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FIRST MARBLEHEAD CORP - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations
(Edgar Glimpses Via Acquire Media NewsEdge)
You should read the following discussion and analysis of our financial condition
and results of operations together with our unaudited consolidated financial
statements and accompanying notes included in Part I of this quarterly report
and in conjunction with our audited consolidated financial statements included
in our annual report on Form 10-K for fiscal 2012 filed with the Securities and
Exchange Commission, or SEC, on September 12, 2012, which we refer to as our
Annual Report.
Unless otherwise indicated, or unless the context of the discussion requires
otherwise, we use the terms "we," "us," "our" and similar references to refer to
The First Marblehead Corporation and its subsidiaries, on a consolidated basis.
We use the terms "First Marblehead" or "FMD" to refer to The First Marblehead
Corporation on a stand-alone basis. We use the term "education loans" to refer
to private education loans, which are not guaranteed by the federal government.
Our fiscal year ends on June 30, and we identify our fiscal years by the
calendar years in which they end. For example, we refer to the fiscal year
ending June 30, 2013 as "fiscal 2013."
Factors That May Affect Future Results
In addition to historical information, this quarterly report includes
forward-looking statements within the meaning of Section 21E of the Securities
Exchange Act of 1934, as amended, or the Exchange Act, and Section 27A of the
Securities Act of 1933, as amended. For this purpose, any statements contained
herein regarding our strategy, future operations and products, financial
performance and liquidity, future funding transactions, projected costs,
projected loan portfolio performance, future market position, prospects, plans
and outlook of management, other than statements of historical facts, are
forward-looking statements. The words "anticipates," "believes," "estimates,"
"expects," "intends," "may," "observe," "plans," "projects," "will," "would,"
and similar expressions are intended to identify forward-looking statements,
although not all forward-looking statements contain these identifying words. We
cannot guaranty that we actually will achieve the results, plans, intentions or
expectations expressed or implied in our forward-looking statements, which
involve risks, assumptions and uncertainties. There are a number of important
factors that could cause actual results, timing of events, levels of activity or
performance to differ materially from those expressed or implied in the
forward-looking statements we make. These important factors include our
"critical accounting estimates" set forth below under "-Critical Accounting
Policies and Estimates" and factors including, but not limited to, those set
forth under the caption "Risk Factors" in Item 1A of Part II of this quarterly
report. Although we may elect to update forward-looking statements in the
future, we specifically disclaim any obligation to do so, even if our estimates
change, and readers should not rely on those forward-looking statements as
representing our views as of any date subsequent to November 8, 2012.
Executive Summary
Overview
We are a specialty finance company focused on the education financing
marketplace. We provide loan programs for K-12, undergraduate and graduate
students, as well as tuition planning, tuition billing, refund management and
payment technology services in the United States. We offer a fully integrated
suite of services through our Monogram® loan product service platform, which we
refer to as the Monogram platform, as well as certain services on a stand-alone,
fee-for-service basis. We partner with lenders to design and administer
education loan programs through our Monogram platform, which are
school-certified and designed to be marketed through educational institutions or
to prospective student borrowers and their families directly and designed to
generate portfolios intended to be held by the originating lender or financed in
the capital markets. We also offer a number of ancillary services in support of
our clients, including loan origination, retail banking, portfolio management
and securitization services.
These offerings are part of a change in our revenue model that we have been
implementing since fiscal 2009 to focus on fee-based revenues. Our long-term
success depends on the continued development of our four principal revenue
lines:
• Partnered lending-We provide customized Monogram-based education loan
programs for lenders who wish to hold originated portfolios to maturity.
We are paid for our origination and marketing services at the time
approved education loans are disbursed and receive monthly payments for
portfolio management services, credit enhancement and administrative
services throughout the life of the loan. We may provide credit
enhancements by funding participation interest accounts, which we refer to
as participation accounts, or, in the case of our subsidiary Union Federal
Savings Bank, which we refer to as Union Federal®, deposit accounts, to
serve as a first loss reserve for defaulted program loans. In
consideration for funding participation accounts, we are entitled to
receive a share of the interest generated on the loans.
• Banking services-Union Federal offers traditional retail banking products
on a stand-alone basis. In addition, Union Federal generates additional
revenues by originating Monogram-based education loan portfolios, subject
to regulatory conditions, with the intent of holding them to maturity.
• Capital markets-Our capital markets experience coupled with our loan performance database and risk analytics expertise provide specialized
insight into funding options available to our clients. We have a right of
first refusal should one of our partner lenders wish to sell some or all
of its education loan portfolio prior to maturity. In addition to
traditional asset-backed securitizations, funding options may also include
whole loan sales or other financing alternatives. We can also earn fees
for analytical and structuring work, on-going fees for portfolio
management services and net interest income by retaining a portion of the
equity in any of these transactions.
• Fee-for-service-Loan origination, portfolio management, tuition billing and payment processing, and refund management services are each available
on a stand-alone, fee-for-service basis. We offer outsourced tuition
planning, tuition billing and payment technology services for
universities, colleges and secondary schools through our subsidiary
Tuition Management Systems LLC, which we refer to as TMS.
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Business Trends, Uncertainties and Outlook
The following discussion of business trends, uncertainties and outlook focuses
on certain developments affecting our business since the beginning of fiscal
2013.
Loan Origination
We began originating education loans based on our Monogram platform in the
beginning of fiscal 2011 and providing services for two lender clients related
to school-certified education loan programs funded by these lender clients based
on our Monogram platform. During fiscal 2012, we began performing services for
Union Federal related to school-certified education loan programs based on our
Monogram platform, including a K-12 loan program. In June 2012, we launched a
Monogram-based loan program with a new lender client and in August 2012, we
launched a Monogram-based loan consolidation program with an existing client.
Our Monogram platform continues to provide us with an opportunity to originate,
administer, manage and finance education loans, and our lender clients'
Monogram-based loan programs are a significant step in our return to the
education financing marketplace.
The following table presents our loan origination metrics with respect to our
Monogram-based programs for the three months ended September 30, 2012 and 2011.
We refer to loans that we have approved following receipt of all applicant data,
including the signed credit agreement, required certifications from the school
or applicant and any required income or employment verification as booked loans.
We refer to loans for which we have disbursed loan funds on behalf of the lender
as disbursed loans.
For three months ended September 30, 2012 For three months ended September 30, 2011
Partnered Lending Union Federal Total Partnered Lending Union Federal Total
(dollars in thousands)
Booked Loans $ 63,089 $ 21,378 $ 84,467 $ 14,798 $ 16,481 $ 31,279
Disbursed Loans 33,077 12,925 46,002 7,256 7,479 14,735
Historically, we have processed the greatest loan application volume during the
summer and early fall months, as students and their families seek to borrow
money in order to pay tuition costs for the fall semester or the entire academic
year. Since we began originating the education loans at Union Federal in fiscal
2012, we have disbursed loans with weighted average FICO scores in the range of
750-760 and 84%-87% of these loans had co-signers. These credit qualities
demonstrate that our strong loan growth has been accomplished while also
focusing on providing loans to high credit quality borrowers.
Portfolio Performance
Credit performance of consumer-related loans generally has been adversely
affected by general economic conditions in the United States over the past four
years. These conditions have included higher unemployment rates and
deteriorating credit performance, including higher levels of education loan
defaults and lower recoveries on such defaulted loans. Although these conditions
have lessened to a certain extent recently, they may have a material adverse
effect on consumer loan portfolio performance in the future. Our Monogram-based
education loan portfolios have yet to experience significant adverse portfolio
performance as a majority of these portfolios has yet to experience more than
12-months of seasoning. Consequently, in evaluating loan portfolio performance,
we review projected gross default rates and projected post-default recovery
rates. Further, we evaluate the loan portfolio performance of the securitization
trusts that we previously facilitated and, accordingly, the estimated fair value
of our service revenue receivables from those trusts. The service revenue
receivables that remain on our consolidated balance sheet at September 30, 2012
and June 30, 2012 have not been significantly impacted by defaults or recoveries
since the trusts possess guarantees that help partially negate the overall
impact of any default activity. These securitization trusts are also cash
flowing, seasoned portfolios that, for the most part, have relatively short
weighted-average lives.
