First Marble-Headache

As the old saw goes, when it rains, it pours. Or was that the Morton umbrella girl? Regardless, someone is pouring salt in the wounds of First Marblehead (NYSE: FMD  ) shareholders today. With shares of the private student loan company already taking a drubbing from the topsy-turvy credit markets, the price plummeted another 35% today on news that the company's loan guarantor just filed for bankruptcy.

The Educational Resource Institute, otherwise known as TERI, provides the financial guarantees for First Marblehead's student loans in the event of a default by a borrower. It's been on shaky ground since rating service Fitch downgraded it in March to junk status. It hasn't been the best of times for bond insurers, including Ambac Financial (NYSE: ABK  ) and MBIA (NYSE: MBI  ) , as rating agencies have been reviewing their risk reassessments lately in the mist of the current credit crisis.

The cracks in First Marblehead have been showing for awhile. Its losses were exceeding those of rival Sallie Mae (NYSE: SLM  ) , whose performance was supposed to be behind its own. Now with the capital markets in turmoil, investor appetite for the student loan-backed bonds packaged by TERI "evaporated," according to CEO Willis Hulings, necessitating the bankruptcy filing.

While First Marblehead has been expecting some difficulties with TERI -- in fact, it was unable to do any securitizations in the first quarter because of the credit landscape -- at least one analyst thinks this news increases the uncertainty surrounding the student loan provider. The credit risks once borne by TERI may now have to be borne by First Marblehead.

Over the past 20 years, TERI has guaranteed more than 2 million loans, totaling more than $20 billion, and has never defaulted on one. It's hopeful it still won't. The benefit of the TERI relationship was that First Marblehead had access to its proprietary database. Some 20 years' worth of payment history had been built up and was said to give TERI special insight into the default prospects of borrowers. Unfortunately, it couldn't foresee the rising tide of defaults that would occur as a result of the worsening credit crisis.

It's not the first time a supposedly bullet-resistant database that gave a company a wide, competitive moat was found to have unforeseen weak points. CompuCredit (Nasdaq: CCRT  ) , a provider of branded credit cards to consumers at the shallow end of the FICO score range, was also thought to have the benefit of a proprietary database that kept its customer defaults low. However, it too has been recently undone by the arid credit markets. Its shares have fallen by 73% over the past year.

The temporary demise of TERI certainly doesn't help the student loan company, and with First Marblehead's share down by 88% over the past 12 months, investors are feeling the pain. The exclusive access to TERI's database gave First Marblehead a competitive advantage in good times, but that doesn't mean it won't have access to other guarantors for its loans now that conditions have changed.

Still, this is a much different company than it was just a few months ago; as cheap as it looks, investors would be wise to use caution before entering here.

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