I last wrote about First Marblehead (FMD) in early August at the height of the liquidity crisis as funding was drying up for nearly every lender and investors were worried about loan assets that might be impaired or overvalued on balance sheets. Since the fed cut the rate at the discount window and then cut the primary Federal Funds rate by 50 basis points last week, many of these fears have been either put to rest or shoved to the back burner. At the same time, I think Wall Street has begun to price securities on a case by case basis instead of the “shoot first, ask questions later” selling from last month. A beneficiary of this individual asset pricing is FMD who truly has little risk linked to a credit crisis due to the fact is is a consulting company and does not carry student loans on its books.
Yesterday (Wednesday) was a very quiet day for FMD as the stock hovered around the unchanged area nearly all day. Suddenly at 3:40 EST, I was surprised to see FMD shoot up nearly three dollars almost immediately. While the price action backed off a bit into the close, the stock finished the day up $1.41. Initially I couldn’t find any news on the stock, but an associate of mine was mentioning a quick drop in SLM Corp (SLM) which occurred at the exact same time. Sure enough they were related as FMD was trading off the news that several banks who were attempting to buy SLM was having second thoughts. If the SLM deal were to go bust, it would have a positive effect on FMD because of the business it currently does with these banks.
FMD’s primary business is to advise financial institutions on marketing and servicing plans for education loans. While SLM operates more on the funding side of the business, it also participates in consulting with the banks on how to set up these loan programs. There was some concern that a merged SLM would take business from FMD as banks would prefer to do the programming and servicing of the loans in house instead of outsourcing some of these functions to FMD. While many of the banks have publicly stated that they expect to continue their relationship with FMD, the SLM concern has been weighing heavily on FMD as an added burden to the stock price. It appears that if this deal is not able to be consummated, or if there are fewer banks participating in the acquisition, FMD will likely receive more business, and the stock price will lift as investors gain more confidence.
From a technical perspective, there still may be a good bit of supply having over the stock. $42.00 is a key area as that is the level from which the stock gapped down in April, and the level has been tested 3 times now as the stock attempts to repair the damage. But while FMD is not out of the woods yet, I believe investors are gaining more confidence in their long-term prospects and the company as a whole is becoming better understood.
FD: Author has long position in FMD.
First Marblehead Corp (FMD) Wicked Musical
September 30th, 2007 at 11:01 pm
You state:
FMD’s primary business is to advise financial institutions on marketing and servicing plans for education loans.
You could not be more wrong! First Marblehead’s main line of business is securitizing private student loans made by their client lending companies. First Marblehead’s advisory services on marketing and servicing plans for education loans is done at cost. The obligation that the clients enter with First Marblehead for this service is that, should they decide to securitize those loans, it will be done through First Marblehead.
October 9th, 2007 at 9:29 am
80% of revenues for the company come from securitization. I use to work in capital markets for them.
As long as they have volume, they are printing money out of the place.
Even with tighter liquidity, their sell-side perspective is weak, but volume will go up because more people go to school in a recession.
May 14th, 2008 at 11:44 am
`FIRSTMARBLE HEAD – FMD -(PRICE 3.40) MAY 12, 2008
BY: TRUTH-IN-MARKETS
FIRST MARBLEHEAD – WILL THERE BE MORE SUPRISES BEFORE THE AUDITORS SIGN OFF ON THE 6-30-08 10-K?
1. By the April of this year (08)First Marblehead (and its officers and directors) were
in its pre-audit stages, preparing for the fully audited 10-k to be approved by its outside auditors. Recall the company’s fiscal year ends 6-30-2008 and not 12-31-2008. Why is this important. As germane as it may sound, it is perhaps the single most important issue for traders; that is, if there is a second shoe to drop (or third), it will take place between now – the pre audit stages and mid-August the date the 10-k is filed. With the drum of the Enron/Arthur Anderson debacle echoing in the distant past, no audit firm, especially for the likes of FMD is going to sign off on a 10-k with accounting flaws. Hence, between now and the 10-k filing the Company will be forced to come clean on any remaining accounting issues or improprieties.