Capital Markets
We believe that conditions in the capital markets generally improved in fiscal
2012 compared to recent years. In particular, investors in asset-backed
securities, or ABS, demonstrated increased interest in ABS backed by private
education loans that exhibited a strong credit profile. Additionally, in fiscal
2012 investors demonstrated increasing interest in longer duration ABS in the
sector. We believe that, as a result of the recent market trends, there has been
a tightening in credit spreads for the private education loan securitization
marketplace during fiscal 2012 and the first quarter of fiscal 2013. The
structure and economics of any financing transaction may be materially different
from prior transactions that we have sponsored. Such differences may include
lower revenues as a result of wider credit spreads and higher initial cash
requirements on our part.
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Uncertainties
Our near-term financial performance and future growth depends in large part on
our ability to successfully and efficiently market our Monogram platform and TMS
services and originate education loans through Union Federal so that we may grow
and diversify our client base and revenues. Facilitated loan volume is a key
element of our financial results and business strategy, and we believe that the
results from the current peak origination season through the first quarter of
fiscal 2013 demonstrate market demand for Monogram-based education loans.
We have invested in our distribution capabilities over the course of the past
two years, including our school channel sales force and TMS, but we face
challenges in increasing loan volumes after our prolonged absence from the
marketplace. For example, competitors with larger customer bases, greater name
or brand recognition, or more established customer relationships than those of
our clients, have an advantage in attracting loan applicants at a lower
acquisition cost than us and making education loans on a recurring, or
"serialized," basis. These disadvantages for us are particularly acute in the
current peak origination season because we have only been operating
Monogram-based loan programs since fiscal 2011.
Outlook
Our long-term success depends on our ability to attract additional lender
clients, or otherwise obtain additional sources of interim or permanent
financing. This is particularly true because of the regulatory conditions and
approvals relating to the Union Federal Private Student Loan Program. To date,
we have entered into education loan program agreements based on our Monogram
platform with four lender clients, including our subsidiary Union Federal. We
are uncertain as to the degree of market acceptance that our Monogram platform
will achieve, particularly in the current economic environment where lenders
continue to evaluate their education lending business models. We believe,
however, that the credit quality characteristics of the loan portfolios
originated in the 2011-2012 and the 2012-2013 academic years will be attractive
to additional potential lender clients, as well as capital markets participants.
We also believe that the ability to permanently finance private education loan
portfolios through the capital markets would make our products and services more
attractive to lenders and would accelerate improvement in our long-term
financial results.
On October 19, 2012, FMD's subsidiary First Marblehead Education Loan Services
LLC currently d/b/a Cology LLC, which we refer to as Cology, completed its
acquisition of a substantial portion of the assets of Cology, Inc. and certain
of its affiliates, which we refer to as Cology, Inc., for $4.7 million in cash
and the assumption of certain liabilities. Cology, Inc. provided processing,
disbursement and life-of-loan servicing to over 250 credit unions and lending
institutions in the United States and processed over $450 million in private
education loans during the twelve month period ended June 30, 2012. We expect to
loan processing services to the former customers of Cology, Inc. similar to the
services provided to them by Cology, Inc. prior to the asset acquisition. In
addition, we expect to provide various Monogram products and services to these
customers to assist them in education loan product design, pricing, marketing,
reporting and analysis, as well as education loan portfolio management services.
We are uncertain of the volume of education loans to be generated by the
Monogram-based loan programs of our four lender clients, one of which is our
subsidiary Union Federal, or any additional lender clients, including clients
acquired through our asset acquisition of Cology, Inc., during fiscal 2013. It
is our view that returning to profitability will be dependent on a number of
factors, including our loan capacity and related volumes, expense management and
growth at TMS and Union Federal, and the availability of financing alternatives,
including our ability to successfully re-enter the securitization market. In
particular, we need to generate loan volumes substantially greater than those
that we have generated to date, as well as to develop funding capacity for
Monogram-based loan programs at loan volume levels greater than those of our
four lender clients with lower credit enhancement levels and higher capital
markets advance rates than those available today. We must also continue to
achieve efficiencies in attracting applicants, through loan serialization or
otherwise, in order to reduce our overall cost of acquisition.
Changes in any of the following factors could materially affect our financial
results:
• Demand for education financing, which may be affected by changes in limitations established by the federal government on the amount of federal
loans that a student can receive, the terms and eligibility criteria for
loans and grants under federal or state government programs and
legislation recently passed or currently under consideration;
• The extent to which our services and products, including our Monogram
platform, Cology offerings and TMS offerings, gain market share and remain
competitive at pricing favorable to us;
• The amount of education loan volume disbursed under our lender clients'
Monogram-based loan programs;
• Our ability to sell Monogram products and services to customers acquired
in our asset acquisition of Cology, Inc.;
• An adverse outcome relating to the federal income tax treatment of our sale of the trust certificate of NC Residuals Owners Trust, which we refer
to as the Trust Certificate, in fiscal 2009 or our asset services
agreement with the purchaser of the Trust Certificate, including any
challenge related to federal tax refunds previously received in the amount
of $176.6 million as a result of the audit currently being conducted by
the Internal Revenue Service, or IRS;
• Regulatory requirements applicable to Union Federal, TMS and us, including conditions and approvals relating to the Union Federal Private Student
Loan Program, which limit Union Federal's ability to fund education loans;
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• Conditions in the education loan financing market, including the costs or
availability of financing, rating agency assumptions or actions, and
market receptivity to private education loan asset-backed securitizations;
• The underlying loan performance of the Monogram-based loan programs, including the net default rates, unemployment rates, and the timing and
amounts of excess credit enhancements that may be material to us;
• The resolution of any appeal of the order of the Massachusetts Appellate Tax Board, or ATB, in the cases pertaining to our Massachusetts state
income tax returns;
• Application of critical accounting policies and estimates, which impact
the carrying value of assets and liabilities, as well as our
determinations to consolidate or deconsolidate a VIE;
• Application of The Dodd-Frank Wall Street Reform and Consumer Protection
Act, or Dodd-Frank Act, enacted in July 2010, through the supervisory
authority of the Consumer Financial Protection Bureau, or CFPB, which has
the authority to regulate consumer financial products such as education
loans, and to take enforcement actions against institutions marketing and
selling consumer financial products under its supervision, such as Union
Federal, and institutions that act as service providers to originators of
education loans, such as our subsidiary First Marblehead Education
Resources, or FMER;
• Applicable laws and regulations, which may affect the terms upon which lenders agree to make education loans, the terms of future portfolio
funding transactions, including disclosure and risk retention
requirements, recovery rates on defaulted education loans and the cost and
complexity of our loan facilitation operations; and
• Departures or long-term unavailability of key personnel.
Critical Accounting Policies and Estimates
Our consolidated financial statements have been prepared in accordance with U.S.
generally accepted accounting principles, or GAAP. The preparation of our
consolidated financial statements requires management to make estimates,
assumptions and judgments that affect the reported amounts of assets and
liabilities, and the disclosure of contingent assets and liabilities, at the
date of our financial statements, as well as the reported amounts of revenues
and expenses during the reporting period. We base our estimates, assumptions and
judgments on our historical experience, economic conditions and on various other
factors that we believe are reasonable under the circumstances. Actual results
may differ from these estimates under varying assumptions or conditions.
Our significant accounting policies are described more fully in Note 2, "Summary
of Significant Accounting Policies," in the notes to our unaudited consolidated
financial statements included in Part I of this quarterly report.
On an ongoing basis, we evaluate our estimates, assumptions and judgments,
particularly as they relate to accounting policies that we believe are most
important to the portrayal of our financial condition and results of operations.
