ISM/OSM yet again

[justin]

"Sallie Mae will continue to have publicly traded debt securities"

Trading on the pink/yellow sheets would still be "public". It just wouldn't be listed on one of the main exchanges, right?

 

[ats5g]

"Sallie Mae will continue to have publicly traded debt securities"

Trading on the pink/yellow sheets would still be "public". It just wouldn't be listed on one of the main exchanges, right?

heh heh... True, I guess the PS would still technically be "public". The above caption did say that SLM "will continue comprehensive financial reporting about its business, financial condition and results of operations," which could mean that SLM will still file reports with the SEC, which indirectly results from the fact that they will have to file reports. Why? Because their other securities will still be registered under Section 12 and/or listed on a national exchange, and hence no delisting of other securities.

I left a message for Joe Fisher @ SLM IR [(703) 984-5755] just to be sure.

- Alec

 

[Texas Proud]

Of course they don't want it to go into bankruptcy, but the efficient market is saying that when the buyout was announced, risk increased. Remember, after the buyout offer the bonds in question came to rest between 16 and $17, down from $22 -$23. That is where a supposedly efficient market balances the risks and rewards on this one. If it works out, the ROI will be way in excess of TIPS. Some of that can be explained by illiquidity; and the rest, by perceived risk.

To pass on this thing is not the same as predicting bankruptcy. Anyway, at least we all are finally up to speed about what class of securities we are talking about here.

Ha

True, true... the risks have risen and the price has declined accordingly.. but the risk of BK is still pretty low for the company.. I know somebody has the percentages with the ratings (ie, AAA is .1% in any year etc...)

And yep, up to speed.. well, maybe still a little slower than other

 

[twaddle]

Moody's rates this issue Baa1, which has a historic default rate of less than 0.1% in any given year, but has a default rate of nearly 8% in a 10 year period.

pdf link

 

[haha]

Moody's rates this issue Baa1, which has a historic default rate of less than 0.1% in any given year, but has a default rate of nearly 8% in a 10 year period.

pdf link

Assuming for the moment that ratings mean anything anymore, this would appear to be a good bet at current prices, -if- one could somehow invest in 1000 such deals that were miraculously uncorrelated.

I was thinking the same thing re: the thread on viaticals. People who did this business got absolutely killed because their risks were highly correlated. When the field got going, the main market was men with AIDS. Men who thought they were terminal, as did their doctors. Then to the great joy of all right thinking people, and certainly the patients, but to the likely consternation of the viatical firms, alone came AZT and other anti-virals.

Even if a firm were able to avoid concentrated disease risk, it would still need many insured lives to get the actuarially predicted result- and then they are subject to the same risk as annuity writers- breakthroughs in big diseases such as heart disease, stroke, diabetes and cancer.

Not to mention that it would be a morbid business suitable only for misanthropes.

Ha

 

[twaddle]

Assuming for the moment that ratings mean anything anymore, this would appear to be a good bet at current prices, -if- one could somehow invest in 1000 such deals that were miraculously uncorrelated.

Yup, I like that it's exchange traded. I like that there are two similar issues (great for tax loss harvesting, arbitrage, etc). I like that it's CPI-linked. But I don't like the single-issue risk on junk bonds. Too easy to diversify that risk away by buying something like VWEHX instead.

 

[youbet]

And the beat goes on...............

Sallie Mae Can Expect Favorable Hearing: Financial News - Yahoo! Finance


This sure has been interesting. If somehow SLM could collect the 900 Mil penalty from Flowers et al, would that be enough to improve the credit rating on ISM/OSM? SLM would march on with degraded government subsidies but with an improved cash position.

 

[haha]

And the beat goes on...............

Sallie Mae Can Expect Favorable Hearing: Financial News - Yahoo! Finance


This sure has been interesting. If somehow SLM could collect the 900 Mil penalty from Flowers et al, would that be enough to improve the credit rating on ISM/OSM? SLM would march on with degraded government subsidies but with an improved cash position.

Youbet, thanks for posting this very interesting article.

To me, the main risk to bond buyers is not the reduction in government subsidies- the estimates of earnings reductions put forth on the low side by Sallie Mae and on the high side by the buyout group would not matter to a bondholder. The risk is that the buyout takes place. This is nicely outlined in the final few paragraphs of the article.

In another recent article (I think it was in the business section of last Sunday's NY Times) I read that the Flowers group would be respnsible for half of the $900,000,000 breakup fee. This is a big hit to the Flowers group, and would likely be enough to annoy his limited partners severely. So he has motivation to get it done. Plus, the swing from complete to non-complete will costs Flowers Group $650,000 because he/they will lose a $200,000,000 completion fee. The same is true of Chairman Albert Lord at SLM. He stands to become close to a billionaire on completion, adding his buyout winnings to his go-home and stay home pay from SLM. What does a few $$ million mean compared to losing the deal?