2. During this past week, was FMD began dropping hints as what is to come, or could it be that the worst is over? During the past 5 years defense lawyers have been coaching public companies on how to control damages when ugly accounting issues arise. These tactics involve delaying disclosure until a positive announcement can be made simultaneously to revealing the issue piece-meal (Sound Familiar? Issuing multiple press releases over a periods of months, slowly leaking the truth). Some may still subscribe to the old axiom that the company should take all it’s medicine at once. The truth is, some can’t afford to do so, especially a company who hasn’t completed a securitization and who may need to complete a securities offering in the absence of generating cash from securitizations. (Sounding even more familiar. Recall December‘s capital raise?? So, to the extent the past is a sign of what is to come, one can make a case that that more accounting issues are coming – just look at how management dealt with some key issues in the most recent past:
ISSUE #1
MANAGEMENT’S CANDOR CONCERNING THE FALL 2007 INVESTIGATION
3. That as part of the New York Attorney General’s ongoing investigation of several lending, educational, and nonprofit institutions, management rushed to rubber stamp new salaries, raises, bonuses and stock awards for themselves and just before the public would learn the company was a target of the investigation and that the co’s accounting was severely flawed.
4. While management’s 2007 compensation was already bloated,
Jack L. Kopnisky $ 800,000
Peter B. Tarr 800,000
John A. Hupalo 450,000
Anne P. Bowen 450,000
Andrew J. Hawley 425,000
5. Just days before the Co would admit it actually received the subponea, management 2007 loot was dwarfed by their incredible salaries and bonuses (second line) they earmarked for themselves for fiscal 2008
Jack L. Kopnisky
$ 1,000,000
$ 2,500,000
Peter B. Tarr
1,000,000
2,500,000
John A. Hupalo
550,000
1,000,000
Anne P. Bowen
450,000
525,000
Andrew J. Hawley
440,000
525,000
6. The company received a subpoena on August 22, 2007. The company’s own Vice Chairman, Abinder, who as a non-officer/director wasn’t able to reap the rewards his co-workers extracted (above) in the days prior, so on August 22, 2007, the very day the Company (later would admit) received the subponea, Abinder took it upon himself to quickly unload more than $1 million worth of his own FMD shares. Again, the Co’s own Vice Chairman, upon learning of the subponea on 8-22-07, sold over $1million worth – the same day!
7. Despite the fact the co. received a subpoena on August 22, 2007, it took every step to conceal its existence. On 8-28-07, the co filed its 10-k wherein the co denied it has legal issues of any kind, then in a press release distributed worldwide, The Company announced the co’s 10-k for 2007 was filed. Given the New York Attorney General’s ongoing investigation of several lending, educational, and nonprofit institutions and that the company was rumored to be a target of such investigations, the market may have been given false hope as it was temporarily tricked into believing the company had made it thru the preliminary investigations unscathed and that it was not a target or even a witness in the investigation. It wouldn’t be until nearly 2 weeks after the co received the subponea that the co was forced to admit its existence.
PROOF?
On 8-28-07 – the company filed its 10K With repect to legal proceedings, the co stated as follows:
Item 3. Legal Proceedings
None.
8. THEN, THE COMPANY EVEN ISSUES A PRESS RELEASE ANNOUNCING THE FILING OF ITS UNBLEMISHED 10-K
August 28, 2007, First Marblehead Corporation has today filed with the Securities Exchange Commission its annual report on Form 10-K for the fiscal year ended June 30, 2007.
The annual report on Form 10-K, which includes First Marblehead’s audited consolidated financial statements, is available for viewing and downloading, free of charge, through the Investors section of First Marblehead’s website at http://www.firstmarblehead.com, or through the Securities and Exchange Commission’s electronic data system at http://www.sec.gov.
Stockholders may also request a hard copy of First Marblehead’s annual report on Form 10-K, free of charge, by submitting a request through the Information Request section of First Marblehead’s website (www.firstmarblehead.com) or writing to Investor Relations, The First Marblehead Corporation, 800 Boylston Street, 34th Floor, Boston,
9. Then on August 31, 2007 , the markets were with shocked by the following revelation entitled
“Statement From The First Marblehead Corporation on the New York Attorney General’s Investigation”
BOSTON, MA-Aug 31, 2007 — The First Marblehead Corporation announced today that, as part of the New York Attorney General’s ongoing investigation of several lending, educational, and nonprofit institutions, the company received a subpoena on August 22, 2007 for information regarding our role in the student loan industry. We plan to cooperate fully with the Attorney General’s information requests.