We regard an accounting estimate or assumption underlying our consolidated
financial statements to be a "critical accounting estimate" where:
• The nature of the estimate or assumption is material due to the level
of subjectivity and judgment necessary to account for highly uncertain
matters or the susceptibility of such matters to change; and
• The impact of the estimates and assumptions on our financial condition
or operating performance is material.
We have discussed our accounting policies with the Audit Committee of the FMD
Board of Directors. We consider the following to be our critical accounting
policies:
• Whether or not to consolidate the financial results of a variable
interest entity, or VIE;
• The determination of goodwill and intangible asset impairment; and
• Income taxes relating to uncertain tax positions accrued for under
Financial Accounting Standards Board Interpretation, or FASB, No. 48,
Accounting for Uncertainty in Income Taxes (now incorporated into
Accounting Standards Codification, or ASC, 740, Income Taxes).
During the three months ended September 30, 2012, there were no significant
changes in our critical accounting policies from those disclosed in Item 7 of
Part II of our Annual Report under the heading "Management's Discussion and
Analysis of Financial Condition and Results of Operations-Liquidity and Capital
Resources-Application of Critical Accounting Policies and Estimates."
Results of Operations-Three Months Ended September 30, 2012 and 2011
Financial Results Summary
The financial results of operations include FMD and its subsidiaries for the
fiscal years then ended. These results are reported through our continuing
operations. Previously consolidated securitization trusts and the results of our
subsidiary First Marblehead Data Services, Inc., or FMDS, are included in
discontinued operations as discussed below for each of the fiscal years then
ended.
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Discontinued Operations
Upon our adoption of Accounting Standards Update, or ASU, 2009-16, Transfers and
Servicing (Topic 860)-Accounting for Transfers of Financial Assets, or ASU
2009-16, and ASU 2009-17, Consolidation (Topic 810)-Improvements to Financial
Reporting by Enterprises Involved With Variable Interest Entities, or ASU
2009-17, effective July 1, 2010, we consolidated 14 securitization trusts that
we facilitated during fiscal 2004 through fiscal 2008. The education loans
purchased by certain of the securitization trusts, which we refer to as the
Trusts, were initially subject to a default repayment guaranty by The Education
Resources Institute, Inc., or TERI, while the education loans purchased by other
securitization trusts, which we refer to as the NCT Trusts, were, with limited
exceptions, not TERI-guaranteed. Of the 14 securitization trusts consolidated on
July 1, 2010, 11 were Trusts and 3 were NCT Trusts. We refer to the consolidated
Trusts as the NCSLT Trusts and the consolidated NCT Trusts as the GATE Trusts.
Consistent with our goal of refining our business model and focusing on our
Monogram platform and tuition billing and payment processing services, we
disposed of certain components of our business in fiscal 2012. In particular, we
sold our variable interests in the Trusts, we sold our trust administrator,
FMDS, and we resigned as the special servicer of the Trusts, including the NCSLT
Trusts. In addition, the new third party owner of FMDS terminated the agreement,
effective September 30, 2012, with our subsidiary FMER for the special servicing
of the NCT Trusts, including the GATE Trusts. During the fourth quarter of
fiscal 2012, we determined that we no longer had any significant continuing
involvement in the operations relating to the NCSLT Trusts and the GATE Trusts
once FMER ceased to provide special servicing to these trusts. Further, we
concluded that this would occur within an appropriate assessment period for both
the NCSLT Trusts and the GATE Trusts. As such, we reported the operations and
activities relating to the NCSLT Trusts, the GATE Trusts and FMDS within
discontinued operations for all prior periods presented.
For additional information, see Note 3, "Discontinued Operations," in the notes
to our unaudited consolidated financial statements included in Part I of this
quarterly report and Note 3, "Discontinued Operations," in the notes to our
consolidated financial statements included in Item 8 of Part II of our Annual
Report.
Overall Results
The following table summarizes the results of our consolidated operations:
Three months ended Change between
September 30, periods
2012 2011 2012 - 2011
(dollars in thousands)
Revenues:
Net interest income:
Interest income $ 1,193 $ 554 $ 639
Interest expense (273 ) (239 ) (34 )
Net interest income 920 315 605
Provision for loan losses 74 172 (98 )
Net interest income after provision for loan losses 994 487 507
Non-interest revenues:
Tuition payment processing fees 7,424 7,279 145
Administrative and other fees 3,415 2,389 1,026
Fair value changes to service revenue receivables 838 948 (110 )
Total non-interest revenues 11,677 10,616 1,061
Total revenues 12,671 11,103 1,568
Total non-interest expenses 26,208 30,681 (4,473 )
Loss from operations (13,537 ) (19,578 ) 6,041
Other income - 1,124 (1,124 )
Loss from continuing operations, before income taxes (13,537 ) (18,454 )
4,917
Income tax expense from continuing operations 395 339 56
Loss from continuing operations (13,932 ) (18,793 ) 4,861
Discontinued operations, net of taxes - (69,165 ) 69,165
Net loss $ (13,932 ) $ (87,958 ) $ 74,026
The net loss on a consolidated basis improved $74.0 million from a net loss of
$88.0 million for the three months ended September 30, 2011 to a net loss of
$13.9 million for the three months ended September 30, 2012. The net loss from
continuing operations improved
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by $4.9 million to a net loss of $13.9 million, or $(0.14) per share on a fully
diluted basis, for the three months ended September 30, 2012 from a net loss
from continuing operations of $18.8 million, or $(0.19) per share on a fully
diluted basis, for the three months ended September 30, 2011. The improvement in
the net loss from continuing operations was largely driven by a decrease in
non-interest expenses of $4.5 million coupled with an increase of $1.1 million
in non-interest revenues partially offset by a decrease in $1.1 million in other
income.
The net loss from discontinued operations, net of taxes totaled $69.2 million,
or $(0.68) per share on a fully diluted basis, for the three months ended
September 30, 2011. The revenues and expenses of discontinued operations for the
three months ended September 30, 2011 were as follows:
For the three months
ended September 30, 2011
(dollars in thousands)
Total revenues $ (65,931 )
Total expenses 9,652
Other income 6,881
Net loss from discontinued operations, before
income taxes (68,702 )
Income tax expense 463
Discontinued operations, net of taxes $ (69,165 )
Net Interest Income after Provision for Loan Losses
Net interest income after provision for loan losses for the three months ended
September 30, 2012 increased by $507 thousand, compared to the three months
ended September 30, 2011. The increase resulted from an improved net interest
margin primarily as a result of increased investments in our higher-yielding
education loans and investment securities.
Non-Interest Revenues
Non-interest revenues include tuition payment processing fees earned by TMS,
fee-for-service revenues for loan origination and program support and fees
related to our Monogram platform, as well as fees for portfolio management.
Non-interest revenues for the three months ended September 30, 2012 were $11.7
million, up $1.1 million from the three months ended September 30, 2011. The
increase was principally the result of increased loan processing and market
support fees received in conjunction with our Monogram platform as a result of
significantly higher partnered lending loan disbursements.
Fair value changes to service revenue receivables We record our service revenue
receivables at fair value on our consolidated balance sheet. At September 30,
2012, our service revenue receivables consisted of additional structural
advisory fee and residual receivables and represent the estimated fair value of
the service revenue receivables expected to be collected over the life of the
various separate securitization trusts that have purchased education loans
facilitated by us, with no further service obligations on our part. Changes in
the estimated fair value of the service revenue receivables due, less any cash
distributions received, were recorded in our consolidated statement of
operations within the fair value changes to service revenue receivables. Prior
to the sale of our variable interests in the Trusts on November 14, 2011, we
recorded asset servicing fees and additional structural advisory fees related to
the NCSLT Trusts. As compensation for our services related to asset servicing,
we were entitled to a monthly asset servicing fee based on the aggregate
outstanding principal balance of the education loans owned by the Trusts.
