a weak market going in to Q3 FY 2008 FMD could be entering seas filled with nasty beasties off the edge of the known world. The Moody’s action, the December no show, things looking unlikely for Q3, naked shorting, price manipulation by Goldman Sachs, all conspired to bring the company to 3 year lows.

First Marblehead is not unique--it does require cash to run and cannot live on air (and residuals) alone. The only “real” cash it gets is from upfront advisory fees for securitizing work, processing fees from TERI, administrative fees as trustee and a wee bit of interest income. Residuals, additional advisory fees, and trust updates do not pay the electric bill. And the processing fees from TERI are a round trip--only reimbursement for expenses FMD accumulates working for TERI. If you use operating income, this nets out. However operating income includes all the residuals and does not reflect what FMD can claim after operating expenses are met.

**All the places where operating income is used net out residuals of any sort

**If you correct operating income for the residual revenue and back it out, again no surprise, FMD is operating at a loss when no upfront fees are paid and expenses exceed operating income. And they burn cash and go CFFO negative. It happens to the best of them at times. How long could the company go without securitizing PSLs? FMD has never [since 2004] tested those limits. It has never drained the piggy bank or had a losing year. No wonder the price spiked to a split adjusted high of around $58 on January 8 2007. It was a very good fiscal year with securitizations every Q and record amounts of loans being handled

An abbreviated look at some of the numbers over the years

FY 2004

Total loans securitized $1245 million

in millions sept 03 dec 03 Mar-04 4-Jun
Q1 2003 Q2 2003 Q3 2003 Annual
no no
securit securit securit securit
income/loss operations ($5.70) $30.96 ($8.84) $50.60
earnings per share ($0.06) $0.62 ($0.06) $1.27
cash burn $7.40 $15.50
cash increase $131.00 $26.80
CFFO cumulative ($6.20) $4.80 ($9.90) $33.40
CFFO by Q ($6.20) $11.00 ($14.70) $43.30

cash burn/expenses 48% 0% 90% 0%
expenses/nonresidual revenue 187% 33% 206% 58%
expenses /operating income 268% 50% 194% 139%
operating income/revenue -70% 67% -106% 42%

upfront fees*/total revenue 0% 60% 75% 61%
upfront fee/revenue
(ex TERI fee) 0% 56% 29% 61%
upfront fees ex TERI/resid 0% 127% 41% 128%

*includes TERI fees

As a neophyte public company doing only 2 securitizations in FY 2004, FMD was skating on a bit of thin ice without the upfront advisory fees, getting to as little as $10 million in cash on the balance sheet, two losing quarters and two cash flow negative quarters. But they ended well with $1.27 in earnings and plenty of cash.It’s apparent from this their worst year as a publicly traded company, management had definite skills understanding the need to conserve cash for laggard months. Upfront fees as a percentage of revenue(corrected for TERI fees) was between 50-60% which is where it settled at over the years by and large except for the BBB Qs. At 50% to 60% levels, FMD was very profitable increasing earnings every year substantially. And it was clear [no surprise] the more securitizations the better.

During the years before the Triple B tranches, FMD was getting about 8% fees/loan principal and making a very good living on just the upfront cash. Enough income to get by a Q or two without any securitization work.

With that in mind here is how FY 2005-FY 2007 turned out



Total loans securitized $2262.5 million

4-Sep 4-Dec 5-Mar Jun-05
Q1 Q2 Q3 Annual
securit securit securit 3 securit

income/loss operations ($13.43) $52.86 $46.63 $105.70
earnings per share ($0.08) $1.15 $0.72 $2.46
cash burn $22.60 $24.70
cash increase $53.00 $19.40
CFFO cumulative ($14.60) $44.45 $75.70 $108.40
CFFO by Q ($14.60) $59.05 $31.25 $32.70

cash burn/expenses 71% 0% 0% 17%
expenses/nonresidual revenue 173% 36% 45% 58%
expenses /operating income -237% 56% 81% 136%
operating income/revenue -73% 64% 55% 42%

upfront fees*/total revenue 84% 57% 68% 60%
upfront fee /revenue (ex TERI) 22% 51% 62% 51%
upfront fees ex TERI/residuals 28% 104% 163% 124%

