Investing in FMD common stock involves a high degree of risk. You should carefully
consider the risks and uncertainties described below in addition to the other information included in Item 1A of Part II of this quarterly report. If any of the following risks actually occurs, our business, financial condition or results of
operations could be adversely affected, which, in turn, could have a negative impact on the price of FMD common stock. Although we have grouped risk factors by category, the categories are not mutually exclusive. Risks described under one category
may also apply to another category, and you should carefully read the entire risk factors section, not just any one category of risk factors.
We have
updated the risk factors described in this Item 1A to reflect financial and operating information for the most recently completed fiscal quarter. In addition, we have made material changes to the following risk factors as compared to the
version disclosed in Item 1A of Part I of our Annual Report under the heading “Risk Factors”:
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We have incurred net losses since fiscal 2008 and could incur losses in the future.
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Challenges exist in implementing revisions to our business model.
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The outsourcing services market for education financing is competitive and if we are not able to compete effectively, our revenues and results of operations may be adversely affected.
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If competitors or potential competitors acquire or develop an education loan database or advanced loan information processing system, our business could be adversely affected.
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Our business processes are becoming increasingly dependent upon technological advancement, and we could lose clients and market share if we are not able to keep pace with rapid changes in technology.
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Our liquidity could be adversely affected if we are unable to successfully resolve our pending state tax matters.
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We are subject to, or will become subject to, new supervision and regulations which could increase our costs of compliance and alter our business practices.
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Our financial results and future growth may continue to be adversely affected if we are unable to structure securitizations or alternative financings.
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The price of FMD common stock may be volatile.
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In addition, we added the following risk factor:
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While FP Resources USA Inc. has submitted a preliminary non-binding indication of interest regarding a possible acquisition of us, there can be no assurance that the discussions will advance beyond the preliminary stage
or that any acquisition or other transaction will be pursued or completed.
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Risks Related to Our Industry, Business and
Operations
We have incurred net losses since fiscal 2008 and could incur losses in the future.
We have generated significant net losses since fiscal 2008, and may continue to incur losses. There can be no assurance that we will report net income in any
future period. We must develop new lender client relationships and substantially increase our revenues derived from our Monogram platform and TMS offerings. We are actively managing our expenses in the current economic environment and in light of
the status of our business. To the extent that we are not able to increase our revenues and continue to manage our operating expenses, we will continue to experience net losses.
We will need to facilitate substantial loan volume, achieve market acceptance of our Monogram platform and TMS’ offerings and continue to manage
our expenses, among other things, in order to return to profitability.
Our ability to achieve and sustain profitability is dependent on many
factors. Primarily, we believe that the following must occur in order for us to return to profitability:
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We need to facilitate Monogram-based loan volumes substantially in excess of those that have been originated to date, and substantially in excess of those contemplated by our current lender clients’ Monogram-based
loan programs. Because the revenues that we expect to generate for Monogram-based loan programs will depend in part on the size, credit mix and actual performance of our lender clients’ loan portfolios, it is difficult for us to forecast the
level or timing of our revenues or cash flows with respect to our Monogram platform generally or a specific lender client’s Monogram-based loan program.
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We need to attract additional lender clients, or otherwise obtain additional sources of interim or permanent financing, such as securitizations or alternative financing transactions, particularly given that one of our
current lender clients provides the majority of our Monogram-based loan program fees, which subjects us to concentration risk as it relates to this revenue stream.
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Deployment of our Monogram platform, and disbursed loan volume under our lender clients’ Monogram-based loan programs, has been limited, and we will need to gain widespread market acceptance of our Monogram
platform among lenders, and of our lender clients’ Monogram-based loan programs among borrowers, in order to improve our long-term financial condition, results of operations and cash flow. If we do not succeed in doing so, we may need to
re-evaluate our business plans and operations.
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We need to gain widespread market acceptance of our refund management services and Student Account Center product among TMS’ existing clients as well as new clients, in order to improve our long-term financial
condition, results of operations and cash flow. In addition, it is uncertain whether our refund management services and Student Account Center product will generate the revenues required to be successful.
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We need to continue to actively manage our expenses in the current economic environment to better align costs with our business. In the past we have engaged in cost reduction initiatives and we may need to engage in
similar cost reduction initiatives in the future. Despite our efforts to structure our business to operate in a cost-effective manner, some cost reduction measures could have unexpected negative consequences. If we are unable to successfully manage
our expenses and run our business in a cost-effective manner, our results of operations would be harmed and it may impact our return to profitability.
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Challenges exist in implementing revisions to our business model.
Since the beginning of fiscal 2009, we have taken several measures to adjust our business in response to economic conditions. Most significantly, we refined
our service offerings and added fee-for-service offerings such as loan origination services and portfolio management. In fiscal 2010, we completed the development of our Monogram platform, including an expanded credit decisioning model and
additional reporting capabilities. We continue to incorporate refinements to our Monogram platform. In fiscal 2011, we began originating Monogram-based education loans under loan program agreements and began offering outsourced tuition planning,
tuition billing and payment technology services for educational institutions through TMS. In fiscal 2012, we began offering refund management services to educational institutions and students through TMS. In fiscal 2013, we began providing education
loan processing and disbursement services to credit union and other lender clients through Cology LLC. Successful sales of our service offerings, particularly our Monogram platform and TMS offerings, will be critical to stemming our losses and
growing and diversifying our revenues and client base in the future.
We are uncertain as to the degree of market acceptance that our Monogram platform
will achieve, particularly in the current economic and regulatory environment where there has been reluctance by many lenders to focus on education lending opportunities. As of May 10, 2016,
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we have loan program agreements with three lender clients for Monogram-based loan programs. We and one of our lender clients, which generates an immaterial portion of our Monogram-based loan
program fees, have agreed not to renew our loan program agreement at the end of the term on May 31, 2016. The process of negotiating loan program agreements can be lengthy and complicated. Both the timing and success of contractual negotiations
are unpredictable and partially outside of our control, and we cannot assure you that we will successfully identify potential clients or ultimately reach acceptable terms with any particular party with which we begin negotiations. Furthermore, we
cannot be sure that, if we do reach acceptable terms with any particular party, we will do so in a timely or cost-effective manner. Our failure to timely and cost-effectively enter into loan program agreements could have a material adverse effect on
our business, results of operations and financial condition.
Moreover, we are uncertain of the extent to which borrowers will choose Monogram-based loans
offered by our lender clients, which depends, in part, on competitive factors such as brand and pricing. Several of our current and potential competitors have longer operating histories and significantly greater financial, marketing, technical or
other competitive resources than we or our clients have, including funding capacity. As a result, our competitors or potential competitors may be better able to overcome capital markets dislocations, adapt more quickly to new or emerging
technologies and changes in customer preferences, compete for skilled professionals, build upon efficiencies based on a larger volume of loan transactions, fund internal growth and compete for market share, or may be able to devote greater resources
to the promotion and sale of their products and services. In particular, 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 and making education loans on a recurring, or “serialized,” basis. We are uncertain of the total application volume for fiscal 2016 and beyond, the extent to which application volume will ultimately result in disbursed
loans and the overall characteristics of the disbursed loan portfolio.
Commercial banks have historically served as the initial funding sources for the
education loans we facilitate and have been our principal clients. Since fiscal 2008, we have not facilitated securitization transactions to support the long-term funding of education loans, and commercial banks may be facing liquidity and credit
challenges from other sources, in particular mortgage, auto loan and credit card lending losses. In addition, the synergies that previously existed between federal and private education loan marketing have been eliminated by legislation that
eliminated the Federal Family Education Loan Program, or FFELP. As a result, many lenders have re-evaluated their business strategies related to education lending. In light of legislative and regulatory changes, general economic conditions, capital
markets disruptions and the overall credit performance of consumer-related loans, the education loan business may be less attractive to commercial banks than in the past. Demand for our services may not increase unless additional lenders enter or
re-enter the marketplace, which could depend in part on capital markets conditions and improved market conditions for other consumer financing segments.
Some of our former clients and competitors have exited the education loan market completely. To the extent that commercial banks exit the education loan
market, the number of our prospective clients diminishes. One of our primary challenges is to convince national and regional lenders that they can address this market opportunity in a manner that meets their desired risk control and return
objectives. A related challenge is to successfully finance education loans generated through our Monogram platform through capital market transactions or other sources of capital. We cannot assure you that we will be successful in either the
short-term or the long-term in meeting these challenges.