In the absence of market-based transactions, we use cash flow modeling
techniques to derive a Level 3 estimate of fair value for financial reporting
purposes. Significant observable and unobservable inputs used to develop our
fair value estimates include, but are not limited to, recovery, default and
prepayment rates, discount rates and the forward London Interbank Offered Rate,
or LIBOR, curve. See "-Financial Condition-Loans-Service Revenue Receivables"
below for a more detailed description of the estimation process at September 30,
2012.
The following table summarizes the estimated increases in the fair value changes
in our service revenue receivables:
Three months ended
September 30,
2012 2011
(dollars in thousands)
Additional structural advisory fees $ 69 $ 479
Residuals 769 413
Asset servicing fees - 56
Total fair value changes to service revenue receivables $ 838 $ 948
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Non-Interest Expenses
The following table reflects the composition of non-interest expenses:
Three months ended Change between
September 30, periods
2012 2011 2012 - 2011
(dollars in thousands)
Compensation and benefits $ 8,813 $ 10,901 $ (2,088 )
General and administrative:
Third-party services 5,993 6,864 (871 )
Depreciation and amortization 1,006 1,234 (228 )
Marketing 3,164 4,501 (1,337 )
Occupancy and equipment 3,095 3,186 (91 )
Servicer fees 168 169 (1 )
Other 3,969 3,826 143
Total general and administrative 17,395 19,780 (2,385 )
Total non-interest expenses $ 26,208 $ 30,681 $ (4,473 )
Total number of employees at fiscal quarter-end 296 341 (45 )
Compensation and Benefits Compensation and benefits expenses for the three
months ended September 30, 2012 was $8.8 million. The decrease of $2.1 million
for the three months ended September 30, 2012 as compared to the three months
ended September 30, 2011 was principally the result of lower headcount due to
expense reduction efforts during the three months ended September 30, 2012 and
certain severance costs incurred during the three months ended September 30,
2011.
General and Administrative General and administrative expenses for the three
months ended September 30, 2012 decreased by $2.4 million compared to the three
months ended September 30, 2011. The decrease in the three months comparison was
largely driven by a decrease in marketing costs of $1.3 million related to our
loan acquisition efforts and third party services of $871 thousand as a result
of lower costs relating to special servicing and decreased professional fees.
Other Income
We recorded other income of $1.1 million for the three months ended
September 30, 2011 due to resolution of certain matters related to the TERI
reorganization. This income represented cash distributions from the liquidating
trust under TERI's confirmed plan of reorganization.
Income Taxes
We are subject to federal income tax, as well as income tax in multiple U.S.
state and local jurisdictions. Our effective income tax rate is calculated on a
consolidated basis. The IRS has begun an audit of our tax returns for fiscal
years 2007 through 2010. In addition, we are involved in several matters before
the ATB relating to the Massachusetts tax treatment of GATE Holdings, Inc.,
which we refer to as GATE, a former subsidiary of FMD. See Note 10, "Commitments
and Contingencies-Income Tax Matters," in the notes to our unaudited
consolidated financial statements included in Part I of this quarterly report
for additional information regarding these matters.
Our state income tax returns in jurisdictions other than Massachusetts remain
subject to examination for various fiscal years ended between June 30, 2008 and
June 30, 2012.
Income tax expense from continuing operations for the three months ended
September 30, 2012 and 2011 was $395 thousand and $339 thousand, respectively.
Beginning in fiscal 2011, we no longer had any taxable income in prior periods
to offset current period net operating losses. As a result, we recorded a net
operating loss carryforward asset as of September 30, 2012 and June 30, 2012,
totaling $32.7 million and $28.0 million, respectively, for which we recorded a
full valuation allowance.
Under current law, we do not have remaining taxes paid within available net
operating loss carryback periods, and it is more likely than not that our
deferred tax assets will not be realized through future reversals of existing
temporary differences or available tax planning strategies. Accordingly, we have
determined that a valuation allowance is necessary for all of our deferred tax
assets not scheduled to reverse against existing deferred tax liabilities as of
September 30, 2012 and June 30, 2012. We will continue to review the recognition
of deferred tax assets on a quarterly basis.
Financial Condition
Total assets increased by $22.6 million since June 30, 2012. Total loans
held-to-maturity increased by $13.6 million, or 33%, during the first three
months of fiscal 2013, with increases of $12.3 million in education loans and
$1.3 million in mortgage loans. Restricted
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cash increased by $18.1 million, offset by a decrease in restricted funds due to
clients of $18.7 million. Investments available-for-sale increased by $5.5
million due to a purchase of a mortgage-backed security of $8.1 million
partially offset by principal repayments and deposits in participation accounts
increased by $4.9 million. Our financial position at September 30, 2012 and
June 30, 2012 reflects our efforts to diversify and grow our fee-for-services
platforms.
Cash, Cash Equivalents and Short-term Investments
We had combined cash, cash equivalents and short-term investments of $186.9
million and $208.5 million at September 30, 2012 and June 30, 2012,
respectively. Of this total, FMD and its non-bank subsidiaries held $155.0
million in interest-bearing and non-interest-bearing deposits, money market
funds and certificates of deposit with highly-rated financial institutions at
September 30, 2012. Union Federal held a total of $31.9 million in
interest-bearing and non-interest-bearing deposits and money market funds at
September 30, 2012. Union Federal is subject to restrictions on the payment of
dividends without prior approval from the Office of the Comptroller of the
Currency, or the OCC.
The decrease of $21.6 million resulted primarily from $10.8 million to fund
operations, $4.9 million to fund deposits in participation accounts on behalf of
certain of our partnered lenders as a result of higher loan origination
activity, and the continued investment in higher yielding assets, including
education loans.
Restricted Cash
At September 30, 2012, restricted cash on our consolidated balance sheet
included cash held by TMS of $79.2 million, net of $40.0 million held at Union
Federal, and restricted cash held by FMD of $4.3 million and its other non-bank
subsidiaries.
Restricted cash held by TMS represents tuition payments collected from students
or their families on behalf of educational institutions. These cash balances are
held in escrow under a trust agreement for the benefit of TMS' educational
institution clients and are generally subject to cyclicality, tending to peak in
August of each school year, early in the enrollment cycle, and to decrease
through May, the end of the school year. During fiscal 2012, TMS' restricted
cash balances ranged from a high of $346.8 million during August 2011 to a low
of $55.3 million during May 2012. In December 2011, we transferred $40.0 million
of TMS deposits from a third party institution to Union Federal. The deposit
remains subject to a trust agreement between TMS and a third party trustee.
Subject to the capital requirements and other laws, regulations, and
restrictions applicable to Union Federal, the cash that is deposited with Union
Federal in connection with the tuition payment plans is not restricted at Union
Federal and, accordingly, is not included in restricted cash and investments in
our consolidated financial statements. This treatment is consistent with how
third party institutions handle cash deposits by TMS. Restricted cash held by
our other subsidiaries relates to recoveries on defaulted education loans
collected on behalf of clients as well as undistributed loan origination
proceeds. We record a liability on our consolidated balance sheet representing
tuition payments due to our TMS clients, recoveries on defaults due to
securitization trusts and education loan proceeds due to schools.
Investments Available-for-Sale
Investments classified as available-for-sale are reported at fair value on our
balance sheet date. Our investment portfolio provides a source of short-term
liquidity and acts as a counterbalance to our loan and deposit flows.
Investments available-for-sale principally consisted of mortgage-backed federal
agency securities held by Union Federal at both September 30, 2012 and June 30,
2012. The investments available-for-sale increased by $5.5 million from $68.6
million as of June 30, 2012 to $74.1 million as of September 30, 2012 as a
result of Union Federal's purchase of $8.1 million in mortgage-backed securities
during the first three months of fiscal 2013. The portfolio had generated net
unrealized gains of $1.1 million and $610 thousand at September 30, 2012 and
June 30, 2012, respectively, which was recognized in accumulated other
comprehensive income, a component of stockholders' equity.