From the article cited by Youbet:


The new student loan law at the center of the dispute cuts about $20 billion in federal subsidies to companies like Sallie Mae, while halving the interest rate on government-backed student loans.
Sallie Mae says the buyout group was on notice about the new law, and the anticipated reduction in earnings isn't a valid reason for the buyers to back out of the deal.
While Sallie Mae says the new student loan law will reduce its net income between 1.8 percent and 2.1 percent each year over the next five years, the buyers group forecasts a much bigger cut in profits: 14.4 percent in 2009 and 20.1 percent in 2012.
Some Wall Street analysts say the legal wrangling is nothing more than a negotiating tactic that Sallie Mae is employing in hopes of closing the deal.
Friedman, Billings, Ramsey analyst Matt Snowling said in a research note Tuesday that Sallie Mae's lawsuit is "a tactic to establish a time line to bring a possible resolution." "Faced with the cost of litigation and a disruption of a deal breaking, we suspect that Sallie is willing to take a reasonable offer," of around $55 to $57 per share, Snowling said.

Ha

 

[clifp]

For those still with OSM/ISM, anybody want to hazard a guess if the bonds are fairly priced or not? They jumped about 5% today on the news of the deal falling through.

Assuming the article is correct and the sides are fighting over the $900 mil deal cancelation fee and not just trying to negoiate a new deal it seems to me that bonds are underpriced. They currently are yielding just under 7% and if they are held to maturity you'll get a capital appreciation of about 45% admittedly in 10 years!

On the other hand the twist and turns of the Sallie Mae saga are far from over, the generous subsidies on student loans vendors I suspect are things of the past, and the risk premium for bonds has sky rocketed over the summer.

 

[twaddle]

The yield seems high to me given the rating. And I figure the rating agencies are smarter than I am about estimating the risks. I would nibble at these prices, but avoid large bites.

 

[youbet]

The yield seems high to me given the rating. And I figure the rating agencies are smarter than I am about estimating the risks. I would nibble at these prices, but avoid large bites.

What is the rating now, and where can I look it up?

 

[haha]

The yield seems high to me given the rating. And I figure the rating agencies are smarter than I am about estimating the risks. I would nibble at these prices, but avoid large bites.

I figure in a situation like this, the market knows more than the rating agencies, and they both know more than I do or could. This is a classical insider play. What really counts is known only to a few people on either side of the deal. And they are only guessing about the other players.

Ha

 

[twaddle]

What is the rating now, and where can I look it up?

Current rating is Baa1 / BBB+ and I believe the rating agencies have them on credit watch. I.e., these ratings only reflect current conditions and they may be downgraded (again) if the LBO happens.

Check QuantumOnline.com for various fun facts about these issues.

 

[youbet]

Thanks.

 

[justin]

What is the rating now, and where can I look it up?

I look at quantumonline.com.

The current rating is Baa1/BBB+. Last reviewed 8/21/07.

I think this rating places ISM/OSM firmly at the top of the heap when it comes to junk bonds. This rating is higher than essentially all of the bonds the Vanguard high yield fund holds. One step below A grade.

I wonder though, if the rating is based on current operations and not the speculative takeover that may/may not occur. In other words, SP and moody's reviewed the company's ability to pay based on their current operations and balance sheet and ignored the fact that in a year or two, they may be privately held, leveraged up with debt.

edit: cross post w/ twaddle

 

[youbet]

I assume this kind of news would drive the wedge between the Flowers Group and SLM even deeper.

Sallie Mae Lost $344 Million in 3Q: Financial News - Yahoo! Finance


This whole caper has helped me understand the concept of individual issue risk!

 

[twaddle]

This whole caper has helped me understand the concept of individual issue risk!

The best education ever!

Take a rock-solid business with government backing and prime-rated debt. Hmm, how can we blow that up? Oooh, I know! How about a few college marketing scandals, followed by an LBO, followed by the government withdrawing their backing. Oh, and toss in a liquidity crisis for good measure!

 

[haha]

A Lot Not To Like

among the personalities involved in this SLM "deal".

In the Trenches at Sallie Mae - Mergers, Acquisitions, Venture Capital, Hedge Funds -- DealBook - New York Times

 

[youbet]

Very interesting read Ha. Thanks.

 

[clifp]

The best education ever!

Take a rock-solid business with government backing and prime-rated debt. Hmm, how can we blow that up? Oooh, I know! How about a few college marketing scandals, followed by an LBO, followed by the government withdrawing their backing. Oh, and toss in a liquidity crisis for good measure!

Interestingly the very first security I ever purchased was a corporate bond. I had saved up $2000, and with a 2 year scholarship for college didn't really need the money until my junior year. I found out that I could buy a bond from a blue chip company that was yielding more than 10% with only a 3 year term (rates were higher in 1977). I asked the broker if it was safe to buy this bond and he said yes I think despite the recent trouble the company would certainly be around to pay back the money. Unfortunately for me the company was Chrysler and the news went from bad to worse to threatened bankruptcy. Luckily Lee Iaccoca got a government loan guarantee, and I got paid off. But I remember cursing myself that I had all the agony associated with Chrysler, but unlike stock holder who would have made a fortune in Chrysler stock, I all I got back was my lousy 10% interest.

Fast forward, 30 year latter to my second individual corporate bond purchase ever, namely ISM and OSM. Once again a seemly safe boring bond turns into anything but dull.