Our business model depends on our ability to facilitate Monogram-based education loan volumes
substantially in excess of those that have been originated to date and those contemplated by our current lender clients’ Monogram-based loan programs. We have been required to expend capital to support loan volume under our Monogram platform.
Specifically, we have been required to provide credit enhancements for Monogram-based loans originated by certain of our lender clients by funding participation accounts to serve as a first-loss reserve for defaulted program loans. While we believe
that we have sufficient capital resources to continue to provide such support to our Monogram platform under our business model, our ability to return to profitability while maintaining appropriate levels of liquidity will be predicated, in part, on
our ability to fund participation accounts at levels lower than we are today, as well as the availability of higher capital markets advance rates than are available today.
If we fail to manage our cost reductions effectively, our business could be disrupted and our financial results could be adversely affected.
We have engaged in cost reduction initiatives in the past and we may engage in cost reduction initiatives in the future. These types of cost
reduction activities are complex. Even if we carry out these strategies in the manner we expect, we may not be able to achieve the efficiencies or savings we anticipate, or on the timetable we anticipate, and any expected efficiencies and benefits
might be delayed or not realized, and our operations and business could be disrupted.
We continue to experience negative net operating cash flows. Our
continued use of cash to fund operations may necessitate further significant changes to our cost structure if we are unable to grow our revenue base to the level necessary to fund our ongoing operations.
In addition, cost reduction initiatives have placed and will continue to place a burden on our management, systems and resources, generally increasing our
dependence on key persons and reducing functional back-ups. We must retain, train, supervise and manage our employees effectively during this period of change in our business and our ability to respond in a timely and effective fashion to
unanticipated exigencies of our business model could be negatively affected during this transition.
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Although we believe that our capital resources as of March 31, 2016 are sufficient to satisfy our operating
needs for the succeeding 12 months, we cannot assure you that they will be sufficient. Insufficient funds could require us to, among other things, terminate employees, which could, in turn, place additional strain on any remaining employees and
could further disrupt our business, including our ability to grow and expand our business.
We may outsource some borrower or client service functions in
an effort to reduce costs, take advantage of technologies and effectively manage the seasonality associated with education loan volume and tuition payment processing. We rely on our vendors to provide high levels of service and support. Our reliance
on external vendors subjects us to risks associated with inadequate or untimely service and could result in problems with service or support that we would not experience if we performed the service functions in-house.
If we are unable to manage our cost reductions, or if we lose key employees or are unable to attract and properly train new employees, our operations and our
financial results could be adversely affected.
If we are unable to retain our key employees and hire qualified sales and technical personnel, our
ability to compete could be harmed.
Our future success depends upon the continued services of our executive officers and other key personnel who
have critical industry experience and relationships. If we were to lose the services of any of our executive officers and other key personnel and were not able to find replacements in a timely manner, our business could be disrupted, it could hinder
or delay the implementation of our business model and the development and introduction of, and negatively impact our ability to sell, our services and other key personnel might decide to leave.
Members of our senior management team and other key personnel have left First Marblehead over the years for a variety of reasons, some of whom possessed
institutional knowledge and experience with our business that could not be immediately replaced through the hiring of new managers. In addition, there is significant competition for talented individuals in our industry, which affects both our
ability to retain key employees and hire new ones.
We have provided credit enhancements in connection with Monogram-based loan programs for certain
of our lender clients and may enter into similar arrangements in connection with future loan programs. As a result, we have capital at risk in connection with our lender clients’ loan programs. We may lose some or all of the capital we have
provided and our financial results could be adversely affected.
In connection with certain of our lender clients’ Monogram-based loan
programs, we have provided credit enhancements by funding participation accounts to serve as a first-loss reserve for defaulted program loans. We have limited amounts of cash available to offer to prospective clients, and there is a risk that
lenders will not enter into loan program agreements with us unless we offer credit enhancement. We expect that the amount of any such credit enhancement arrangement offered to a particular lender would be determined based on the particular terms of
the lender’s loan program, including the anticipated size of the lender’s program and the underwriting guidelines of the program, as well as the particular terms of our business relationship with the lender. Should additional lenders
require credit enhancement from us as a condition to entering into a loan program agreement, our growth may be constrained by the level of capital available to us.
We have made deposits pursuant to our credit enhancement arrangements and agreed to provide periodic supplemental deposits, up to specified limits, during the
disbursement periods under our loan program agreements based on the credit mix and volume of disbursed program loans and adjustments to default projections for program loans. To the extent that outstanding loan volume decreases as a result of
repayments, or if actual loan volumes or default experience are less than our funded amounts, we are eligible to receive periodic releases of funds. The timing and amount of releases, if any, from the participation accounts are uncertain and vary
among the loan programs. As of March 31, 2016, the fair value of our funded credit enhancements was $22.6 million. We could lose some or all of the amounts that we have deposited, or will deposit in the future, in the participation accounts,
depending on the performance of the portfolio of program loans. Such losses would weaken our financial position and could damage business prospects for our Monogram platform.
Our Monogram platform is based on proprietary scoring models and risk mitigation and pricing strategies that we have developed. We have limited experience
with the actual performance of loan portfolios generated by lenders based on our Monogram platform, and we may need to adjust marketing, pricing or other strategies from time to time based on the distribution of loan volume among credit tiers or
competitive considerations. We must closely monitor the characteristics and performance of each lender’s loan portfolio in order to suggest adjustments to the lenders’ programs and tailor our default prevention and collection management
strategies. The infrastructure that we have built for such monitoring requires extensive operational and data integration among the loan servicer, multiple default prevention and recovery collection agencies and us. To the extent that our
infrastructure is inadequate or we are otherwise unsuccessful in identifying portfolio performance characteristics and trends, or to the extent that lenders are unwilling to adjust their loan programs, our risk of losing amounts deposited in the
participation accounts may increase.
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The outsourcing services market for education financing is competitive and if we are not able to compete
effectively, our revenues and results of operations may be adversely affected.
We offer our clients and prospective clients, national and
regional financial and educational institutions, services in structuring and supporting their education loan programs and tuition payment processing plans. The outsourcing services market in which we operate is competitive with a number of active
participants, some of which have longer operating histories and significantly greater financial, marketing, technical or other competitive resources than we or our clients have, including funding capacity. As a result, our competitors or potential
competitors may be better able to overcome capital markets dislocations, adapt more quickly to new or emerging technologies and changes in customer preferences, compete for skilled professionals, build upon efficiencies based on a larger volume of
loan transactions, fund internal growth and compete for market share, or may be able to devote greater resources to the promotion and sale of their products and services. In particular, competitors with larger customer bases, greater name or brand
recognition or more established customer relationships than us or those of our clients have an advantage in attracting loan applicants at a lower acquisition cost.
Based on the range of services that we offer, we believe that SLM Corporation, also known as Sallie Mae, is our principal competitor. Our business could be
adversely affected if Sallie Mae’s private education loan program continues to grow, or if Sallie Mae seeks to market more aggressively to third parties the full range of services that we offer. Other education loan competitors include Wells
Fargo & Company and Discover Financial Services. In addition, Nelnet Business Solutions, TouchNet Information Systems, Inc. and Higher One Holdings, Inc. compete directly with TMS and LendKey Technologies, Inc. and Campus Door Holdings Inc.
compete directly with Cology LLC.
Demand for our services could also be affected by developments with regard to federal loan programs. For example, in
Spring 2015, the President announced a “Student Aid Bill of Rights” that would seek, among other initiatives, to increase certain grant aid and reduce certain tuitions, both of which could decrease the demand for private education loans.
We cannot assure you that we will be able to compete successfully with new or existing competitors. If we are not able to compete effectively, our
results of operations may be adversely affected.
If our clients do not actively or successfully market and fund education loans, our business will
be adversely affected.
We have in the past relied, and will continue to rely in part, on our clients to market and fund education loans to
borrowers. If our clients do not devote sufficient time, emphasis or resources to marketing their Monogram-based loan programs or are not successful in these efforts, then we may not reach the full potential of our capacity for disbursed loan volume
and our business will be adversely affected. In addition, our lender clients’ Monogram-based loan programs, and related marketing efforts, may not necessarily extend nationwide and, in fact, may focus on a limited geographic footprint.