The following table provides a summary of investments available-for-sale by
major category:
Amortized cost Unrealized gains Unrealized losses Fair value
(dollars in thousands)
At September 30, 2012:
Government-sponsored enterprises
(GSE) mortgage-backed securities $ 57,516 $ 1,071 $ - $ 58,587
Mortgage-backed securities issued by
U.S. government agencies 15,505 202 (164 ) 15,543
Total $ 73,021 $ 1,273 $ (164 ) $ 74,130
At June 30, 2012:
GSE mortgage-backed securities $ 51,972 $ 369 $ (56 ) $ 52,285
Mortgage-backed securities issued by
U.S. government agencies 16,016 299 (2 ) 16,313
Total $ 67,988 $ 668 $ (58 ) $ 68,598
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At September 30, 2012 and June 30, 2012, two and three investment securities
totaling $9.0 million and $16.0 million, respectively, had unrealized losses of
$164 thousand and $58 thousand, respectively, and had been in an unrealized loss
position for less than one year. Management evaluates impairments in values,
whether caused by adverse interest rates or credit movements, to determine if
they are other-than-temporary. Additionally, management evaluates whether it
intends to sell, or will be required to sell, the debt securities before the
anticipated recovery of their remaining amortized cost. Management concluded the
unrealized losses at September 30, 2012 and June 30, 2012 were temporary in
nature.
Loans
At September 30, 2012 and June 30, 2012, we classified all education loans and
substantially all mortgage loans as held-to-maturity. The net carrying value of
loans consisted of the following, as of the dates indicated:
September 30, 2012 June 30, 2012
(dollars in thousands)
Education loans held-to-maturity, net $ 45,374 $ 33,095
Mortgage loans held-to-maturity, net 9,163 7,811
Education Loans Held-to-Maturity
We began originating Monogram-based loans through Union Federal in fiscal 2012.
At September 30, 2012 and June 30, 2012, education loans outstanding primarily
consisted of education loans held by Union Federal, totaling $45.6 million and
$33.3 million, respectively. Other education loans consisted of loans totaling
$1.1 million at both September 30, 2012 and June 30, 2012 that were transferred
by Union Federal to FMD in 2009 prior to the launch of our Monogram platform.
These loans were fully reserved for at September 30, 2012 and June 30, 2012.
The increase of $12.3 million in education loans at September 30, 2012 from
June 30, 2012 was related to disbursed education loans through our Monogram
platform at Union Federal.
The following table summarizes the composition of the net carrying value of our
education loans held-to-maturity as of the dates indicated:
September 30, 2012 June 30, 2012
(dollars in thousands)
Gross loan principal outstanding $ 46,734 $ 34,404
Allowance for loan losses (1,360 ) (1,309 )
Education loans held-to-maturity, net of
allowance $ 45,374 $ 33,095
Allowance for Loan Losses
The following is a roll forward of the net carrying value of education loans
held-to-maturity during the first quarter of fiscal 2013 and fiscal 2012:
Three months ended September 30,
2012 2011
Allowance Allowance
Gross loans for loan Net carrying Gross loans for loan Net carrying
outstanding losses value outstanding losses value
(dollars in thousands)
Balance, beginning of period $ 34,404 $ (1,309 ) $ 33,095 $ 1,336 $ (1,336 ) $ -
Disbursements of principal to
borrowers
12,925 - 12,925 7,479 - 7,479
Principal receipts from borrowers (794 ) - (794 ) (213 ) - (213 )
Interest capitalized on loans in
deferment and forbearance 17 - 17 5 (5 ) -
Interest capitalized on defaulted
loans 15 (15 ) - - - -
Provision for loan losses - 131 131 - 181 181
Net charge-offs (recoveries):
Charge-offs (18 ) 18 - (104 ) 104 -
Recoveries on defaulted loans 185 (185 ) - 201 (201 ) -
Net charge-offs 167 (167 ) - 97 (97 ) -
Balance, end of period $ 46,734 $ (1,360 ) $ 45,374 $ 8,704 $ (1,257 ) $ 7,447
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To estimate the allowance for loan losses on our newly originated Monogram-based
loan portfolio, we utilized specific default and recovery rates projected for
the Monogram-based loan portfolio over the 12-month loss confirmation period. We
may also apply qualitative adjustments in determining the allowance for loan
losses. Our default experience with this loan portfolio is limited by the
seasoning of the portfolio; however, we have utilized our historical database
and experience in projecting the level of defaults and recoveries of the
Monogram-based loan portfolio relying in part on historical results from our
securitization trusts that we previously facilitated for loans that have similar
credit characteristics to those in our Monogram-based loan portfolio.
At September 30, 2012 and June 30, 2012, there were $36 thousand and $54
thousand, respectively, of educations loans that were on non-accrual status and
no education loans that had specific reserves. These loans consisted of loans
that were transferred by Union Federal to FMD in 2009, prior to the launch of
our Monogram platform. Our policy is to have a specific allowance for loans
greater than 180 days past due, but not yet charged-off. Due to the nature and
extent of the Monogram-based education loans issued through Union Federal, none
of these loans were greater than 120 days past due at September 30, 2012 and
June 30, 2012.
Overall Education Loan Credit Quality
Management monitors the credit quality of an education loan based on loan
status, as outlined below. The impact of changes in loan status, such as
delinquency and time in repayment, is incorporated into the quarterly allowance
for loan loss calculation through our projection of defaults.
The following table represents our loan origination metrics with respect to our
Monogram-based programs held at Union Federal at September 30, 2012 and June 30,
2012:
September 30, June 30,
2012 2012
Weighted-average FICO score 752 753
Co-signers 84.2 % 84.8 %
Delinquent loans 0.19 % 0.03 %
The following table provides additional information on the status of education
loans outstanding:
As a percentage As a percentage
September 30, 2012 of total June 30, 2012 of total
(dollars in thousands)
Principal of loans outstanding:
In basic forbearance $ 197 0.4 % $ 171 0.5 %
In school and in deferment 19,459 41.6 14,781 43.0
In repayment, classified as:
Current: £30 days past due 26,823 57.4 19,289 56.0
Delinquent: >30 days past due, but £120 days
past due 219 0.5 109 0.3
Delinquent: >120 days past due, but
£180 days past due 36 0.1 54 0.2
In default: >180 days past due, but not yet
charged-off - - - -
Total gross loan principal outstanding $ 46,734 100.0 % $ 34,404 100.0 %
Non-accrual loan principal (>120 days past
due) $ 36 0.1 % $ 54 0.2 %
Past due loan principal (>90 days, but
£120 days past due still accruing interest) 8 0.0 11 0.0
We use the following terms to describe borrowers' payment status:
In School and In Deferment Pursuant to the terms of the education loans, a
borrower is eligible to defer principal and interest payments while carrying a
specified academic course load and may be eligible to defer payments for an
additional six months after graduation during a grace period. At the end of the
deferment period, any remaining accrued but unpaid interest is capitalized and
added to principal outstanding. At September 30, 2012, approximately 42% of
education loans were in school and in deferment.
In Repayment We determine the repayment status of a borrower, including a
borrower making payments pursuant to alternative payment plans, by contractual
due dates. A borrower making reduced payments for a limited period of time
pursuant to an alternative payment plan will be considered current if such
reduced payments are timely made. Under our Monogram platform, borrowers may be
in repayment while in school. Payment options while in school include full
principal and interest, partial interest and interest only.
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Forbearance Pursuant to the terms of the education loans, a borrower may apply
for forbearance, which is a temporary reprieve from making full contractual
payments. Forbearance can take many forms, at the option of the creditor. The
most common forms of forbearance include the following:
• Basic forbearance-Cessation of all contractual payments for a maximum
allowable forbearance period of one year, granted in three-month
increments.
• Alternative payment plans-Pursuant to an alternative payment plan, a
borrower can make a reduced payment for a limited period of time. The
amount of the payment varies depending on the program and may be set at a
fixed dollar amount, a percentage of contractual required payments or
interest-only payments. Generally, approval for alternative payment plans
is granted for a maximum of six to 24 months, depending on the program.
