Heh, ISM/OSM again

[justin]

Brewer, you mentioned 18 being a juicy number to get into ISM/OSM. Is that based in part on the worst case of default/BK, then getting ~18/25th's of your value back via BK when you trade the debt for equity in the reorganized post-BK company?

I'm tempted to put in a limit order around 20.00 and see what happens. These two have been very volatile the last few days, and I might get my order filled before the price gaps back up. Or I might get filled on its way to 18!

 

[brewer12345]

I think 18 is attractive because if it got to that level, the spread over treasuries would be on a par with a single B-rated junk bond. I think it is unlikely that SLM would get downgraded that far, and if it did, the price risk on the bonds would be pretty low from 18.

Actually, if a copany goes bust, the full par amount of the bond is your claim. So even if you paid 18 for it, the nominal amount of your claim (to determine your pro rata share of whather bondholders get) would be based on 25.

 

[wabmester]

Pretty heavy trading on JSM today. 660,000 shares so far, and went sub-$20 for a bit. Already in the mild-junk yield territory.

 

[brewer12345]

Pretty heavy trading on JSM today. 660,000 shares so far, and went sub-$20 for a bit. Already in the mild-junk yield territory.

All the hallmarks of indiscriminate dumping, IMO. C'mon guys beat it down to 18...

 

[bongo2]

Why would Flowers et all buy Sallie Mae if they thought it was going bust? Doesn't the very fact that someone is paying billions for the company mean that it is unlikely to default? I understand the equityholders and the bond holders are not aligned and that these new guys may be inclined to do some risky stuff, but this just doesn't seem that dire.

 

[Texas Proud]

No hysteria here. Just curious.

Do they stop payments on all issued bonds simultaneously? Or do they get to pick and choose?

If unsecured bond holders wind up owning the company, could that result in their bonds having some value, even if it is much less than PAR?

Usually there is a trigger bond... the payment is high and all the fancy moves have been done... once it is in default, the other bonds usually have a clause to default them...

The moves they do are like try and renegotiate the terms. This happened to me a few times (when I was the trustee)... if the company is not going well, then the bondholders might accept 85 cents on the dollar and extend terms instead of BK and who knows what then...

 

[brewer12345]

Why would Flowers et all buy Sallie Mae if they thought it was going bust? Doesn't the very fact that someone is paying billions for the company mean that it is unlikely to default? I understand the equityholders and the bond holders are not aligned and that these new guys may be inclined to do some risky stuff, but this just doesn't seem that dire.

Exactly. So what is going on is a messy repricing of the bonds to reflect a higher risk issuer. I think that at some point the bonds will overshoot in the corretion, and therein lies the buying opportunity.

 

[Texas Proud]

Why would Flowers et all buy Sallie Mae if they thought it was going bust? Doesn't the very fact that someone is paying billions for the company mean that it is unlikely to default? I understand the equityholders and the bond holders are not aligned and that these new guys may be inclined to do some risky stuff, but this just doesn't seem that dire.

I agree... they are not buying this to cause it to go bust... so the talk is very premature IMO..

However, when you are a lender, you want to price your loan on the percent probability that they will go bust... I am sure someone has the table, but I think AAA is like .1% and junk is over 10%. So if you remove the name of the company and only looked at its bond rating... would you invest in a B or a AAA? And what premium would you want for that B??

 

[wabmester]

Why would Flowers et all buy Sallie Mae if they thought it was going bust? Doesn't the very fact that someone is paying billions for the company mean that it is unlikely to default? I understand the equityholders and the bond holders are not aligned and that these new guys may be inclined to do some risky stuff, but this just doesn't seem that dire.

Pre-LBO, the company was very unlikely to default. The LBO will saddle the new private company with a lot of debt. The buyers don't have that much skin in the game, so as long as they can extract their gains somehow (e.g., selling off assets), they don't really care what happens to the remaining company or the bond holders. Not to say that will happen here, but that has certainly happened in past LBO's.

 

[haha]

I defer to all experts here. But in my opinion, it is rarely smart to speculate on an income investment that is not backed by an obviously well financed operation. Maybe buy a junk mutual fund when the spread gets huge. But normally, IMO, a reasonable bond speculation would be one where you can see at least the lower limit of your recovery in the event of bankruptcy. One should see a comfortable margin of error in case things don't work out. At $20.50 ISM would be quite satisfactory in the most probable case of it sailing along fine, meeting its challenges and paying the bond in 2018.

