Thursday, April 15, 2010

Going to school with Sallie Mae

Moral hazard is alive and well, why not make some money off of it? A great candidate is Sallie Mae.

Recent policy changes by the Federal government banned the private origination of Federal student loans, Sallie Mae's most profitable activity.

As a result, Sallie Mae has contended that it will need to layoff 2000 workers as it retools to be one of the four designated Federal student loan servicers.

This rebalance in revenue streams pales in comparison to the current liquidity issues facing Sallie Mae. In 2010 and 2011 Sallie Mae is facing a rollover of $11B in debt with only $6B in cash and a hostile credit market. In March Sallie Mae completed a new 1.5B 10-year offering at a horrific 8% fixed. Although this is horrific at first glance in comparison to their current lending rates (5.5% - 6%), since Federal loans often float with interest rates, a rate increase could make this offering cheap in comparison to the discount rate.

Bottom line, the author believes that the Federal Goverment will do whatever it takes to make sure Sallie Mae can rollover their debt. It is not in the interest of the Federal Government to have another major lender fall due to a lack of liquidity, and that has been the minimum criteria for applying moral hazard.

So what do we do? Buy Sallie Mae senior unsecured exchange traded debt (NYSE:JSM) yielding close to 8.3% ($18 price / $25 par) maturing 12/15/2043. Buy at the limit price - $17.50.


Lockstep said...

Once again, I have bid too low. Changing limit purchase price to $18.25.

Shawn said...

You should have kept it low. I think that I am going to take your advice and jump in on this one tomorrow. You make a solid arguement.

Lockstep said...

This investment is holding steady and doing well. I have no intention of selling this because the yield to maturity is so good.

Sallie Mae has major debt rollovers this summer. I will be watching closely to see how this goes.

Lockstep said...

The Sallie Mae debt rollovers have been uneventful. The transition to a private label and servicing based revenue stream is on course.

The best indicator is the federal crackdown on for profit colleges. For profit institutions receive over 83% of their funding from federal student loans yet have horrendous default rates. Less bad loans means more profits for servicers like Sallie Mae. Long and strong.


What a name for a company.