*includes TERI fees


FY 2006

Total loans securitized $3362.6

5-Sep 5-Dec Mar-06 Jun-06
Q1 Q2 Q3 Annual
securit securit securit 3 securit
income/loss operations ($18.30) $79.70 $38.30 $135.30
earnings per share ($0.08) $1.75 $0.94 $3.71
cash burn ($37.70) ($3.60) ($9.90)
cash increase $0.30
CFFO cumulative ($33.40) $46.40 $43.70 $49.70
CFFO by Q ($33.40) $79.80 ($2.70) $6.00

cash burn/expenses 82% 8% 20% 0%
expenses/nonresidual revenue 167% 36% 56% 58%
expenses /operating income -250% 55% 128% 139%
operating income/revenue -67% 64% 44% 42%

upfront fees*/total revenue 78% 54% 59% 57%
upfront fee/revenue(ex TERI) 16% 48% 50% 47%
upfront fees ex TERI/residuals 19% 92% 99% 90%

*includes TERI fees


FY 2007

Total loans securitized $4292.5

6-Sep 6-Dec Mar-07 Jun-07
Q1 Q2 Q3 Annual
securit securit securit 4 securit
income/loss operations $148.91 $64.00 $81.34 $360.80
earnings per share $2.24 $0.86 $0.75 $3.94
cash burn ($8.40) ($55.20)
cash increase $122.10 $33.60
CFFO $146.40 $135.20 $187.40 $195.40
CFFO by Q $146.40 ($11.20) $52.20 $8.00

cash burn/expenses 0% 14% 0% 22%
expenses/nonresidual revenue 31% 48% 43% 41%
expenses /operating income 44% 92% 75% 70%
operating income/revenue 69% 52% 57% 59%

upfront fees*/total revenue 71% 62% 79% 70%
upfront fee/revenue(ex TERI) 67% 56% 74% 64%
upfront fees ex TERI/residuals 246% 171% 403% 238%

*includes TERI fees


Great years with good growth and upfront fees [real money] going up in FY 2007 with the invention of the BBB tranche and investors happy to buy increased risk. Expenses were easily covered by nonresidual revenue and margins [ as measured by corrected operating income ex residuals] were amazing

   FY 2008

Total loans securitized $2043.6 million

2 securit
income/loss operations $148.00
earnings per share $1.81
cash increase $145.30
CFFO $12.10

cash burn/expenses 0%
expenses/nonresidual revenue 40%
expenses /operating income 66%
operating income/revenue 60%

upfront fees*/total revenue 65%
upfront fee/revenue(ex TERI) 61%
upfront fees ex TERI/residuals 61%

*includes TERI fees


In FY 2008, the company had a few concessions to make to a difficult market--Ambac wrapped the bonds in an extra layer of protection, many of the tranches were auctioned to increase liquidity, no lower rated tranches to boost upfront fees to 12% [margins went backwards to 8.6%). It was better than nothing and got loans off lender-partners books and out of jeopardy. Jeopardy would mean that these loans if left unsecuritized longer than 180 days would start ticking down to a 1% penalty of total loan principal for FMD to pay. They made decent if not spectacular money and added to cash reserves in advance of what management had to know was going to be a December no-show.

Just how close to death was FMD? Not very imo and at $11 per share it was tempting. If I had had this done last week I might have been buying it. GS beat me to it

The CC was pure genius and in stark contrast to the other-worldly attempt to converse with the public made by SLM. How can you not stand back and gasp and applaud in admiration as FMD announces a $185 million write down of residuals and the price goes up 50%. Pure genius. They preempted the Moody’s strike and suffered no “residual” damage. I love these guys.

A few highlights

 FMD Business Update Call Dec. 21, 2007

Jack L. Kopnisky, Chief Executive Officer, Chief Operating Officer and President

First Marblehead has entered into a definitive agreement where GS Capital Partners will invest up to $260.5 million to acquire up to 19.99% of the company and provide the company with $1 billion of warehouse financing.

This investment provides our company with additional capital resources to fund our longterm strategy.