In addition, if education loans were or are marketed by our clients in a manner that is found to be unfair, deceptive or abusive, or if the marketing,
origination or servicing violated or violates any applicable law, federal or state unfair and deceptive practices acts could impose liability or, in limited circumstances, create defenses to the enforceability of the loan. Investigations by state
Attorneys General, the CFPB, the U.S. Congress or others could have a negative impact on lenders’ desire to originate and market education loans. The Higher Education Opportunity Act creates significant additional restrictions on the marketing
of education loans.
Our business could be adversely affected if PHEAA fails to provide adequate, proper or timely services or if our relationship
with PHEAA terminates.
As of March 31, 2016, Pennsylvania Higher Education Assistance Agency, also known as AES and which we refer to as
PHEAA, served as the sole loan servicer for our Monogram-based loan programs. Our arrangements with PHEAA allow us to avoid the overhead investment in servicing operations, but require us to rely on PHEAA to adequately service the education loans,
including collecting payments, responding to borrower inquiries, effectively implementing servicing guidelines applicable to loans and communicating with borrowers whose loans have become delinquent. Reliance on PHEAA and other third parties to
perform education loan servicing or collections subjects us to risks associated with inadequate, improper or untimely services. In the case of PHEAA, these risks include the failure to properly administer servicing guidelines, including forbearance
programs, and failure to provide notice of developments in prepayments, delinquencies and defaults, and usage rates for forbearance programs, including alternative payment plans. In the case of third-party collection agencies, these risks include
failure to properly administer collections guidelines and compliance with federal and state laws and regulations relating to interactions with debtors. If our relationship with PHEAA terminates, we would either need to expand our operations or
develop a relationship with another loan servicer, which could be time consuming and costly. In such event, our business could be adversely affected.
If competitors or potential competitors acquire or develop an education loan database or advanced loan information processing system, our business could
be adversely affected.
We own a database of historical information on education loan performance that we use to help us enhance our proprietary
origination risk score model, determine the terms of portfolio funding transactions and derive the estimates and assumptions we make in preparing our consolidated financial statements and cash flow models. We have also developed a proprietary loan
information processing system to enhance our application processing and loan origination capabilities. We believe that our education loan database and loan
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information processing system provide us with a competitive advantage in offering our services. A third party could create or acquire databases and systems such as ours. As lenders and other
organizations in the education loan market originate or service loans, they compile over time information for their own education loan performance database. Our competitors and potential competitors may have originated or serviced a greater volume
of education loans than we have over the past several years, which may have provided them with comparatively greater borrower or loan data, particularly during the most recent economic cycle. If a third party creates or acquires an education loan
database or develops a loan information processing system, our competitive positioning, ability to attract new clients and business could be adversely affected.
If we are unable to protect the confidentiality of our proprietary information and processes, the value of our services and technology could be
adversely affected.
We rely on trade secret laws and restrictions on disclosure to protect our proprietary information and processes. We have
entered into confidentiality agreements with third parties and with most of our employees to maintain the confidentiality of our trade secrets and proprietary information. These methods may neither effectively prevent use or disclosure of our
confidential or proprietary information nor provide meaningful protection for our confidential or proprietary information if there is unauthorized use or disclosure.
We own no material patents. Accordingly, our technology, including our loan information processing system, is not covered by patents that would preclude or
inhibit competitors from entering our market. Monitoring unauthorized use of the systems and processes that we have developed is difficult, and we cannot be certain that the steps that we have taken will prevent unauthorized use of our technology.
Furthermore, others may independently develop substantially equivalent proprietary information and techniques or otherwise gain access to our proprietary information. If we are unable to protect the confidentiality of our proprietary information and
know-how, the value of our technology and services could be adversely affected.
An interruption in or breach of our information systems, or those
of a third party on which we rely, may result in lost business.
We rely heavily upon communications and information systems to conduct our
business. Our systems and operations are vulnerable to damage or interruption from network failure, hardware failure, software failure, power or telecommunications failures, computer viruses and worms, penetration of our network by hackers or other
unauthorized users and natural disasters. Any failure, interruption or breach in security of our information systems or the third-party information systems on which we rely could cause underwriting or other delays and could result in fewer loan
applications being received, slower processing of applications or tuition-related payments and reduced efficiency in loan processing or our other services, including TMS’ and Cology LLC’s offerings. A failure, interruption or breach in
security could also result in an obligation to notify clients in a number of states that require such notification, with possible civil liability and potentially large fines and penalties resulting from such failure, interruption or breach. Although
we maintain and periodically test a business continuity and disaster recovery plan, the majority of our infrastructure and employees are concentrated in the Medford, Massachusetts, Warwick, Rhode Island and Sacramento, California metropolitan areas.
An interruption in services for any reason could adversely affect our ability to activate our contingency plan if we are unable to communicate among locations or employees.
We cannot assure you that systems failures, interruptions or breaches will not occur, or if they do occur that we or the third parties on whom we rely will
adequately address them. The precautionary measures that we have implemented to avoid systems outages and to minimize the effects of any data or communication systems interruptions may not be adequate, and we may not have anticipated or addressed
all of the potential events that could threaten or undermine our information systems. The occurrence of any systems failure, interruption or breach could significantly impair the reputation of our brand, diminish the attractiveness of our services
and harm our business.
Our business processes are becoming increasingly dependent upon technological advancement, and we could lose clients and
market share if we are not able to keep pace with rapid changes in technology.
Our future success depends, in part, on our ability to process
loan applications and tuition-related payments in an automated manner with high-quality service standards. The volume of loan originations and tuition-related payments that we are able to process is based, in large part, on the systems and processes
we have implemented and developed. These systems and processes are becoming increasingly dependent upon technological advancement, such as the ability to review applications and process loans and payments via the Internet, accept electronic
signatures and provide initial credit decisions instantly. Our future success also depends, in part, on our ability to develop and implement technology solutions that anticipate and keep pace with continuing changes in technology, industry standards
and client preferences. We may not be successful in anticipating or responding to these developments on a timely basis. In addition, the industry in which TMS competes has undergone rapid technological change over the past several years. We have
made, and need to continue to make, investments in our technology platform in order to provide competitive products and services to our clients. If competitors in any business line introduce products, services, systems and processes that are better
than ours or that gain greater market acceptance, those that we offer or use may become obsolete or noncompetitive. In addition, if we fail to execute our lender clients’ origination requirements or properly administer our lender clients’
credit agreements or required disclosures, if TMS fails to properly administer its tuition payment plans or other services or if Cology LLC fails to properly provide its education loan processing and disbursement services, we could be subject to
breach of contract claims and related damages. Any one of these circumstances could have a material adverse effect on our business reputation and ability to obtain and retain clients.
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We may be required to expend significant funds to develop or acquire new technologies. If we cannot offer new
technologies as quickly as our competitors, we could lose clients and market share. We also could lose market share if our competitors develop more cost effective technologies than those we offer or develop.
If we or one of our third-party service providers experience a data security breach and confidential customer information is disclosed, we may be
subject to penalties imposed by regulators, civil actions for damages and negative publicity, which could be costly, affect our customer relationships and have a material adverse effect on our business. In addition, state and federal legislative
proposals, if enacted, may impose additional requirements on us to safeguard confidential customer information, which may result in increased compliance costs.
Data security breaches suffered by well-known companies and institutions have attracted a substantial amount of media attention, prompting state and federal
legislation, legislative proposals and regulatory rule-making to address data privacy and security. Consequently, we may be subject to rapidly changing and increasingly extensive requirements intended to protect the consumer information that we
process in connection with education loans and tuition payment plans. Implementation of systems and procedures to address these requirements has increased our compliance costs, and these costs may increase further as new requirements emerge. If we
or one of our third-party service providers were to experience a data security breach, or if we were to otherwise improperly disclose confidential customer or consumer information, such breach or other disclosure could be costly, generate negative
publicity about us and adversely affect our relationships with our clients, including the lenders and educational institutions with which we do business, any of which could have a material adverse effect on our business. In addition, such pending
legislative proposals and regulations, if adopted, likely would result in substantial penalties for unauthorized disclosure of confidential consumer information. Failure to comply with those requirements could result in regulatory sanctions imposed
on our lender clients and loss of business for us.