So far this education on the perils of individual bond purchasing has cost me a quarter worth of tuition at a public university in realized losses, and entire years worth of tuition a private school in paper losses. I wonder if Lee Iaccoca is still available?

The morale of the story is that individual bond purchases have none of the upside of stocks but much of the downside. I thought I learned this 30 years ago but I guess not. The obvious take away for the rest of you is if I buy a bond, you should sell!!

 

[soupcxan]

The morale of the story is that individual bond purchases have none of the upside of stocks but much of the downside.

That's an incorrect assumption based on your limited experiences in the fixed income universe...if you had bought JSM at 17 you'd be sitting on a 12% gain right now. But your point that less diversification = more risk certainly holds true for bonds as well as stocks.

 

[haha]

But I remember cursing myself that I had all the agony associated with Chrysler, but unlike stock holder who would have made a fortune in Chrysler stock, I all I got back was my lousy 10% interest.

I think this is a very important point, easy to forget when we are looking for income. Years ago I had a great older broker who owned a small botique shop. This was before a lot of rules and regs about information control. His first rule was don't buy anything other than a treasury or a group of AAA municipals unless you have reason to expect a speculative payoff that more than compensates for what is inherently an unknowable risk. I got the feeling that he only included municipals because people hate to pay tax. His second rule was don't buy anything where you don't have relationships with the executives involved.

The second rule is less useful today when investing has become democratized and rule-burdened. I try to substitute an awareness of insider buying/selling for this aspect.

Today when stocks only go up I don't expect many people would be in a mood to listen to this fuddy-duddy advice, but its time will likely come again.

Ha

 

[twaddle]

I used to own some FDC, which was recently taken private via LBO. This will give you an idea of what the debt of a completed LBO might yield: 10.875%!

KKR Bankers Sell $2.2 Billion of First Data Bonds

 

[clifp]

That's an incorrect assumption based on your limited experiences in the fixed income universe...if you had bought JSM at 17 you'd be sitting on a 12% gain right now. But your point that less diversification = more risk certainly holds true for bonds as well as stocks.

I am not saying that you can't make very good returns on corporate Bonds. The total return on ISM/OSM assuming 2-3% inflation is in the 11-12% CAGR and probably a similar number for JSM. I know that big smart bond investor routines buy highly distressed bonds for 5 to 20 cents on the dollars and often triple their money, when the company comes out of bankruptcy.

I am just saying that there is a risk premium with individual investment grade corporate bonds, and has Ha Ha's broker wisely said the risk is highly unknowable. In the case of ISM/OSM there was no opportunity for speculative pay off. My orginal post when I decided to buy these things on Feb 25 was this.

Well I sat down and created a spreadsheet to compare ISM vs TIPs. ISM is better, assuming you can live with the risk that Congress decide to get out of the business of guarrantee Student Loans which would impact Sallie Mae. Assuming a reinvestment of dividends for both ISM and a mythical 11 Year TIPs bond @2.375%. (Which obviously isn't practically because of the monthly dividends from ISM)
It looks like ISM provides a future value that is almost 200 basis points higher than the same TIPs at the current price of $21.32

The major assumption I made was that ISM approached par at either a linear rate or an exponential rate of 1.3% per year. Varying interest rates didn't seem to matter much.

I was aware of some risk associated with buying these bonds but as it turns out I had no clue about any of the real risks. My upside is clearly limited. I sold 2012 TIP bond with 3.5% coupon (and current real rate of around 2.3%) and used the proceeds to buy ISM and OSM at prices right around 21.30. In fact, I intend to hold the bonds to maturity and so very may well end up $25k richer in 2017 than if I had done nothing.

Now obviously in hindsight I wish I hadn't made the purchase. The realization for me on this whole experience is I don't have the temperment for corporate bond purchases. The small incremental income isn't for me worth the head ache. It is somewhat ironic that at least dozen stocks in my portfolio have had bigger price swings in the last 8 months then the 20% drop in ISM/OSM. In some case I've sold the stock, in other case I've bought more, but I haven't lost a nights sleep.

For me bonds are something you buy, you hold until they mature, or you buy a bond fund. I'm finding that is not something you can do with corporates.

 

[youbet]

Now obviously in hindsight I wish I hadn't made the purchase. The realization for me on this whole experience is I don't have the temperment for corporate bond purchases. The small incremental income isn't for me worth the head ache. It is somewhat ironic that at least dozen stocks in my portfolio have had bigger price swings in the last 8 months then the 20% drop in ISM/OSM. In some case I've sold the stock, in other case I've bought more, but I haven't lost a nights sleep.

For me bonds are something you buy, you hold until they mature, or you buy a bond fund. I'm finding that is not something you can do with corporates.

Similar feelings here. I've taken worse hits on equity positions and shrugged it off but, for some reason, the SLM/ISM/OSM situation has been irritating. As others have already mentioned, I suppose it's because I picked up a few of these to place in the income generating portion of my portfolio where I place "sure thing" income producers. What I wound up with is a speculative holding!

They did poop out another interest payment this week though!