ISM/OSM yet again

[FIRE'd@51]

OSM is trading below 18 which is a real YTM of nearly 6%. This is a very attractive return for a fixed income instrument. The risk to a buy and hold investor, of course, is that SLM defaults on its debt. Here's what I'm thinking.

SLM shareholders vote on the proposed deal August 15. IMO, they will approve the deal at 60, given SLM is currently trading around 48, which will force Flowers' hand. However, I think Flowers et al will demand a renegotiation of the deal at a considerably lower price given the unfavorable legislation that is working its way through Congress and is likely to be signed by President Bush. There's even a possibility that Flowers et al will walk away from the deal altogether. So where does that leave the bondholders?

Case I: Flowers walks away claiming the new legislation has materially affected the business going forward. Although, the business is less profitable going forward, the company should remain a going concern and the bondholders get paid what they expect (i.e. no defaults). This scenario may even result in an increase in the bond's rating.

Case II: Deal is done at a lower price (possibly significantly lower). Assuming the % debt involved in the deal remained the same, it seems this would result in less debt overall for SLM, which would be positive for the bondholders. This case is harder to evaluate.

Case III: Deal is done at the original $60 price - this would obviously be the worst case for current bondholders, and coupled with the likely new legislation, could put the future of SLM in peril. For this reason, I can't imagine this Case actually taking place.

At current ISM/OSM prices, is anyone interested in dabbling in these notes under the assumption of Cases I or II being the likely outcome? And does anyone have any strong feelings as to which case will occur? Or, do I have it all wrong? I'd be interested in thoughts from those of you who have followed this saga.

[haha]

Quote:

Originally Posted by FIRE'd@51 At current ISM/OSM prices, is anyone interested in dabbling in these notes under the assumption of Cases I or II being the likely outcome? And does anyone have any strong feelings as to which case will occur? Or, do I have it all wrong? I'd be interested in thoughts from those of you who have followed this saga.

Your analysis sounds good to me, but I don't think the investment makes sense. You mention dabbling in it- IMO not wise to invest at all in anything that you would tend to look at as dabbling.

Ask yourself- what are the chances of a really big payday? (Impossible, IMO, since the upside is capped.) What are the chances of a flameout? Who knows, but definitely non-zero.

This investment has equity like uncertainty but junk bond max returns.

Edited to add: Another negative is that your competition here is well informed arbs. Somebody is in a better position than an outside investor to put probabilities on the scenarios that you mention- or even come up with others.

If you don't like it for 5-10% of your assets, why do it? It will take up a lot of mental space likely better spent elsewhere.

Ha

[FIRE'd@51]

Quote:

Originally Posted by haha Your analysis sounds good to me, but I don't think the investment makes sense. You mention dabbling in it- IMO not wise to invest at all in anything that you would tend to look at as dabbling. Ask yourself- what are the chances of a really big payday? (Impossible, IMO, since the upside is capped.) What are the chances of a flameout? Who knows, but definitely non-zero. This investment has equity like uncertainty but junk bond max returns. If you don't like it for 5-10% of your assets, why do it? It will take up a lot of mental space likely better spent elsewhere. Ha

Sorry, perhaps I shouldn't have said "dabbling". By dabbling, I was thinking in terms of starting to average into a position of a few percent of my portfolio (not more than 5%).

I agree that it's a capped return, but other than the default risk, the risk is unlike equity risk in that there is no "beta risk", if you will. Either you earn a 6% real return, or SLM "flames out". Also, no inflation risk, which is present, at least to some extent in junk bonds.

[haha]

Quote:

Originally Posted by FIRE'd@51 Sorry, perhaps I shouldn't have said "dabbling". By dabbling, I was thinking in terms of starting to average into a position of a few percent of my portfolio (not more than 5%). I agree that it's a capped return, but other than the default risk, the risk is unlike equity risk in that there is no "beta risk", if you will. Either you earn a 6% real return, or SLM "flames out". Also, no inflation risk, which is present, at least to some extent in junk bonds.

Beta risk is less important to me than risk of permanent loss. JNJ common has more beta risk than ISM, but IMO is a less risky investment, and one likely to have higher returns.

But you seem to like ISM/OSM, so go for it! I still can't see the attraction of a high maintenance position that is only at most 5% of a portfolio, unless it has a very high possible payoff.

For myself, I feel so lucky to have escaped this thing with modest losses.

Ha

[Texas Proud]

I like the JSM better as it goes out to '43...

Yes, there is a default possibility, but IMO it is small... and the first hit it the common....

BTW, these are NOT bonds... there are a lot of bonds that are outstanding who get priority to these issues.. Still, an 8% plus yield looks good to me...