The growth of our business could be adversely affected by changes in government education loan
programs or expansions in the population of students eligible for loans under government education loan programs.
We focus our business on the
market for private education loans, and the majority of our business is concentrated in products for post-secondary education. The availability and terms of loans that the government originates or guarantees affects the demand for private education
loans because students and their families often rely on private education loans to bridge a gap between available funds, including family savings, scholarships, grants and federal and state loans, and the costs of post-secondary education. The
federal government currently places both annual and aggregate limitations on the amount of federal loans that any student can receive and determines the criteria for student eligibility. These guidelines are generally adjusted in connection with
funding authorizations from the U.S. Congress for programs under the Higher Education Act of 1965. Recent federal legislation expanded federal grant and loan assistance, which could weaken the demand for private education loans. In Spring 2015, the
President announced a “Student Aid Bill of Rights” that would seek, among other initiatives, to increase certain grant aid and reduce certain tuitions, both of which could decrease the demand for private education loans. The creation of
similar federal or state programs that make additional government loan funds available could decrease the demand for private education loans.
Access to alternative means of financing the costs of education may reduce demand for private education loans.
The demand for private education loans could weaken if student borrowers use other vehicles to bridge the gap between available funds and costs of
post-secondary education. These vehicles include, among others:
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Home equity loans or other borrowings available to families to finance their education costs;
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Pre-paid tuition plans, which allow families to pay tuition at today’s rates to cover tuition costs in the future;
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Section 529 plans, which include both pre-paid tuition plans and college savings plans, that allow a family to save funds on a tax-advantaged basis;
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Education IRAs, now known as Coverdell Education Savings Accounts, under which a holder can make annual contributions for education savings;
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Government education loan programs, generally, and interest rates on the loans under these programs, specifically; and
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Direct loans from colleges and universities.
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In addition, certain colleges and universities offer discounts
to tuition costs and fees as a way to maintain their competitive positioning in the education marketplace. If demand for private education loans weakens, we would experience reduced demand for our services, which could have a material adverse effect
on our results of operations.
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Continuation of the current economic conditions could adversely affect the education loan industry.
High unemployment rates and the unsteady financial sector have adversely affected many consumers, loan applicants and borrowers throughout the
country. Loan applicants that have experienced trouble repaying credit obligations may not be able to meet the credit standards of our lender clients’ Monogram-based loan programs, which could limit our lending market or have a negative effect
on the rate at which loan applications convert into disbursed loans. In addition, current borrowers may experience more trouble in repaying credit obligations, which could increase loan delinquencies, defaults and forbearance, or otherwise
negatively affect loan portfolio performance and the estimated fair value of our service revenue receivables and participation accounts. Forbearance programs may have the effect of delaying default emergence, and alternative payment plans may reduce
the utilization of basic forbearance. In addition, some consumers may find that higher education is an unnecessary investment during turbulent economic times and defer enrollment in educational institutions until the economy improves or turn to less
costly forms of secondary education, thus decreasing education loan application and funding volumes. Finally, many lending institutions have been reluctant to lend and have significantly tightened their underwriting standards, and several clients
and potential clients have exited the education loan business and may not seek our services as the economy improves. If the adverse economic environment continues, our financial condition may deteriorate for any one of the foregoing reasons.
We may face risks related to litigation that could result in significant legal expenses and settlement or damage awards.
From time to time, we are subject to claims and litigation, which could seriously harm our business and require us to incur significant costs. In the past, we
have been named as a defendant in securities class action lawsuits. We are generally obligated, to the extent permitted by law, to indemnify our current and former officers and directors who are named as defendants in these lawsuits. Defending
against litigation may require significant attention and resources of management. Regardless of the outcome, such litigation could result in significant legal expenses.
We may also be subject to employment claims in connection with employee terminations. In addition, companies in our industry whose employees accept positions
with us may claim that we have engaged in unfair hiring practices. These claims may result in material litigation. We could incur substantial costs defending ourselves or our employees against those claims, regardless of their merits. In addition,
defending ourselves from those types of claims could divert our management’s attention from our operations.
If we are a party to material litigation
and if the defenses we claim are ultimately unsuccessful, or if we are unable to achieve a favorable settlement, we could be liable for large damage awards that could have a material adverse effect on our business and consolidated financial
statements.
Risks Related to Our Financial Reporting and Liquidity
If sufficient funds to finance our business and meet our obligations are not available to us when needed or on acceptable terms, we may be required to
delay, scale back, otherwise alter our strategy or cease operations.
We have generated significant net losses since fiscal 2008, and we cannot
predict at this time when or if we will return to profitability. Furthermore, while we have made progress towards reducing our overall cash needs, we continue to utilize significant levels of cash to fund the many priorities required of a diverse
business such as ours. We may require additional funds for our products, operating expenses, including expenditures relating to TMS and Cology LLC, capital in connection with credit enhancement arrangements for Monogram-based loan programs or
capital markets financings, the pursuit of regulatory approvals, acquisition opportunities and the expansion of our capabilities. In addition, under certain of Cology LLC’s loan origination agreements, it has agreed to indemnify those lender
clients for certain claims and damages in connection with its performance under such agreements. As a result, we may incur substantial costs in the event of a claim for damages related to these agreements, which could have a material adverse effect
on our liquidity or financial condition. See Note 10, “Commitments and Contingencies—Cology LLC Contingent Liability,” in the notes to our unaudited consolidated financial statements included in Item 1 of Part I of this quarterly
report for additional information.
Historically, we have satisfied our funding needs primarily through fees earned from education loan asset-backed
securitizations. We have not accessed the securitization market since fiscal 2008, and the securitization market may not be accessible to us in the future or, if available, not on terms that are acceptable to us. We have also satisfied our funding
needs through equity financings. We cannot be certain that additional public or private financing would be available in amounts or on terms acceptable to us, if at all. If sufficient funds to finance our business and meet our obligations are not
available to us when needed or on acceptable terms, we may be required to delay, scale back or eliminate certain of our products, eliminate our ability to provide credit enhancement commitments to prospective clients relating to Monogram-based loan
programs, curtail, delay or terminate plans for TMS or Cology LLC, terminate personnel, further scale back our expenses or cease operations.
Our
liquidity could be adversely affected if we are unable to successfully resolve our pending state tax matters.
We are involved in several matters
relating to the Massachusetts tax treatment of GATE. We took the position in the ATB proceedings that GATE was properly taxable as a financial institution and not as a business corporation and was entitled to apportion its income under applicable
provisions of Massachusetts tax law. The Commissioner took alternative positions: that GATE was properly taxable as a business corporation, or that GATE was taxable as a financial institution, but was not entitled to apportionment or was subject to
100% Massachusetts apportionment. In December 2009, the Commissioner made additional assessments of taxes, along with accrued
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interest, of approximately $11.9 million for GATE’s taxable years ended June 30, 2004, 2005 and 2006, and approximately $8.1 million for our taxable years ended June 30, 2005 and
2006. On November 9, 2011, the ATB issued the ATB Order which concurred with our position that GATE was a financial institution but disagreed with our methodology utilized to apportion income. In the third quarter of fiscal 2012, we made a $5.1
million payment that satisfied our obligation to the Massachusetts Department of Revenue for GATE’s taxable years ended June 30, 2004, 2005 and 2006. On April 17, 2013, the ATB issued an opinion confirming the rulings and findings
included in the ATB Order. On January 28, 2015, the SJC issued an opinion affirming the decision of the ATB. On October 13, 2015, the Supreme Court issued an order granting our petition for a writ of certiorari, summarily vacated the
decision issued by the SJC on January 28, 2015 and remanded the case to the SJC for further consideration. The SJC must now reconsider our appeal of the ATB’s findings with regard to the Property Factor. On November 30, 2015, we filed
our supplemental brief with the SJC. On December 30, 2015, the Commissioner filed its supplemental brief with the SJC. On January 13, 2016, we filed our reply brief with the SJC. On May 3, 2016, the SJC heard arguments on the appeal.
If we are unsuccessful in the SJC’s reconsideration of our appeal of the ATB Order, we could be required to make additional tax payments, including interest, as discussed below, for GATE’s taxable years ended June 30, 2008 and 2009,
which could materially adversely affect our liquidity position.