Although these plans are available as part of our Monogram-based programs,
they have not been substantially utilized due to the seasoning of our
Monogram-based education loan portfolio.
The use of forbearance is contemplated at the origination of an education loan
and is included in the credit agreement with the borrower. Under both basic
forbearance and alternative payment plans, the education loan continues to
accrue interest. When forbearance ceases, unpaid interest is capitalized and
added to principal outstanding, and the borrower's required payments are
recalculated at a higher amount to pay off the loan, plus the additional accrued
and capitalized interest, at the original stated interest rate by the original
maturity date. There is no forgiveness of principal or interest, reduction in
the interest rate or extension of the maturity date.
Forbearance programs result in a delay in the timing of payments received from
borrowers, but at the same time, assuming the collection of the forborne
amounts, provide for an increase in the gross volume of cash receipts over the
term of the education loan due to the additional accrued interest capitalized
while in forbearance. Forbearance programs may have the effect of delaying
default emergence, and alternative payment plans may reduce the utilization of
basic forbearance.
Mortgage Loans Held-to-Maturity
Through Union Federal we carry a held-to-maturity portfolio of mortgage loans.
We maintain an allowance for loan losses for our mortgage loan portfolio
held-to-maturity on a specific-identification basis when the loan becomes
30 days past due or the borrower makes modified payments. We set the allowance
for loan losses at an amount believed to be adequate so that the net carrying
value of the mortgage loan does not exceed the net realizable value of the
collateral. In addition, we establish a general allowance for loan losses for
mortgage loans less than 30 days past due based upon characteristics
attributable to the loans in the portfolio and the related collateral. A
mortgage loan for which we have foreclosed on the property is reclassified to
other real estate owned, a component of other assets, and is carried at
estimated net realizable value after any initial write-downs through the
allowance for loan losses. We do not have any mortgage loans greater than
90 days past due that are accruing interest.
Service Revenue Receivables
We record our service revenue receivables at fair value on our consolidated
balance sheet. At September 30, 2012 and June 30, 2012, our service revenue
receivables consisted of additional structural advisory fees and residual
receivables and represented the estimated fair value of the service revenue
receivables expected to be collected over the life of the various separate
securitization trusts that have purchased education loans facilitated by us,
with no further service obligations on our part related to the GATE Trusts and
other securitization trusts we previously facilitated.
Changes in the estimated fair value of the service revenue receivables due, less
any cash distributions received, are recorded in our consolidated statement of
operations within the fair value changes to service revenue receivables.
In the absence of market-based transactions, we use cash flow modeling
techniques to derive a Level 3 estimate of fair value for financial reporting
purposes. Such estimates include, but are not limited to, recovery, default and
prepayment rates, discount rates and the forward LIBOR curve.
The following table summarizes the fair value of our service revenue receivables
on our consolidated balance sheet as of the dates indicated:
September 30, June 30,
2012 2012
(dollars in thousands)
Additional structural advisory fees $ 2,716 $ 3,170
Residuals 13,351 13,171
Total fair value of service revenue receivables $ 16,067 $ 16,341
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Sensitivity to Changes in Assumptions
As noted above, the service revenue receivables recorded at June 30, 2012 were
related to the GATE Trusts and other securitization trusts we previously
facilitated. Unlike the NCSLT Trusts, these trusts are very well seasoned and
are not as sensitive to default rates or recovery rates because these trusts
have guarantees from schools and, in some cases, from a third party bank. As
such, these guarantees help to partially negate the overall impact of default
activity. In addition, the recoveries are returned back to the schools or bank,
as applicable, not the residual interest holder. Further, due to the seasoning
of these education loans, they have relatively short weighted-average lives and,
as such, are not significantly impacted by other assumptions, such as discount
rates. At September 30, 2012, there were no significant changes to the recovery,
default, prepayment and discount rate assumptions used.
Goodwill & Intangible Assets
Goodwill represents the excess of the cost of an acquisition over the fair value
of the net tangible and other intangible assets acquired. Other intangible
assets represent purchased assets that can be distinguished from goodwill
because of contractual rights or because the asset can be exchanged on its own
or in combination with a related contract, asset or liability. In connection
with our acquisition of TMS, we recorded other intangible assets related to the
TMS customer list and tradename, each of which we amortize on a straight-line
basis over 15 years, and technology, which we amortize on a straight-line basis
over six years. We record amortization expense in general and administrative
expenses in our consolidated statement of operations.
The customer list intangible asset is related to educational institutions with
which TMS had existing tuition programs in place as of December 31, 2010. The
trade name intangible asset relates to the name and reputation of TMS in the
tuition payment industry. Intangible assets attributable to technology
represented the replacement cost of software and systems acquired that are
necessary to support operations, net of an obsolescence factor. Goodwill
represents the value ascribed to the acquisition of TMS that cannot be
separately ascribed to a tangible or intangible asset.
In 2012, we evaluated our goodwill for impairment on May 31, which is our annual
impairment testing date, and concluded that the fair market value of the TMS
reporting unit was greater than 10% in excess of our recorded book value and,
therefore, was not impaired as of that date. In determining whether impairment
exists, we assess impairment at the level of the TMS reporting unit. There have
been no indicators of impairment since that date.
Various assumptions go into our assessment of whether there is any goodwill
impairment to be recorded. The more meaningful assumptions that contribute to
the cash flow model used to determine the fair value of the TMS reporting unit
include the net retention rate of new and existing clients, the penetration rate
achieved in the overall customer portfolio, adoption of refund management and
Campus Advantage products and pricing, the level of interest income to be earned
by TMS on funds received but not yet disbursed to client schools, including the
forward LIBOR curve, the level of cash balances and the applicable hold periods,
all of which impact net interest income, expense levels at TMS and the discount
rate used to determine the present value of the cash flow streams. TMS' business
would be adversely affected if any of the following were to occur: higher
attrition rates than planned as a result of the competitive environment or our
inability to provide products and services that are competitive in the
marketplace, lower than planned adoption rates of refund management and Campus
Advantage products, higher expense levels incurred to provide services to TMS'
clients, a lower interest rate environment than depicted by the LIBOR curve,
shorter hold periods or lower cash balances than contemplated, which would
reduce our overall net interest income opportunity for cash that is held by us
on behalf of our school clients, increases in equity returns required by
investors and changes in our business model that may impact one or more of these
variables.
During the quarter ended September 30, 2012, we recorded amortization expenses
on our intangible assets of $533 thousand, which reduced our balance of
intangible assets from $20.9 million at June 30, 2012 to $20.4 million at
September 30, 2012.
Contractual Obligations
Our consolidated contractual obligations consist of commitments under operating
leases. At September 30, 2012, there were no material changes from the
contractual obligations disclosed under Item 7 of Part II of our Annual Report
under the heading "Management's Discussion and Analysis of Financial Condition
and Results of Operations-Financial Condition-Contractual Obligations."
Total Stockholders' Equity
Total stockholders' equity decreased during the three months ended September 30,
2012 from June 30, 2012 as a result of our net loss of $13.9 million partially
offset by an increase in additional paid in capital for stock compensation of
$1.1 million and a $499 thousand increase in accumulated other comprehensive
income for the net unrealized gains on the investments available-for-sale
portfolio, net of tax.
Off-Balance Sheet Arrangements
We offer outsourcing services in connection with education loan programs, from
program design through securitization of the education loans. We have
historically structured and facilitated the securitization of education loans
for our clients through a series of special purpose trusts.
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The principal uses of the securitization trusts we facilitated have been to
generate sources of liquidity for our clients' and Union Federal's assets sold
into such trusts and make available more funds to students and colleges. See
Note 2, "Summary of Significant Accounting Policies-Consolidation" in the notes
to our unaudited consolidated financial statements included in Part I of this
quarterly report for a discussion of our determination to not consolidate these
securitization trusts.