ISSUE #2 MANAGEMENT’S CANDOR WHEN RAISING FUNDS
10. On November 9, 2007, the company filed its 10-Q which explained its assumptions for valuing Prepayment Rates, Residuals, and Advisory Fees again reminding investors they had taken all necessary adjustments for these assets and
stated in part:
Prepayment Rates. Loans in the securitization trusts have been experiencing higher prepayment rates than we had estimated would occur at certain points in the life of the loans as a result of a number of factors, including a prolonged unfavorable interest rate environment. During the third quarter of fiscal 2007, we altered our assumption regarding the annual rate of prepayments that we use to estimate the fair value of our residual and structural advisory fee receivables.
This fair value claim was convenient while raising funds the following month, but short lived:
11. On 12-21-07, the Company raised $59.8 million vis-à-vis the sale of preferred stock, an agreement to invest, (upon receipt of regulatory approval,) up to $200.7 million to acquire additional shares and also obtained a $1.0 billion warehouse facility.
The following month, after pocketing tens of millions of dollars, on 1-31-08, the Company began to admit their own accounting was flawed as they wrote down their loan related assets by hundreds of millions of dollars:
*With respect to “service receivables” the Company admitted:
Now let’s discuss the write-down of the service receivables that was recorded this quarter. As indicated previously we have adjusted down with the value of our service receivables by approximately $178 million as a result of revisions to the package of assumptions used to value our residuals and additional structural advisory fees.
Three quarters ago, we increased our assumption for the average prepayment rate from 7% to 8%. As we said in the past, we consider two important variables when considering data on prepayments. The rate of prepayments and the shape of the prepayment curve, that is, in what year do the prepayments occur in the life of a loan pool? The continued good news is that prepayment rates have continued to decline over the past year. But the changes we have observed to the shape of the curve have persisted. In this quarter we modified our assumption for the shape of the curve specifically by raising the assumed prepayment rates in each of the first three years of repayment.
For illustrative purposes slide 5, shows the relative shape of these curves with their projected average prepayment rates. The impact of this adjustment slightly increased the average prepayment rate from an average over the life of the pool of 8% to an average of 8.4%. This change resulted in a 5.4% or $50 million reduction in the fair value of the service receivables.
*Net Default Assumptions:
[w]e are adjusting our net default assumption. In order to provide investors with a more meaningful quantification to defaults we will report on net default rates, which are gross rates after recoveries. We will continue to provide investors with the underlying data from gross default rates and recoveries, but the more important metric measure is net defaults.
In this quarter, we have raised our assumption for the average net default rates for the portfolio from 5.81% to 7.68%. Our new assumption for the average projected gross default rate increases from 9.68% to 14.76% and the recovery rate increases from 40% to 48%. The resulting negative adjustment to our service receivables is $38.8 million or 4% of the service receivables. We believe that the favorable recovery rates we are currently observing in combination with improvements we expect from revised collections practices and tightened underwriting criteria will reduce net default rates overtime.
*With respect to the net discount rate, the defs admitted:
Next the discount rates. Given the unprecedented turmoil in the debt capital markets, the company increased the rate used to discount the residuals by 100 basis points to 13% for the trust that did not issue triple B securities and to a 14% for transactions with triple B issuance. Given spread widening and other markets, we also increased the discount rates for the additional structural advisory fees by 100 basis points to the 10 year treasury plus 300 basis points. The result is a negative adjustment of $54.6 million, or 5.8 of the service receivables.
With respect to the assumptions for future credit spread on our trust outstanding auction rate securities, the Company admitted:
The remaining write down of $34.4 million comes from our revised assumption for future credit spread on our trust outstanding auction rate securities.
12. By mid April, 2008, Goldman’s private-equity arm, GS Capital Partners, which made the commitment in December to invest up to $260.5 million in First Marblehead along with the December 07credit-line commitment, was getting cold feet. It invested $59.8 million at that time, with the remaining up to $200.7 million consummated in the following months, or Goldman was so originally duped into agree. So, in light of the companies revelations of even more accounting faux-pas and the decline in the share price Goldman rightfully not invest full original agreed to amount
13. As if the things could not have gotten worse, on 4-17-2008, the company’s key client/partner Bank of America, elected to exercise its right to terminate its agreements with First Marblehead, causing the equivalent of a stroke to this once Billion Dollar Corporation.