On August 6, 2013, the Massachusetts Department of Revenue delivered a notice of
assessment for GATE’s taxable years ended June 30, 2008 and 2009, which included an assessment for penalties of $4.1 million. We have not accrued for the penalties as we believe that it is more likely than not that the penalties will
ultimately be abated, which is consistent with the Massachusetts Department of Revenue’s treatment of GATE’s taxable years ended June 30, 2004, 2005 and 2006. On August 26, 2013, we filed an application to have the assessed
amounts abated in full. On March 26, 2014, the Massachusetts Department of Revenue denied our application. While we have filed an appeal on this matter with the ATB, it is on hold pending resolution of the petition for a writ of certiorari we
filed with the Supreme Court on May 31, 2015 related to GATE’s taxable years ended June 30, 2004, 2005 and 2006. We expect the outcome for the taxable years ended June 30, 2008 and 2009 to be influenced by the SJC’s
reconsideration of our appeal of the ATB’s findings related to GATE’s taxable years ended June 30, 2004, 2005 and 2006. We plan to vigorously pursue the litigation pending before the ATB in the cases pertaining to GATE’s taxable
years ended June 30, 2008 and 2009. If we are unsuccessful in this litigation, we could be required to make additional tax payments, including interest, for GATE’s taxable years ended June 30, 2008 and 2009, which could materially
adversely affect our liquidity position. As of March 31, 2016, we had accrued a total income tax liability of $27.1 million, including interest, related to GATE’s tax returns for the taxable years ended June 30, 2008 and 2009, which
amount was included in income taxes payable on our consolidated balance sheet. We cannot predict the outcome of this matter or the timing of such payments, if any, at this time.
See Item 1 of Part II, “Legal Proceedings,” and Note 10, “Commitments and Contingencies—Massachusetts Appellate Tax Board
Matters,” in the notes to our unaudited consolidated financial statements included in Item 1 of Part I of this quarterly report for additional information.
If the estimates we make, or the assumptions on which we rely, in preparing our consolidated financial statements prove inaccurate, our actual results
may vary materially from those reflected in our consolidated financial statements.
Our consolidated financial statements include a number of
estimates, which reflect management’s judgments. Some of our estimates also rely on certain assumptions. The most significant estimates we make include income taxes relating to uncertain tax positions under ASC 740,
Income Taxes
, the
valuation of our service revenue receivables and deposits for participation accounts and our determination of goodwill and intangible asset impairment.
In our determination of the fair value of our service revenue receivables and deposits for participation accounts, we use discounted cash flow modeling
techniques and certain assumptions to estimate fair value because there are no quoted market prices.
Our key assumptions to estimate fair
value include, as applicable:
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Discount rates, which we use to estimate the present value of our future cash flows;
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The annual rate and timing of education loan prepayments;
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The trend of interest rates over the life of the loan pool, including the forward LIBOR curve, which is a projection of future LIBOR rates over time;
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The expected annual rate and timing of education loan defaults, including the effects of various risk mitigation strategies, such as basic forbearance and alternative payment plans and school and lender guarantees;
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In the case of participation accounts, the timing of the return of capital;
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The expected amount and timing of recoveries on defaulted education loans; and
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The fees and expenses of the securitization trusts.
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Because our estimates rely on quantitative and
qualitative factors, including our historical experience, to predict default, recovery and prepayment rates, management’s ability to determine which factors should be more heavily weighted in our estimates, and to accurately incorporate those
factors into our loan performance assumptions, are subjective and can have a material effect on valuations.
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If the actual performance of the education loan portfolios held by us or our clients who hold Monogram-based
loans were to vary appreciably from the assumptions we use, we might need to adjust our key assumptions. Such an adjustment could materially affect our earnings in the period in which our assumptions change. In addition, our actual service revenue
receivables or releases from participation accounts could be significantly less than reflected in our current consolidated financial statements. In particular, economic, regulatory, competitive and other factors affecting the key assumptions used in
the cash flow model could cause or contribute to differences between actual performance of the portfolios and our other key assumptions.
Changes in
macro-economic conditions, including interest rates, could affect the value of our additional structural advisory fees, residual receivables and participation accounts, as well as demand for education loans and our services.
Education loans held by us and the securitization trusts facilitated by us typically carry floating interest rates tied to prevailing short-term interest
rates. Changes in interest rates could have the following effects on us:
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Higher interest rates would increase the cost of the education loan to the borrower, which, in turn, could cause an increase in delinquency and default rates for outstanding education loans, as well as increased use of
forbearance programs;
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Higher interest rates, or the perception that interest rates could increase in the future, could cause an increase in full or partial prepayments; or
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Higher interest rates could reduce borrowing for education generally, which, in turn, could cause the overall demand for our services to decline.
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In addition to higher interest rates, other factors, such as challenging economic times, including high unemployment rates, can also lead to an increase in
delinquency and default rates. If the prepayment or default rates increase for the education loans held by us or our Monogram platform clients, we may experience a decline in the value of service revenue receivables and our participation accounts,
as well as a decline in fees related to Monogram-based loan programs in the future, which could cause a decline in the price of FMD common stock and could also prevent, or make more challenging, any future portfolio funding transactions.
A significant portion of the purchase price for our acquisition of TMS and our acquisition of a substantial portion of the operating assets of the
Cology Sellers is allocated to goodwill and intangible assets that are subject to periodic impairment evaluations. An impairment loss could have a material adverse impact on our financial condition and results of operations.
At March 31, 2016, we had $20.1 million of goodwill and $17.7 million of intangible assets related to our acquisition of TMS and our acquisition of a
substantial portion of the operating assets of the Cology Sellers. As required by current accounting standards, we review intangible assets for impairment either annually or whenever changes in circumstances indicate that the carrying value may not
be recoverable.
The risk of impairment to goodwill is higher during the early years following an acquisition. This is because the fair values of these
assets align very closely with what we paid to acquire the reporting units to which these assets are assigned. As a result, the difference between the carrying value of the reporting unit and its fair value (typically referred to as
“headroom”) is smaller at the time of acquisition. Until this headroom grows over time, due to business growth or lower carrying value of the reporting unit, a relatively small decrease in reporting unit fair value can trigger impairment
charges. When impairment charges are triggered, they tend to be material due to the size of the assets involved. TMS’ business would be adversely affected, and impairment of goodwill could be triggered, 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 Student Account
Center products, higher-than-expected expense levels 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 TMS school clients, increases in equity returns required by investors and changes in our business model that may impact one or more of these variables. Cology
LLC’s business would be adversely affected, and impairment of goodwill could be triggered, if any of the following were to occur: higher attrition rates than planned, higher-than-expected expense levels to provide services to Cology LLC clients
and changes in our business model that may impact one or more of these variables.
Risks Related to Regulatory Matters
We are subject to, or will become subject to, new supervision and regulations which could increase our costs of compliance and alter our business
practices.
Various regulators have increased diligence and enforcement efforts and new laws and regulations have been passed or are under
consideration in the U.S. Congress as a result of turbulence in the financial services industry. The Dodd-Frank Act requires various federal agencies to adopt a broad range of new implementing rules and regulations, and the federal agencies are
given significant discretion in drafting the implementing rules and regulations. Consequently, many of the details and much of the impact of the Dodd-Frank Act may not be known for some time.
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The Dodd-Frank Act established the CFPB as an independent agency within the Board of Governors of the Federal
Reserve System, or Federal Reserve. The CFPB has been given broad powers, including the power to:
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Supervise non-depository institutions, including those that offer or provide education loans;
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Supervise depository institutions with assets of $10 billion or more for compliance with consumer protection laws, as well as the service providers to such institutions;
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Regulate consumer financial products, including education loans, and services offered primarily for personal, family or household purposes;
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Promulgate rules with respect to unfair, deceptive or abusive practices; and
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Take enforcement action against institutions under its supervision.
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The CFPB may institute regulatory
measures that directly impact our business operations. The CFPB has initiated an examination program of non-depository institutions (which could include service providers such as FMER). The Federal Trade Commission, or FTC, maintains parallel
authority to enforce Section 5 of the Federal Trade Commission Act prohibiting unfair or deceptive acts or practices against non-depository financial providers, such as FMER, TMS and Cology LLC.