Consolidated Average Balance Sheet
The following table reflects our consolidated average balance sheet, net
interest income and yields earned and paid on interest-earning assets and
interest-bearing liabilities from continuing operations:
Three months ended September 30,
2012 2011
Average Average Average Average
Balance Interest Yield Balance Interest Yield
(dollars in thousands)
Assets:
Interest-bearing cash and cash
equivalents $ 128,380 $ 53 0.16 % $ 211,652 $ 84 0.16 %
Short-term investments
69,239 102 0.59 50,000 57 0.45
Interest-bearing restricted cash 21,372 22 0.40 129,676 242 0.74
Investments available-for-sale 69,823 348 1.98 10,787 70 2.57
Education loans held-to-maturity 37,610 590 6.22 1,445 22 5.94
Mortgage loans held-to-maturity 8,720 78 3.56 6,824 79 4.63
Total interest-earning assets 335,144 1,193 1.41 410,384 554 0.54
Non-interest-bearing cash 1,054 2,230
Allowance for loan losses and lower of
cost or fair value adjustments (1,947 ) (2,225 )
Other assets 173,211 130,280
Total assets $ 507,462 $ 540,669
Liabilities:Time and savings account deposits $ 48,891 $ 125 1.02 % $ 41,830 $ 98 0.93 %
Money market account deposits
40,046 108 1.07 21,747 60 1.09
Other interest-bearing liabilities 2,607 40 6.10 5,456 81 5.95
Total interest-bearing liabilities 91,544 273 1.18 69,033 239 1.38
Non-interest-bearing deposits - 5
All other liabilities 195,838 224,463
Total liabilities 287,382 293,501
Stockholders' equity 220,080 247,168
Total liabilities and stockholders'
equity $ 507,462 $ 540,669
Total interest-earning assets $ 335,144 $ 410,384
Net interest income $ 920 $ 315
Net interest margin 1.09 % 0.30 %
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Analysis of changes in net interest income
Change between periods for three months ended September 30,
2012 - 2011
Due to change in
Volume Rate Net change
(dollars in thousands)
Interest-bearing cash and
cash equivalents $ (34 ) $ 3 $ (31 )
Short-term investments 28 17 45
Interest-bearing restricted
cash (108 ) (112 ) (220 )
Investments
available-for-sale 294 (16 ) 278
Education loans
held-to-maturity 567 1 568
Mortgage loans
held-to-maturity 17 (18 ) (1 )
Total interest income 639
Time and savings account
deposits 18 9 27
Money market account deposits 49 (1 ) 48
Other interest-bearing
liabilities (43 ) 2 (41 )
Total interest expense 34
Net increase in net interest
income $ 605
Liquidity and Capital Resources
Sources and Uses of Cash
The following is a discussion of sources and uses of cash on a GAAP basis as
presented in our consolidated statements of cash flows included in our unaudited
consolidated financial statements included in Part I of this quarterly report.
We also use a non-GAAP financial metric, "net operating cash usage," when
evaluating our cash and liquidity position, discussed in detail under "-Non-GAAP
Measure: Net Operating Cash Usage" below.
Net cash used in operating activities of continuing operations for the three
months ended September 30, 2012 was $19.9 million, compared with net cash used
in operating activities of continuing operations of $9.8 million for the three
months ended September 30, 2011. The increase in cash used was principally the
result of the change in net funding of participation accounts of $9.0 million as
the September 30, 2011 period included a $4.0 million return of cash.
We anticipate continuing to receive fees related to loan origination and
portfolio management services and fees related to Monogram-based loan programs.
We believe that our significant cash, cash equivalents and investments, coupled
with management of our expenses and these fees, will be adequate to fund our
operating losses in the short term as we seek to expand our client and revenue
base over the short- and long-term. We are uncertain, however, as to whether we
will be successful in selling our Monogram platform to additional lenders or how
much loan volume may be originated by current or any additional lenders in the
future.
Net cash provided by investing activities of continuing operations for the three
months ended September 30, 2012 was $6.1 million, compared with net cash used in
investing activities of continuing operations of $17.6 million for the three
months ended September 30, 2011. The improvement of $23.7 million was primarily
due to maturities of short-term investments of $25.0 million, and a reduction in
$4.8 million in net purchases of investments available-for-sale partially offset
by an increase in education loans held-to-maturity of $4.9 million. Net cash
provided by financing activities of continuing operations was $17.1 million for
the three months ended September 30, 2012, primarily reflecting an increase in
deposits. Net cash provided by financing activities of continuing operations was
$5.8 million for the three months ended September 30, 2011, primarily reflecting
an increase in deposits.
The OCC regulates all capital distributions by Union Federal directly or
indirectly to us, including dividend payments. Union Federal is required to
file a notice with the OCC at least 30 days before the proposed declaration of a
dividend or approval of a proposed capital distribution by Union Federal's board
of directors. Union Federal must file an application to receive the approval of
the OCC for a proposed capital distribution when, among other circumstances, the
total amount of all capital distributions (including the proposed capital
distribution) for the applicable calendar year exceeds net income for that year
to date plus the retained net income for the preceding two years.
A notice or application to make a capital distribution by Union Federal may be
disapproved or denied by the OCC if it determines that, after making the capital
distribution, Union Federal would fail to meet minimum required capital levels
or if the capital distribution raises safety or soundness concerns or is
otherwise restricted by statute, regulation or agreement between Union Federal
and the OCC or a condition imposed by an OCC agreement. Under the Federal
Deposit Insurance Corporation Improvement Act, or FDICIA, an Federal Deposit
Insurance Corporation, or FDIC, insured depository institution such as Union
Federal is prohibited from making capital distributions, including the payment
of dividends, if, after making such distribution, the institution would become
"undercapitalized" (as such term is used in the FDICIA).
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Sources and Uses of Liquidity
We expect to fund our short-term liquidity requirements primarily through cash
and cash equivalents and revenues from operations, and we expect to fund our
long-term liquidity requirements through revenues from operations and various
financing vehicles available to us in the ABS markets and may utilize issuances
of common stock, promissory notes or other securities. We expect to assess our
financing alternatives periodically and access the capital markets
opportunistically. If our existing resources are insufficient to satisfy our
liquidity requirements, or if we were to enter into a strategic arrangement with
another company, we may need to sell additional equity or debt securities. Any
sale of additional equity or convertible debt securities may result in
additional dilution to our stockholders, and we cannot be certain that
additional public or private financing 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 to further delay, reduce the scope of, or
eliminate one or more aspects of our operational activities, which could harm
our business.
Our liquidity and capital funding requirements may depend on a number of
factors, including:
• Cash necessary to fund our operations, including the operations of Union
Federal and TMS, and capital expenditures;
• The extent to which our services and products, including Monogram-based
loan programs and TMS offerings, gain market share and remain competitive
at pricing levels favorable to us;
• The results of the audit conducted by the IRS of our tax returns for fiscal
2007 through fiscal 2010, which could result in challenges to tax refunds
previously received in the amount of $176.6 million in connection with our
sale of the Trust Certificate;
• The profitability of our Monogram platform, which is dependent on, among
other things, the amount of loan volume our lender clients are able to
generate and costs incurred to acquire such volume;
• The extent to which we fund credit enhancement arrangements or contribute
to credit facility providers in connection with our Monogram platform;
• The ability to access wholesale financing opportunities within Union
Federal to help meet the liquidity needs generated by Monogram-based loans;
• The regulatory capital requirements applicable to Union Federal (see "-Support of Subsidiary Bank" below for additional information) as well as
any capital contributions FMD may make to Union Federal;
• The resolution of any appeal of the order issued by the Massachusetts
Appellate Tax Board on November 9, 2011, which we refer to as the ATB
Order, in the cases pertaining to our Massachusetts state income tax returns for fiscal 2004 through fiscal 2006, which could also affect our
state tax liabilities in subsequent tax years through fiscal 2009; and
• The timing, size, structure and terms of any securitization or other funding transactions that we structure, as well as the composition of the
loan pool being securitized;
Liquidity is required for capital expenditures, working capital, business
development expenses, business acquisitions, income tax payments, costs
associated with alternative financing transactions, general corporate expenses,
capital provided in connection with Monogram-based loan program credit
enhancement arrangements or capital markets transactions and maintaining the
regulatory capital of Union Federal. In order to preserve capital and maximize
liquidity in challenging market conditions, we have in past periods taken
certain broad measures to reduce the risk related to education loans and
residual receivables on our consolidated balance sheet, to change our fee
structure and to add new products and reduce our overhead expenses. See Item 7
of Part II of our Annual Report under the heading "Management's Discussion and
Analysis of Financial Condition and Results of Operations-Executive
Summary-Overview," for an expanded description of actions taken by us since
fiscal 2009 in response to the economic challenges facing us. In addition, the
FMD Board of Directors has eliminated regular quarterly cash dividends for the
foreseeable future.
