Friday, September 17, 2010

Doubling down: Sallie Mae senior debt

With the sell off of Student Loan Corp from Citigroup to Discover, the market is finding undervalued assets in private student loans. Sallie Mae, as a third party involved in the deal, purchased a portfolio of $28B portfolio of FFELP, Federal backed student loans, from Student Loan Corp to service. This makes SLM, the 800 pound gorilla, even bigger in the FFELP marketplace. Sallie Mae will be able to use this leverage to support prices and manage supply in this market niche.

"While Sallie Mae will no longer originate FFELP loans, it will still be able to manage its existing $150 billion FFELP portfolio, which generated about $800 million in cash flow in the first quarter, according to analysts." (1)

Sallie Mae has bigger problems. The low interest rate environment hurts earnings because much of the their portfolio floats in a spread to treasuries. Thus the longer the Fed keeps interest rates low the lower the revenue base from the portfolio.

But the real concern is the outstanding debt and whether Sallie Mae will be able to continue to pay it's debt load. Bondholders like us want to know that regardless of the outcome with the company, we are paid what we are owed. A key analyst sees a margin of safety in the current value of the bonds, which are selling at 75cents on the USD.

"For bondholders, the key issue is not the viability of Sallie Mae's business model but the fact that its assets, conservatively valued, more than cover its $27 billion of unsecured borrowings, according to CreditSights. If the company did nothing to restructure, it would have enough value in its current book of business to service its debt, CreditSights analyst Adam Steer said in an interview." (1)

So assuming bonds will pay out at par there is a 25% margin of safety while accumulating a 8% return on investment. Excellent risk reward ratio to the author.

Long SLM again at $19.1 (NYSE: JSM)

(1) Reuters, July 2010

Sunday, September 5, 2010

Maybe a weather man would be better

Everyone knows that the there is no better job than the weather man. Every morning this person checks the lastest satellite images for the latest weather trends without insight to cause and tells the public with the utmost confidence what the day will bring. What sets apart stock market analysts and weathermen is belief in an observable and discernable causality. We don't know what makes the weather. We do know what makes money.

Recent data from the US economy makes the weather man look rather insightful. The mixed influence of a worldwide slowdown and a stimulus has the economy giving strange signals. As recently as July, the technology bellweather, Intel, raised guidance for the year by 10% on high demand. Then just three weeks later the company recanted their upward guidance and stated they will achieve the lower end of their original guidance.

Then on the premise of an upside surprise on the August ISM manufacturing index, the market bounced and gained 5% on renewed optimism. A few days later, when the much larger services sector index underperformed showing only slight growth in the August and the July factory orders index came in below expectations, the market showed no reaction.

It is impossible to tell what is driving the economy right now, or if it is growing or falling off. Many analysts can point to many different data points, but they should defer to a professional who is comfortable with extreme uncertainty. The safest person to ask the direction of the market is to ask the weatherman.