The CFPB has significant rulemaking and enforcement powers and the potential reach of the CFPB’s broad new rulemaking powers and enforcement authority on
the operations of financial institutions offering consumer financial products or services, including FMD, is currently unknown. In addition, the Dodd-Frank Act established a Student Loan Ombudsman within the CFPB, who, among other things, receives,
reviews and attempts to resolve informally complaints from education loan borrowers. To date, the Student Loan Ombudsman has issued four Annual Reports. The first of these reports, the 2012 Annual Report of the Student Loan Ombudsman, noted concerns
that education loan borrowers may not have fully understood all the terms and conditions of their different loans. As a result, we expect private education loan marketing practices will continue to be carefully scrutinized. The 2013 Annual Report of
the Student Loan Ombudsman analyzed complaints received by the CFPB regarding education loans during the prior year, noting trends in complaints related to payment processing, loan modification, treatment of military families and other servicing
practices. The 2014 Annual Report of the Student Loan Ombudsman again analyzed complaints received by the CFPB regarding education loans during the prior year, noting trends in complaints related to servicing practices and focused on issues related
to co-signers. In 2015, the CFPB issued a “Mid-Year Update on Student Loan Complaints” that again was strongly focused on servicing and collection concerns, including co-signers, payment allocation among billing groups, and the
ability of borrowers to obtain payoff statements to allow them to refinance their education loan obligations. Later in 2015, the CFPB issued a Student Loan Servicing Report, which reviewed and discussed public comments submitted in response to a
Request for Information Regarding Student Loan Servicing published by the CFPB in the Federal Register. This CFPB action was exclusively focused on student loan servicing. The 2015 Annual Report again focused exclusively on student loan servicing
issues. As a result, we expect marketing and origination statements made regarding co-signers to receive additional scrutiny. We also expect to see increased scrutiny of the entire life cycle of education loans by the CFPB and other regulatory
and enforcement agencies.
The CFPB’s initiatives could increase our costs and the complexity of our operations. See Item 1,
“Business—Government Regulation,” included in Part I of our Annual Report for additional information.
The Dodd-Frank Act also includes
several provisions that could affect our future portfolio funding transactions, if any, including potential risk retention requirements applicable to any entity that organizes and initiates an ABS transaction, new disclosure and reporting
requirements for each tranche of ABS, including new loan-level data requirements, and new disclosure requirements relating to the representations, warranties and enforcement mechanisms available to ABS investors. The Dodd-Frank Act may have a
material impact on our operations, including through increased operating and compliance costs.
On October 30, 2015, the Department of Education
issued a final rule updating Part 668 of its regulations, including Subpart K, which governs how an institution requests, maintains, disburses and otherwise manages funds received under Title IV of the Higher Education Act of 1965. Among other
things, the rulemaking revised existing regulations to address the allowable methods and procedures for institutions to pay students their Title IV student aid credit balance. The revisions, which will be implemented beginning on July 1, 2016,
will limit the fees that we are able to charge related to disbursing refunds via prepaid cards, impact the terms and conditions under which refunds may be provided on those cards and may reduce the number of institutions interested in disbursing
refunds via prepaid cards, any of which could impede our ability to offer prepaid cards as a refund management option.
In October 2016, creditors will be
required to implement new regulations adopted by the Department of Defense under the Military Lending Act. These regulations would, among other things, require a private student loan creditor to identify borrowers who are entitled to the Military
Lending Act’s protections and provide such borrowers with special disclosures. In addition, the new regulations will prohibit certain contractual terms, such as mandatory arbitration clauses.
Although the Department of the Treasury does not regulate student lending, Treasury officials have noted concerns that borrowers from for-profit schools,
two-year institutions, and certain other non-selective institutions have had materially greater difficulties after they left school, with materially higher default rates and with many failing to realize significant benefits from their higher
education.
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In addition, the CFPB has initiated enforcement actions against a number of major for-profit schools, indicating concerns that students at for-profit schools may be taking on excessive debt
obligations. It is possible that this regulatory trend could lead to actions that would limit the ability of students at for-profit schools to obtain private education loans.
We may become subject to additional state registration or licensing requirements, which could increase our compliance costs significantly and may result
in other adverse consequences.
Many states have statutes and regulations that require the licensure of small loan lenders, loan brokers, credit
services organizations, loan arrangers, money transmitters and collection agencies. Some of these statutes are drafted or interpreted to cover a broad scope of activities. While we believe we have satisfied all material licensing, registration and
other regulatory requirements that could be applicable to us based on current laws and the manner in which we currently conduct business, we may determine that we need to submit additional license applications, and we may otherwise become subject to
additional state licensing, registration and other regulatory requirements in the future. In particular, certain state licenses or registrations may be required if we change our operations, if regulators reconsider their prior guidance or if federal
or state laws or regulations are changed. Even if we are not physically present in a state, its regulators may take the position that registration or licensing is required because we provide services to borrowers located in the state by mail,
telephone, the Internet or other remote means.
We may be subject to state consumer protection laws in each state where we do business and those laws may
be interpreted and enforced differently in different states. We will continue to review state registration and licensing requirements, and we intend to pursue registration or licensing in applicable jurisdictions where we are not currently
registered or licensed if we elect to operate through an entity that does not enjoy federal preemption of such registration or licensing requirements. We cannot assure you that we will be successful in obtaining additional state licenses or
registrations in a timely manner, or at all. If we determine that additional state registrations or licenses are necessary, we may be required to delay or restructure our activities in a manner that will not subject us to such licensing or
registration requirements. Compliance with state licensing requirements could involve additional costs or delays, which could have a material adverse effect on our business. Our failure to comply with these laws could lead to, among other things:
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Curtailment of our ability to continue to conduct business in the relevant jurisdiction, pending a return to compliance or processing of registration or a license application;
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Administrative enforcement actions;
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The assertion of legal defenses delaying or otherwise affecting the enforcement of loans; and
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Criminal as well as civil liability.
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Any of the foregoing could have a material adverse effect on our
business.
We may be exposed to liability for failures of third parties with which we do business to comply with the registration, licensing and
other requirements that apply to them.
Third parties with which we do, or have done, business, including federal and state chartered financial
institutions and non-bank loan marketers, are subject to registration, licensing and governmental regulations, including the Trust-in-Lending Act and other consumer protection laws and regulations. For example, some of the third-party marketers with
which we have done or may do business may be subject to state registration or licensing requirements and laws and regulations, including those relating to loan brokers, small loan lenders, credit services organizations, loan arrangers and collection
agencies. As a result of the activities that we conduct or may conduct for our clients, it may be asserted that we have some responsibility for compliance by third parties with whom we do business with the laws and regulations applicable to them,
whether on contractual or other grounds. If it is determined that we have failed to comply with our obligations with respect to these third parties, we could be subject to civil or criminal liability. Even if we bear no legal liability for the
actions of these third parties, the imposition of licensing and registration requirements on them, or any sanctions against them for conducting business without a license or registration, may reduce the volume of loans we process from them in the
future.
Regulatory agencies have increased their expectations with respect to how regulated institutions oversee their relationships with service
providers, which could impact us as both a provider of services to financial institutions as well as a consumer of such services by third-party service providers.
The CFPB, the Office of the Comptroller of the Currency, the Federal Deposit Insurance Corporation, the Federal Reserve and the Department of Education have
each issued guidance documents outlining their expectations of supervised banks and non-banks with respect to their relationships with service providers that increase the responsibilities of parties to vet and supervise the activities of service
providers to ensure compliance with federal consumer financial laws. Regulators increasingly espouse a “life cycle” approach to vendor management that includes five important stages of the vendor relationship, including planning, due
diligence and service provider selection, contract negotiation, ongoing monitoring and termination. The issuance of regulatory guidance, and the enforcement of the enhanced vendor management standards via examination and investigation of us or any
third party with whom we
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do business, may increase our costs, require increased management attention and adversely impact our operations. In the event we should fail to meet the heightened standards for management of
service providers, either in our supervision of vendors or as a result of acts or omissions of counter parties who are deficient in their supervision of us as a service provider, we could in the future be subject to supervisory orders to cease and
desist, civil monetary penalties or other actions due to claimed noncompliance, which could have an adverse effect on our business, financial condition and operating results.
Failure to comply with consumer protection laws could subject us to civil and criminal penalties or litigation, including class actions, and have a
material adverse effect on our business.