Here is how the investment is structured, the first step is an investment of $59.8 million, which will be made today to acquire securities convertible into 5.3 million shares of common stock at a conversion price of $11.24 per share that was yesterday’s closing stock price for First Marblehead. Upon receipt of regulatory clearances and determinations the second step will take place.

An additional investment of up to $200.7 million will be made to acquire additional securities that are convertible into and up to 13.4 shares of common stock at a conversion price of $15 per share.

In total, an investment up to $260.5 million will be made for up to 18.7 million shares of First Marblehead.

Board of Directors have reviewed its dividend policy and decided to eliminate the regular quarterly cash dividend for the foreseeable future.

The company expects these assumption changes to result in an aggregate pre-tax charge to its residuals of approximately 170 to $185 million approximately 18 to 20% of service receivables as of the end of the last quarter. More than half of the adjustment results from estimated changes related to the future cost of variable rate debt and for the discount rate used in estimating the fair value of the service receivables.

Short, sweet and coherent.

At the end of Q1 Sept 30, FMD had $380.3 million in cash
Total expenses were $97.5 million

In an attempt to extrapolate what might be I used Q1 ex upfront fees to guess at Q2 and beyond.

Without the upfront fees from a securitization FMD would have had processing fees from TERI and administrative fees as trustee to pay expenses equaling $97 million.

Income from operations[excluding residuals ] was $148 million. Without the upfront fees operating income drops to around -$30 million. Approximately $47 million of expenses is TERI and paid by TERI in a round trip netting zero.That leaves $51 million to be covered by FMD with only $21 million in administrative fees

Cash burn would have been around $30 million give or take a few million.

If this scenario could be taken forward a few quarters in the absence of securitizations, with TERI coming in and going out at 45%-50% of expenses FMD would probably keep burning $30-$40 million per quarter providing its non TERI SGA and compensation stayed flat. That's a lot of Qs at $380 million in cash reserves. Since they cut dividends, that freed up about $25 million per quarter [good idea] Don't need any extra pesky expenses. FMD has been repurchasing stock and that will stop[could account for some cash burn in good years]. No more of that for awhile. No debt due. Some accrued expenses of $50 million. There are $58 million in taxes due--don't know when. But by and large the $380 million would have been good for a few quarters.

Of some concern was the 1% late fees that accumulating lender-partner loans was going to cost at a possible $4 billion in loans FMD might have been on the line for by years end. That's $40 million.

FMD would have had negative earnings. Hard to know what the tax provision would be but without it, the loss could be as high $0.32 per share per quarter. Any provisional taxes would make it higher--FMD does have a net deferred tax liability hanging over them. I think the market had priced the negative earnings in to the low low prices. Earnings per quarter are less important with FMD than the amount of product accumulating waiting to be turned in to cash. The extreme price drop was imo largely due the unknown Moody’s actions potentially eating into both residuals and the up front fees and the possibility future securitizations were on long term hold with possible late fees and loss of lending partners. The TERI downgrade looming over all this also put the fear of retribution on undercollateralization in the hearts of investors. TERI is still a question mark--have not had time to look at their spreadsheet.

What GS did for them (and very well timed) is offer a warehouse that I think could be used to buy some of the lending partner loans. Thus FMD is spared some ticking time bomb 180 day late fees from loans not securitized on time. There were $1.1 billion of those ticking away at the end of Q1. Of course Q2 will be seeing ongoing loan activity from loan originators but this Q should be slower than peak summer time. There is an uptick as students borrow for next term. FMD is originating their own product strongly. Not one to say I told you so but someone questioned my taking management to task last summer for continuing to tell us they were doing research--I told you so.When FMD can clear some partner lenders loans off the partner books the GS warehouse will add mightily to their current puny $300 million warehouse. At present $94 million of that has been used. Of course the $260 million in cash can be handy to have around. The share dilution will not be too damaging.The company has been stingy about passing out shares, decreasing shares out by 3% since 2004.

Not a bad company in a brilliant business in a temporary bind now bailed out by about the most successful investment bank on the street currently. IMO not much danger of them going BK but the year could have been an ugly one without help. What we don’t know yet is if the upfront margins of fee/loan principal will be left intact. That is of paramount importance. Without it they are just another SLM. OK maybe not that pathetic, but it is a nice feature of FMD.
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