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Deposits
Union Federal has liabilities for retail time, money market and savings deposits
accounts. The following table summarizes Union Federal's time deposits greater
than $100 thousand by maturity at September 30, 2012:
(dollars in thousands)
Within three months $ 222
Three to six months 2,460
Six months to twelve months 7,589
Greater than twelve months 9,041
Total time deposits >$100 thousand $ 19,312
The maturities of these deposits are not directly indicative of the future
timing of cash needed for financing activities because they do not take into
account the customers that may reinvest their funds into new time deposits or
into other types of deposit accounts.
Restricted Funds Due to Clients
As part of our TMS operations, we collect tuition payments from students or
their families on behalf of educational institutions. Included in restricted
cash on our consolidated balance sheet are recoveries on defaulted education
loans due to our portfolio management clients (primarily securitization trusts
facilitated by us), undisbursed education loan proceeds for our loan origination
clients and tuition payments in custody at other financial institutions. These
cash balances are recorded as restricted cash on our consolidated balance sheet
because they are deposited in segregated depository accounts. Included in
restricted funds due to clients on our consolidated balance sheet were tuition
payments due to our TMS clients, recoveries on defaults due to securitization
trusts and education loan proceeds due to students or schools.
Line of Credit
At September 30, 2012, through Union Federal we had $70.3 million available for
borrowing under an unused line of credit with the Federal Home Loan Bank of
Boston. There were no borrowings outstanding under this line of credit at
September 30, 2012 or June 30, 2012.
Support of Subsidiary Bank
Union Federal is a federally-chartered thrift that is subject to various
regulatory capital requirements administered by the federal banking agencies.
Failure to meet minimum capital requirements can result in initiation of certain
mandatory and possible additional discretionary actions by the regulators that,
if undertaken, could have a direct material effect on our liquidity. Under
capital adequacy guidelines and the regulatory framework for prompt corrective
action, Union Federal must meet specific capital guidelines that involve
quantitative measures of Union Federal's assets and liabilities as calculated
under regulatory accounting practices. The capital amounts and classifications,
however, are also subject to qualitative judgments by the regulators about
components, risk weightings and other factors.
Union Federal's equity capital was $19.1 million at September 30, 2012, up from
$16.3 million at June 30, 2012, principally due to a $2.3 million capital
contribution paid to Union Federal by FMD during the three months ended
September 30, 2012. Quantitative measures established by regulation to ensure
capital adequacy require Union Federal to maintain minimum amounts and ratios of
total capital and Tier 1 capital to risk-weighted assets (each as defined in the
regulations). As of September 30, 2012 and June 30, 2012, Union Federal was well
capitalized under the regulatory framework for prompt corrective action.
In March 2010, the FMD Board of Directors adopted resolutions required by the
U.S. Office of Thrift Supervision, or OTS, undertaking to support the
implementation by Union Federal of its business plan, so long as Union Federal
is owned or controlled by FMD, and to notify the OTS in advance of any
distribution to our stockholders in excess of $1.0 million per fiscal quarter
and any incurrence or guarantee of debt in excess of $5.0 million. These
resolutions continue to be applied by the Board of Governors of the Federal
Reserve System, or the Federal Reserve.
FMD is subject to regulation, supervision and examination by the Federal Reserve
as a savings and loan holding company, and Union Federal is subject to
regulation, supervision and examination by the OCC.
Union Federal's regulatory capital ratios were as follows as of the dates below:
Regulatory Guidelines
Well September 30, June 30,
Minimum Capitalized 2012 2012
Capital ratios:
Tier 1 risk-based capital 4.0 % 6.0 % 28.0 % 31.3 %
Total risk-based capital 8.0 10.0 28.3 31.7
Tier 1 (core) capital 4.0 5.0 11.1 11.0
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Table of Contents
Non-GAAP Measure: Net Operating Cash Usage
In addition to providing financial measurements based on GAAP, we present below
an additional financial metric that we refer to as "net operating cash usage"
that was not prepared in accordance with GAAP. We define "net operating cash
usage" to approximate cash required to fund our operations. "Net operating cash
usage" is not directly comparable to our consolidated statement of cash flows
prepared in accordance with GAAP. Legislative and regulatory guidance discourage
the use of, and emphasis on, non-GAAP financial metrics and require companies to
explain why a non-GAAP financial metric is relevant to management and investors.
Management and the FMD Board of Directors use this non-GAAP financial metric, in
addition to GAAP financial measures, as a basis for measuring and forecasting
our core operating performance and comparing such performance to that of prior
periods. This non-GAAP financial measure is also used by us in our financial and
operational decision-making.
We believe that the inclusion of this non-GAAP financial metric helps investors
to gain a better understanding of our results, including our non-interest
expenses and liquidity position. In addition, our presentation of this non-GAAP
financial measure is consistent with how we expect that analysts may calculate
their estimates of our financial results in their research reports and with how
clients, investors, analysts and financial news media may evaluate our financial
results.
There are limitations associated with reliance on any non-GAAP financial measure
because any such measure is specific to our operations and financial
performance, which makes comparisons with other companies' financial results
more challenging. Nevertheless, by providing both GAAP and non-GAAP financial
measures, we believe that investors are able to compare our GAAP results to
those of other companies, while also gaining a better understanding of our
operating performance, consistent with management's evaluation.
"Net operating cash usage" should be considered in addition to, and not as a
substitute for, or superior to, financial information prepared in accordance
with GAAP. "Net operating cash usage" excludes the effects of income taxes,
acquisitions or divestitures, participation account net fundings and changes in
other assets and other liabilities that are solely related to short-term timing
of cash payments or receipts.
In accordance with the requirements of Regulation G promulgated by the SEC, the
table below presents the most directly comparable GAAP financial measure, loss
from continuing operations, before income taxes, for the three months ended
September 30, 2012 and 2011 and reconciles the GAAP measure to the comparable
non-GAAP financial metric:
September 30,
2012 2011
(dollars in thousands)
Loss from continuing operations, before income taxes $ (13,537 ) $ (18,454 )
Adjustments to net loss from continuing operations,
before income taxes:
Fair value changes to service revenue receivables (838 ) (948 )
Depreciation and amortization 1,006 1,234
Stock-based compensation 1,068 1,342
TMS deferred revenue 1,458 781
Cash receipts from trust distributions 1,112 28
Other, net of cash flows from FMDS in 2011 (1,107 ) 147
Non-GAAP net operating cash usage $ (10,838 ) $ (15,870 )
"Net operating cash usage" for the three months ended September 30, 2012
decreased by $5.0 million compared to the three months ended September 30, 2011.
The decrease of $5.0 million for the three months ended September 30, 2012 as
compared to the three months ended September 30, 2011 was largely the result of
a decrease in non-interest expenses of $4.5 million driven principally by
decreases of $2.1 million in compensation and benefits expenses, $1.3 million in
marketing costs and $871 thousand in third party services and increased cash
receipts from trust distributions of $1.1 million offset by $1.1 million of cash
flows related to FMDS not received in the three months ended September 30, 2012.
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