We are subject to a broad range of federal and state consumer protection laws applicable to our student
lending activities, including laws governing fair lending, unfair, deceptive and abusive acts and practices, service member protections, licensing, interest rates and loan fees, disclosures of loan terms, marketing, brokering, servicing, collections
and foreclosure.
Violations or changes in federal or state consumer protection laws or related regulations, or in the prevailing interpretations thereof,
may expose us to litigation, result in greater compliance costs, constrain the marketing of education loans, adversely affect the collection of balances due on the loan assets held by securitization trusts or otherwise adversely affect our business.
We could incur substantial additional expense complying with these requirements and may be required to create new processes and information systems. Moreover, changes in federal or state consumer protection laws and related regulations, or in the
prevailing interpretations thereof, could invalidate or call into question the legality of certain of our services and business practices.
Violations of
the laws or regulations governing our operations, or the operations of our clients, could result in the imposition of civil or criminal penalties, the cancellation of our contracts to provide services or our exclusion from participating in education
loan programs. These penalties or exclusions, were they to occur, would impair our business reputation and ability to operate our business. In some cases, such violations may render the loan assets unenforceable.
Recent legislative proposals could affect the ability of an owner of an education loan to receive all of the principal and interest due, including
proposals to change the non-dischargeability of education loans in bankruptcy, the obligation of borrowers who die or become disabled and the obligation of borrowers whose financial circumstances make repayment difficult. If the legislative
proposals are enacted, it could adversely affect the loan portfolios under our Monogram platform, including loans for which we have provided credit enhancements with certain of our lender clients, and adversely affect the overall desirability of
private education loan assets to investors.
Under current law, education loans can be discharged in bankruptcy only upon a court finding of
“undue hardship” if the borrower were required to continue to make loan payments. Legislation has been introduced in both houses of the U.S. Congress that would generally end the bankruptcy exemption from dischargeability for certain
private education loans. If enacted as initially proposed, this legislation would apply retroactively to private education loans already made, and would not require the borrower to make any payments before seeking discharge in bankruptcy. This
legislation is substantially similar to legislation that was previously introduced in both houses of the U.S. Congress. If enacted, such legislation may adversely affect the performance of the education loans under our Monogram platform, restrict
the availability of capital to fund education loans and increase loan pricing to borrowers to compensate for the additional risk of bankruptcy discharge, which could adversely affect the competitiveness of our Monogram platform and our ability to
engage lenders to fund loans based on our Monogram platform.
In addition, the CFPB’s Annual Reports in 2012, 2013 and 2014 recommended that the U.S.
Congress reconsider the advisability of continuing the current non-dischargeable status of private education loans.
The CFPB has also raised concerns
that education loan servicers have taken insufficient measures to enter into work-outs with borrowers who are having difficulties repaying their education loans, and there is legislation pending to affect the obligations of both borrowers and
co-signers on loans obtained by a borrower who dies or becomes disabled. Similar to the dischargeability issue, although our operations would not be directly affected because we are not engaged in the servicing of education loans, these proposals
may make private education loans less attractive to investors.
Recent litigation has sought to re-characterize certain loan marketers and other
originators as lenders; if litigation on similar theories were successful against us or any third-party marketer we work with, the education loans that we facilitate would be subject to individual state consumer protection laws.
A majority of the lenders with which we work are federally-insured banks and credit unions. As a result, they are able to charge the interest rates, fees and
other charges available to the most favored lender in their home state. In addition, our lender clients or prospective lender clients may be chartered by the federal government and enjoy preemption from enforcement of state consumer protection laws.
In providing our education loan services to our lender clients, we do not act as a lender, guarantor or loan servicer, and the terms of the education loans that we facilitate are regulated in accordance with the laws and regulations applicable to
the lenders.
The association between marketers of high-interest “payday” loans, tax-return anticipation loans, subprime credit cards and online
payment services, on the one hand, and banks, on the other hand, has come under recent scrutiny. Recent litigation asserts that loan marketers use lenders with a bank charter that authorizes the lender to charge the most favored interest rate
available in the lender’s
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home state in order to evade usury and interest rate caps, and other consumer protection laws imposed by the states where they do business. Such litigation has sought, successfully in some
instances, to re-characterize the loan marketer as the lender for purposes of state consumer protection law restrictions. Similar civil actions have been brought in the context of gift cards. Moreover, federal banking regulators and the FTC have
undertaken enforcement actions challenging the activities of certain loan marketers and their bank partners, particularly in the context of subprime credit cards. We believe that our activities, and the activities of third parties whose marketing on
behalf of lenders may be coordinated by us, are distinguishable from the activities involved in these cases.
Additional state consumer protection laws
would be applicable to the education loans we facilitate if we, or any third-party loan marketer engaged by us, were re-characterized as a lender, and the education loans (or the provisions governing interest rates, fees and other charges) could be
unenforceable unless we or a third-party loan marketer had the requisite licenses or other authority to make such loans. In addition, we could be subject to claims by consumers, as well as enforcement actions by regulators. Even if we were not
required to cease doing business with residents of certain states or to change our business practices to comply with applicable laws and regulations, we could be required to register or obtain licenses or regulatory approvals that could impose a
substantial delay or cost to us. There have been no actions taken or threatened against us on the theory that we have engaged in unauthorized lending; however, if such actions occurred, they could have a material adverse effect on our business.
Risks Related to Asset-Backed Securitizations and Other Funding Sources
Our financial results and future growth may continue to be adversely affected if we are unable to structure securitizations or alternative financings.
Although our Monogram platform has been designed to generate recurring revenues with less dependence on the securitization market and third-party
credit enhancement, a return to profitability is dependent on a number of factors, including the facilitation of Monogram-based loan volumes substantially in excess of those that have been originated to date, and substantially in excess of those
contemplated by our current lender clients’ Monogram-based loan programs or other financing alternatives, expense management and growth at TMS. Accordingly, our future financial results and growth may continue to be affected by our inability to
structure securitizations or alternative financing transactions involving education loans on terms acceptable to us. In particular, such transactions may enable us to generate fee revenues or access and recycle capital previously deployed as credit
enhancement for interim financing facilities. If we are able to facilitate securitizations in the near-term, we expect the structure and economics of the transactions to be substantially different from our past transactions, including lower revenues
and lower advance rates.
If our inability to access the ABS market on acceptable terms continues, our revenues may continue to be adversely impacted, and
we may continue to generate net losses, which would further erode our liquidity position.
A number of factors, some of which are beyond our
control, have adversely affected or may adversely affect our portfolio funding activities and thereby adversely affect our results of operations.
The success of our business may depend on our ability to structure securitizations or other funding transactions for our clients’ loan portfolios.
Several factors have had, or may have, a material adverse effect on both our ability to structure funding transactions and the revenue we may generate for providing our structural advisory and other services, including the following:
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Volatility in the capital markets generally or in the education loan ABS sector specifically, which could restrict or delay our access to the capital markets;
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The timing and size of education loan asset-backed securitizations that other parties facilitate, or the adverse performance of, or other problems with, such securitizations, which could impact pricing or demand for our
future securitizations, if any;
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Challenges to the enforceability of education loans based on violations of federal or state consumer protection or licensing laws and related regulations, or imposition of penalties or liabilities on assignees of
education loans for violations of such laws and regulations;
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Our inability to structure and gain market acceptance for new products or services to meet new demands of ABS investors, rating agencies or credit facility providers; and
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Changes to bankruptcy laws that change the current non-dischargeable status of private education loans, which could materially adversely affect the profitability of the loan portfolios if applied to loans originated
prior to the date of the change.
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Recent legislation will affect the terms of future securitization transactions.
The SEC is considering new rules governing issuance of securities backed by education loans, which may affect the desirability of issuing this type of ABS as
a funding strategy. In addition, the Dodd-Frank Act grants federal banking regulators substantial discretion in developing specific risk retention requirements for all types of consumer credit products and requires the SEC to establish new data
requirements for all issuers, including standards for data format, asset-level or loan-level data, the nature and extent of the compensation of the broker or originator and the amount of risk retention required by loan securitizers.
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The Dodd-Frank Act and its implementing regulations, once adopted, will affect the terms of future securitization
transactions, if any, that we facilitate and may result in greater risk retention and less flexibility for us in structuring such transactions.
In
structuring and facilitating securitizations of our clients’ education loans, administering securitization trusts or providing portfolio management, we may incur liabilities to transaction parties.