ISSUE #3 MANAGEMENT’S CANDOR WHEN CONCERNING THE NEED FOR FUTURE WRITEDOWNS
14. In the above release, the company does offer the following as a positive note as to the company’s future:
We believe that the favorable recovery rates we are currently observing in combination with improvements we expect from revised collections practices and tightened underwriting criteria will reduce net default rates overtime.
BUT WHAT HAPPENED LAST WEEK?
The company took a $315 million write-down on the value of service receivables, which is deteriorating as delinquencies increase.
ISSUE #4 WHAT ACTION, IF ANY, IS THERE WITH THE CO’S SHARES SO LOW?
15. THE COMPANY’S SHARES TRADING NEAR 3.50, IS IT SAFE TO GO BACK IN? WITH THIS CONSTANT CHANGE IN TUNE, THE AUDITORS WILL BE ESPECIALLY CAREFULL THIS YEAR BEFORE SIGNING OFF ON THE 10-K. ONE MIGHT CONSIDER SITTING ON THE SIDELINES UNTIL THE AUDIT IS OVER, THE 10-K IS FILED…AND THEN READ, VERY CAREFULLY. BUT GIVEN MANAGEMENT’S CREDIBILITY IT’S NOT A SURPRISE THAT THE OPEN INTEREST ON THE MAY 2.50 PUTS IS NEARLY 900% GREATER THAN THE MAY 2.50 CALLS. WITHOUT A CRYSTAL BALL, HINDSIGHT MAY BE A BETTER BAROMETER OF THE FUTURE…AT LEAST THE OPTION TRADERS APPARENTLY THINK SO. ONE THING IS CERTAIN HOWEVER, MANAGEMENT’S NOT GOING TO BE BELIEVED FOR A VERY LONG TIME.
FOR THOSE WITHOUT A POSITION
16. IF THE CO’S CASH IS GOING RUN OUT BEFORE THE CO’S STREET CREDIBILITY RETURNS, MAYBE THE FALL $2.50 PUTS ARE WORTH THE RISK.
FOR LONG TERM HOLDERS OR EVEN RECENT PURCHASERS:
17. While “hope” and “faith” helped many deal with the dark ages; relying on these to save the company from the bankruptcy courts provides infinitely greater odds than, having faith or hope in this management to turn this sinking ship around and away from the icebergs that have already caused hemorrhaging cash. Only if the company can find a buyer before its coffers have run dry will this albatross in your portfolio remain within the $2.00 to $4.00 range. The company’s next securitization is perhaps quarters away. The best outcome is for the company to reach the auction block before it makes its way to the bankruptcy courts. And remember, shareholders are “owners” if you have an opinion on whether the Board should be dismissed, sued, have their options cancelled or retain a banker to put the co up for sale, then WRITE TO THE BOARD AND TELL THE BOARD HOW YOU FEEL ABOUT THE WAY IT HAS RUN YOUR COMPANY.
Caveat 1:
18. If the co is sold the management will receive millions in “change of control payments” so consider demanding that management waive its right to these payments. After all, these extra payments do not fall out of the sky, the come out of the price that is offered for the company and redirected to management as “change of control” payments, retention bonuses, gross-up tax payments and accelerated vesting payments. Call it whatever fancy name you wish, it’s your money, demand it stay in the company or demand (with legal counsel, if necessary), that your investment be returned to you.
Caveat 2:
19. Given the status of the Company, it’s rare for management to show its hand so blatant, albeit hidden. That is, is it planning to turn the company around or is it anticipating walking up the steps of the bankruptcy court?
The Co’s most recent DEF 14A filed 10/5/2007, speaks volumes of management’s intent, when read carefully:
In the event of a proposed liquidation or dissolution of First Marblehead, our board of directors will provide that all then unexercised options under the director plan will become exercisable in full as of a specified time at least 10 business days prior to the effective date of the liquidation or dissolution and then terminate effective upon the liquidation or dissolution, if not previously exercised.
20. FMD, isn’t just sell, it’s a short.