[haha]

Quote:

Originally Posted by Texas Proud BTW, these are NOT bonds... there are a lot of bonds that are outstanding who get priority to these issues.. Still, an 8% plus yield looks good to me...

Texas, could you elaborate on this statement? They are described as "senior unsecured obligations" of Sallie Mae. How are they not bonds?

Also, news today of a conflict. Flowers et al are refusing to do the deal at the planned price, citing changes in the environment which they say activates an escape clause. They also signal that they are willing to look at "new terms".

So it seems that one cannot assume that this deal does not get done. It may well get done just at a lower price. I suppose that might also lower the amount of new debt involved, but for me it is still too hazy and unpredictable.

http://biz.yahoo.com/ap/070926/sallie_mae_buyout.html?.v=5

Ha

[twaddle]

Somebody thinks they can value them. The bonds jumped $1 or so in the last hour of trading today. My impression was that these things will still be rated as junk even if the deal falls through.

[youbet]

Sooooooo.........

Let's assume that SLM and the buyout group sit back down and negotiate a lower price and the deal proceeds. But, it turns out the buyout group (Flowers firm, Bank of America Corp. and JPMorgan Chase & Co.) is wrong and the business is a disaster and they default on their financial obligations. How would this manifest for ISM/OSM? I assume monthly interest payments would stop and therefore the market determined trading price for ISM/OSM shares would plummit to pennies. Is that it?

[FIRE'd@51]

Quote:

Originally Posted by youbet Sooooooo......... Let's assume that SLM and the buyout group sit back down and negotiate a lower price and the deal proceeds. But, it turns out the buyout group (Flowers firm, Bank of America Corp. and JPMorgan Chase & Co.) is wrong and the business is a disaster and they default on their financial obligations. How would this manifest for ISM/OSM? I assume monthly interest payments would stop and therefore the market determined trading price for ISM/OSM shares would plummit to pennies. Is that it?

Here's the way I understand it. If SLM were to default on its interest payments, the bondholders could force the company into bankruptcy. Since ISM/OSM are unsecured senior notes, there are no directly identifiable assets (e.g. a specific pool of loans) that they would have recourse to. However, they would be continue to be unsecured creditors of the company and wait in line for some type of payout. If SLM then emerged from bankruptcy, any bondholders not made whole (including holders of ISM/OSM) would end up with stock in the reorganized entity.

This is a worst-case scenario, and IMO, extremely unlikely - although not entirely impossible. Remember, you have two large banks involved in this who will be providing credit lines to SLM, plus it's unlikely that the Federal Government would want to see the company fail. Probably the biggest nuisance to ISM/OSM holders will be the de-listing of the securities, which I believe will happen once SLM is taken private, so selling them will become more cumbersome and, probably, more costly. However, one who plans to hold the securites until maturity will likely continue to receive the expected interest payments plus $25 at maturity. There is also the possibly that JC Flowers et al, will make the company more efficient and then try to take it public again. In this case, the ISM/OSM holders might even get the $25 par value paid to them early.

[haha]

FIRE'D, I assume you are a holder. How much do you place here? (Raw$ or %)

Ha

[FIRE'd@51]

Quote:

Originally Posted by haha FIRE'D, I assume you are a holder. How much do you place here? (Raw$ or %)

Yes, HA, I am. And as a new stockholder in BAC, you will be paying me interest if the deal goes through.

[youbet]

Quote:

Originally Posted by FIRE'd@51 Probably the biggest nuisance to ISM/OSM holders will be the de-listing of the securities, which I believe will happen once SLM is taken private, so selling them will become more cumbersome and, probably, more costly.

Thanks FIRE'd@51!

It hadn't occurred to me that ISM/OSM would be de-listed once SLM goes private. Interesting.......

[justin]

Practical question: if these get delisted, will they go to the "pink sheets" or something similar? In other words, less liquidity and bigger bid/ask spreads, but it'll eventually sell for something?

[ats5g]

Quote:

Originally Posted by justin Practical question: if these get delisted, will they go to the "pink sheets" or something similar? In other words, less liquidity and bigger bid/ask spreads, but it'll eventually sell for something?

Justin,

IIRC, equities are quoted on the Pink Sheets and corporate bonds are quoted on the Yellow Sheets, but I think Pink Sheets, LLC owns both [yellowsheets.com redirects you to pinksheets.com]. But these are just places for market makers to only post quotes, there's no execution system. Corporate bond executions are usually reported to TRACE.

hth

[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]

Quote:

Originally Posted by 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?

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

[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]

Quote:

Originally Posted by 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

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]

Quote:

Originally Posted by haha 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.