We facilitated and structured a number of special purpose trusts that have been used in securitizations to finance education loans that our clients
originated, including securitization trusts that have issued auction rate notes. Under applicable state and federal securities laws, if investors incur losses as a result of purchasing ABS that those securitization trusts have issued, we could be
deemed responsible and could be liable to those investors for damages. We could also be liable to investors or other parties for certain updated information that we have provided subsequent to the original ABS issuances by the trusts. If we have
failed to cause the securitization trusts or other transaction parties to disclose adequately all material information regarding an investment in any securities, if we or the trusts made statements that were misleading in any material respect in
information delivered to investors in any securities or if we breached any duties as the structuring advisor, administrator or special servicer of the securitization trusts, it is possible that we could be sued and ultimately held liable to an
investor or other transaction party. This risk includes failure to properly administer or oversee servicing or collections guidelines and may increase if the performance of the securitization trusts’ loan portfolios degrades, and rating
agencies over the past several years have downgraded various ABS issued by the trusts we facilitated. Investigations by state Attorneys General, as well as private litigation, have focused on auction rate securities, including the marketing and
trading of such securities. It is possible that we could become involved in such matters in the future. In addition, under various agreements entered into with underwriters or financial guaranty insurers of those ABS, as well as certain lenders, we
are contractually bound to indemnify those persons if an investor is successful in seeking to recover any loss from those parties and the securitization trusts are found to have made a materially misleading statement or to have omitted material
information.
If we are liable to an investor or other transaction party for a loss incurred in any of the securitizations that we have facilitated or
structured and any insurance that we may have does not cover this liability or proves to be insufficient, our results of operations or financial position could be materially adversely affected.
We may determine to incur near-term losses based on longer-term strategic considerations.
We may consider long-term strategic considerations more important than near-term economic gains when assessing business arrangements and opportunities,
including financing arrangements for education loans. For example, we expect the structure and pricing terms in near-term future securitization transactions, if any, to be substantially different from our past transactions, including lower revenues
and lower advance rates. We may nevertheless determine to participate in, or structure, future financing transactions based on longer-term strategic considerations. As a result, net cash flows over the life of a future securitization trust,
particularly any trust that we may facilitate in the near-term as we re-enter the securitization market, could be negative as a result of transaction size, transaction expenses or financing costs.
Risks Related to Ownership of FMD Common Stock
The price of FMD common stock may be volatile.
The trading price of FMD common stock may fluctuate substantially, depending on many factors, some of which are beyond our control and may not be related to
our operating performance. These fluctuations could cause you to lose part or all of your investment in your shares of FMD common stock. Those factors that could cause fluctuations include, but are not limited to, the following:
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The success of our Monogram platform and our fee-for-service offerings, including our TMS offerings, together with our ability to attract new clients for each of our product offerings;
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Announcements by us, our competitors or our potential competitors of acquisitions, new products or services, significant contracts, commercial relationships or capital markets activities;
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Actual or anticipated changes in our earnings or fluctuations in our operating results or in the expectations of securities analysts, including as a result of the timing, size or structure of any portfolio funding
transactions;
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The resolution of our appeal of the ATB Order in the cases pertaining to GATE’s Massachusetts state income tax returns for the taxable years ended June 30, 2004, 2005 and 2006, which could also affect our
state tax liabilities for fiscal 2008 and fiscal 2009, and the litigation pending before the ATB in the cases pertaining to GATE’s Massachusetts state income tax returns for the taxable years ended June 30, 2008 and 2009;
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Difficulties we may encounter in structuring securitizations or alternative financings, including disruptions in the education loan ABS market or demand for securities offered by securitization trusts that we
facilitate, or the loss of opportunities to structure securitization transactions;
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General economic conditions and trends, including unemployment rates and economic pressure on consumer asset classes such as education loans;
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Legislative initiatives affecting federal or private education loans, including initiatives relating to bankruptcy dischargeability and the federal budget and regulations implementing the Dodd-Frank Act;
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Changes in the education finance marketplace generally;
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Negative publicity about the education loan market generally or us specifically;
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Regulatory developments or sanctions directed at us;
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Price and volume fluctuations in the overall stock market and volatility in the ABS market, from time to time;
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Significant volatility in the market price and trading volume of financial services and process outsourcing companies;
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Major catastrophic events;
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Purchases or sales of large blocks of FMD common stock or other strategic investments involving us;
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Dilution from raising capital through a stock or other equity instrument issuance;
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Our ability to effectively and efficiently manage our expense base; or
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Departures or long-term unavailability of key personnel, including FMD’s Chief Executive Officer, who we believe has unique insights and experience at this point of change in our business and the education loan
industry.
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Following periods of volatility in the market price of a company’s securities, securities class action litigation has often
been brought against that company. We have, in the past, been the target of securities litigation. Although we succeeded in having prior litigation dismissed without any compensation passing to plaintiffs or any of their attorneys, any future
litigation could result in substantial costs and divert management’s attention and resources from our business.
Stockholders that own large
blocks of FMD common stock could substantially influence matters requiring approval by FMD stockholders and could limit your ability to influence the outcome of key transactions, including a change of control.
There are certain investors that hold large blocks of FMD common stock, which could impact the outcome of key transactions. In addition, FMD’s directors
and executive officers owned approximately 10.5% of the outstanding shares of FMD common stock as of March 31, 2016, excluding shares issuable upon vesting of outstanding restricted stock units and shares issuable upon exercise of outstanding
vested stock options. These stockholders, if acting together, could substantially influence matters requiring approval by FMD stockholders, including the election of directors and the approval of mergers or other extraordinary transactions. They may
also have interests that differ from yours and may vote in a way with which you disagree and which may be adverse to your interests. The concentration of ownership may have the effect of delaying, preventing or deterring a change of control of our
company, could deprive FMD stockholders of an opportunity to receive a premium for their common stock as part of a sale of our company and might ultimately affect the market price of FMD common stock.
Some provisions in FMD’s restated certificate of incorporation and amended and restated by-laws may deter third parties from acquiring us.
FMD’s restated certificate of incorporation and amended and restated by-laws contain provisions that may make the acquisition of our company
more difficult without the approval of the FMD Board of Directors, including the following:
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Only the FMD Board of Directors, FMD’s Chairman of the Board or FMD’s President may call special meetings of FMD’s stockholders;
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FMD stockholders may take action only at a meeting of FMD stockholders and not by written consent;
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FMD has authorized undesignated preferred stock, the terms of which may be established and shares of which may be issued without stockholder approval;
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FMD’s directors may be removed only by the holders of 75% of the votes that all stockholders would be entitled to cast in the election of directors; and
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FMD imposes advance notice requirements for stockholder proposals.
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These anti-takeover defenses could
discourage, delay or prevent a transaction involving a change in control of our company. These provisions could also discourage proxy contests and make it more difficult for you and other stockholders to elect directors of your choosing or cause us
to take other corporate actions you desire.
Section 203 of the Delaware General Corporation Law may delay, defer or prevent a change in
control that FMD stockholders might consider to be in their best interests.
We are subject to Section 203 of the Delaware General
Corporation Law which, subject to certain exceptions, prohibits “business combinations” between a Delaware corporation and an “interested stockholder,” which is generally defined as a stockholder who
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becomes a beneficial owner of 15% or more of a Delaware corporation’s voting stock, for a three-year period following the date that such stockholder became an interested stockholder.
Section 203 could have the effect of delaying, deferring or preventing a change in control that FMD’s stockholders might consider to be in their best interests.
While FP Resources USA Inc. has submitted a preliminary non-binding indication of interest regarding a possible acquisition of us, there can be no
assurance that the discussions will advance beyond the preliminary stage or that any acquisition or other transaction will be pursued or completed.
On March 25, 2016, FP Resources USA Inc., a corporation organized in Delaware and controlled by John Risley, which we believe owns approximately 14.9% of
our Common Stock and which we refer to as FP Resources, filed an amendment to its Schedule 13D indicating it and Mr. Risley had initiated exploratory discussions with us regarding a possible acquisition of us by FP Resources. While FP Resources
has submitted a non-binding indication of interest, the discussions are preliminary in nature and there can be no assurance that the discussions will advance beyond the preliminary stage or that any acquisition or other transaction will be pursued
or completed.