SLM has great value as a going concern because of its awesome spreads between what they can harvest in terms of fees, spread, etc. from their loans held and originated. But in the very low but non-zero probability event of a bankruptcy, there aren't going to be many standalone or readily saleable assets relative to the amount of senior debt with claims on those assets.

ISM has rarely traded over $22.50 since we have been following it on this board. Whatever it is worth now, it can’t be more than when SLM Corp. had positive shareholders' equity!

So at today’s price of $20.50 or so, we are sending $20.50 looking for $2.

I convinced myself as I wrote this. As of now, I’m out!

Ha

 

[wabmester]

SLM has great value as a going concern because of its awesome spreads between what they can harvest in terms of fees, spread, etc. from their loans held and originated. But in the very low but non-zero probability event of a bankruptcy, there aren't going to be many standalone or readily saleable assets relative to the amount of senior debt with claims on those assets.

ISM has rarely traded over $22.50 since we have been following it on this board. Whatever it is worth now, it can’t be worth more than it was worth when it had a positive net worth! So at today’s price of $20.50 or so, we are sending $20.50 looking for $2.

I convinced myself as I wrote this. As of now, I’m out! Yahoo!

Aw, c'mon, you're not going to speculate on the deal not getting done? What happened to your sense of adventure?

 

[Texas Proud]

Hey guys... can someone give me a site that you can see the info on the securities.... ISM, OSM and JSM

I look at Yahoo and they have very little.. look in Ameritrade... and not much there either...

Also, is JSM fixed?? Looks like 6% to me with a long maturity...

Thanks...

 

[brewer12345]

http://www.quantumonline.com/incometables.cfm

You have to register, but its free. I am registered as "Heywood Jahblowme."

 

[cute fuzzy bunny]

Cool, i'm registered as haywood jablowme...no kidding.

 

[youbet]

Your comments folks.....

I purchased ISM as a inflation hedge in my portfolio. Planned to hold it until maturity and with an "A" rating figured they would actually be able to perform as promised and pay me if inflation sky rocketed. But as junk status, am I dreaming that if years from now, inflation goes up to the moon, that they could actually pay out the big bux without defaulting?

I could get out now with a minor bruise and a lesson learned. Or I can stay and count on them being able to deliver if inflation hits the big numbers in the next twelve years........

 

[clifp]

Your comments folks.....

I purchased ISM as a inflation hedge in my portfolio. Planned to hold it until maturity and with an "A" rating figured they would actually be able to perform as promised and pay me if inflation sky rocketed. But as junk status, am I dreaming that if years from now, inflation goes up to the moon, that they could actually pay out the big bux without defaulting?

I could get out now with a minor bruise and a lesson learned. Or I can stay and count on them being able to deliver if inflation hits the big numbers in the next twelve years........

I am in pretty much the same boat as you and sold one of my TIPs positions to acquire ISM/OSM. At the time I was getting a premium of almost 2% for holding ISM vs 4 year TIPs, now the premium is slightly larger, but the default risk has increased significantly but I still think it is low. In order for Sallie Mae to default a lot of bad things would have to happen between now and 2017/18.

o The deal has to go through. The stock is still trading at 8% discount to the $60 assuming a deal close in 6 to 8 months this is roughly 3x the risk free rate. There is decent chance somebody in the government will nix the sale.
o The new owners have to take out lots of expensive debt, while I have little doubt that we will see increased debt on Sallie Mae's bookss, there will probably be some government oversight to prevent excess debt.
o The new management will have to screw up.
o Some combination of higher inflation, lower net interest rates, reduced government support for student loans, will have to make the company unprofitable for many years.
o No bail out by the government or the JPM and BAC will occur


Then and only then will we bondholders not get our money out. When I first bought the bonds my back of the envelope calculation was 98% of getting my money back... I concluded additional 20% worth of income was worth the risk. Unfortunately at this point the only thing I know for sure is that the probability of defaut has increased.

 

[Texas Proud]

Not to discount everybody's concern that it will be a good default candidate...

BOA and JPM aren't the kind of companies that drop $2.2 billion into an investment to let it slip away... I would think that both would use this company for their portfolios going forward.... I think that it will become a stronger company in the future...

I'm just looking to see how low it will go and pick some up for me and my mother....

 

[youbet]

clifp and Texas Proud.....

Thanks for your thoughtful comments. But, more specifically, what are your feelings about the new SLM's ability to pay if inflation goes through the roof some years from now? For my purposes, there's no point to owning ISM if it can't stand the test of paying in a very high inflation period.

I'm not all that worried about a default if the economy maintains reasonable metrics over the next 11 or 12 twelve years. But is counting on a junk rated cpi indexed bond to pay in a period of hyper-inflation not realistic?

 

[clifp]

I think that Sallie Mae is in better shape than most companies to withstand periods of high inflation.

Many of Sallie Mae loans have adjustable rates tied to the prime, if inflation kicks in the interest rate (baring a period where the inflation rate exceeds the Prime rate) on the loan will go up in tandem with inflation. In general Sallie Mae securitizes its loans (in debt instruments like OSM/ISM ) and attempts to match the characteristic of the loans fixed or variable with the debt instrument.

It makes money off of the spread + fees. I think as long as the real interest remains relatively constant Sallie Mae will be ok. The obvious problem is the new owners are going borrow a lot of money driving down Sallie Mae credit, thus increasing the cost of funds, and lowering the spread.

One huge advantage that Sallie Mae is the 84% (from the last annual report) of student loans are back by the federal government, if the student default Uncle Sam pays back between 98-100% of the loan.

There is a good section in the annual report about the interest rates risks.

 

[brewer12345]

I think the inflation thing is a non-issue. Most of SLM's assets are floating rate or swapped to floating rate, so if inflation rises, so will short term rates. No biggie.

I am in the same boat in these bonds. I think that default risk will be higher if the deal goes through, but it won't be excessive, IMO. So I am willing to maintain a 5 or 6% portfolio exposure at current prices. I would suggest you re-examine your comfort level with the amount of bonds you hold. If you feel you have too much, hit the bid when it creeps up/over 21 until you have reduced your position to match your comfort level.

I think reasonable estimate of downside is maybe, barring some short term irrational dumping. But like all bonds, barring default, even if the bonds dump down that far they will recover closer to par as we get closer to maturity.

 

[justin]

I have no idea of the scale of SLM's total portfolio of inflation-indexed bond issuances. But ISM and OSM are very small compared to their entire bond debt outstanding (somewhere in the $100 billion range). ISM is $75 million at par, and OSM is $100 million at par, IIRC. Even if inflation gets really high, the overall impact won't be that great to SLM (unless they owe on a lot of other inflation linked bonds).

 

[brewer12345]

(unless they owe on a lot of other inflation linked bonds).

They don't. I can't recall if they ever disclosed the exact amount, but I would be surprised if the total amounted to over $1 billion.

 

[youbet]

Thanks for the comments and insights! Great discussion!

ISM is about 3.9%, at acquisition price, of my total portfolio. That would be 9.7% of my fixed portion. I was targeting to have 5% of my total portfolio, 12.5% of the fixed portion, in inflation protected securities and was muddling through the question of whether to buy TIPs directly, an ETF or an MF when the ISM idea came up.

More than the default fear, my concern through this has been the same as if I suddenly learned that the firm that insures my house and cars had been downgraded. Will SLM/ISM be there for me if we experience hyper-inflation?

I believe I'm going to fill out th balance of my inflation protected security goal percentage with gov issued dept, still need to decide on the vehicle, and hold the already owned ISM and watch.

Again, thanks for your comments.

 

[Texas Proud]

If hyperinflation occurs, I think there will be a lot of other problems than a few defaulted bonds...


From Wiki...

In economics, hyperinflation is inflation that is "out of control", a condition in which prices increase rapidly as a currency loses its value. No precise definition of hyperinflation is universally accepted. One simple definition requires a monthly inflation rate of 50% or more. In informal usage the term is often applied to much lower rates. The definition used by most economists is "an inflationary cycle without any tendency toward equilibrium." A vicious circle is created in which more and more inflation is created with each iteration of the cycle. Although there is a great deal of debate about the root causes of hyperinflation, it becomes visible when there is an unchecked increase in the money supply or drastic debasement of coinage, and is often associated with wars (or their aftermath), economic depressions, and political or social upheavals.

 

[Texas Proud]

Guys... I want to thank you for the info on this board.... I bought my mom some of the JSM this morning, but only got a few shares as the price jumped up... might buy some more soon as the yield is pretty good.. just have to get her to move some money to her brokerage account...