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]

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]

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]

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]

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]

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

 

[youbet]

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.......

 

[FIRE'd@51]

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.

 

[haha]

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

Sorry man, sold that already! Sometimes I have a high turnover.

Ha

 

[FIRE'd@51]

Sorry man, sold that already! Sometimes I have a high turnover.

Wow, I guess you do! Tax loss or short-term gain at ordinary income rates?

 

[haha]

Short term gain, but I had ST loss from expired puts that I thought I might as well use instead of losing it against LT gain that I have already booked. Earlier I thought I would have more ST gain from puts yet to expire, but that looks less and less likely as the year grinds on.

Ha

 

[Texas Proud]

Maybe I am not as informed as others, but I do see some remarks that do not add up to me...

Why would ISM/OSM be delisted?? They are preferred stock from what I can tell, not common. They are NOT being bought by the investment group, so they would still be outstanding and trading just like they are today.

As for Ha's questions... If they are preferred like I think, then they are not 'bonds' and would be in a different class during bankruptcy. Bondholders get paid before preferred stock, so if there are a lot of bonds outstanding that can not be paid, then you will not get anything. This makes them a bit riskier than a bond.

As for analysis... I do not see SLM 'flaming out' under any three of your options... they say that the new legislation will cost them maybe 2% of revenue... that is not something that will cause them to flame... and if they can increase volume like some people think (due to the new legislation) then they can make it up.

I would think that they will take the $900 million and run if the group tries to buy them at a much lower price.. they were selling for $45 or so dollars before the bid, so more than likely they are still a $45 stock...

 

[Texas Proud]

OK... looked it up and the JSM (which I have) is a 'note' and not preferred stock... so it ranks with other unsecured debt instruments...

I will assume ISM/OSM is the same.

 

[FIRE'd@51]

ISM/OSM/JSM are NOT preferred stock - they are unsecured notes (i.e. bonds).

I'm not 100% sure about the delisting, although, typically the NYSE does not list securities of privately-held companies. If you're saying these will be "grandfathered", I don't know the answer for sure. I think it is likely that they would be delisted, especially since, as a privately-held company SLM will not have the same reporting requirements as would a public company.

 

[haha]

I'm not 100% sure about the delisting, although, typically the NYSE does not list securities of privately-held companies. If you're saying these will be "grandfathered", I don't know the answer for sure. I think it is likely that they would be delisted, especially since, as a privately-held company SLM will not have the same reporting requirements as would a public company.

I think it is very likely that they would be de-listed, once SLM goes private. Also, I would like to comment on another poster who took comfort from the fact that 2 large banks have made loans here. IMO, this means zilch. Though I haven't spent the time to try to find out the details of this case, typically bank loans go to the front of the queue, senior to unsecured debentures. So in some circumstances, it could even be advantageous from the POV of the banks to let it slip into BK.

Back to the de-listing. While it might be fine to have a black box paying pretty good semi-annual payouts with a mandated 50% or so nominal gain 10 years out, it also might not be worth giving up liquidity to get this. The possibilities of death, divorce, unexpected other expenses could make some people be less sanguine about de-listing.

Ha

 

[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]

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

 

[FIRE'd@51]

Also, I would like to comment on another poster who took comfort from the fact that 2 large banks have made loans here. IMO, this means zilch. Though I haven't spent the time to try to find out the details of this case, typically bank loans go to the front of the queue, senior to unsecured debentures. So in some circumstances, it could even be advantageous from the POV of the banks to let it slip into BK.

The two large banks are BAC and JPM. Both are part of the purchasing group; so, should the deal go through, they will have a sizable equity position in the private SLM, which will be at the bottom of the BK queue.

 

[Texas Proud]

Anybody who thinks that any buyer will pay many billions of dollars for an equity position only to have it go in BK is kidding themselves..

Also, the securities might be delisted from NYSE, but could they go to NASDAQ or somewhere else?? I would think that the SEC would require them to be continue to keep following GAAP and make all the filings because of the various issues that they have... they are in the hands of the general public, not the (can't remember what it is, but 144 or something?) high dollar people which do not have to file much... maybe someone who has the time could read one of the prospectus and see what they put down for filing requirements.

 

[haha]

Anybody who thinks that any buyer will pay many billions of dollars for an equity position only to have it go in BK is kidding themselves..

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

 

[ats5g]

Anybody who thinks that any buyer will pay many billions of dollars for an equity position only to have it go in BK is kidding themselves..

Also, the securities might be delisted from NYSE, but could they go to NASDAQ or somewhere else?? I would think that the SEC would require them to be continue to keep following GAAP and make all the filings because of the various issues that they have... they are in the hands of the general public, not the (can't remember what it is, but 144 or something?) high dollar people which do not have to file much... maybe someone who has the time could read one of the prospectus and see what they put down for filing requirements.

The 6/27/07 Proxy Statement says

[FONT=Arial,Helvetica]

Delisting and Deregistration of Common Stock​

[/FONT]
If the merger is completed, the Company’s common stock will be delisted from the NYSE and deregistered under the Exchange Act and we will no longer file periodic reports with the SEC on account of the Company’s common stock.

However, according to the 10-K SLM Corp currently also has the Series A + B, preferred stock, and CPI linked notes [ISM/OSM] registered under Section 12(b) of the '34 Act. Unless SLM deregisters all of its securities registered under Section 12(b), it will still be obligated to file reports with the SEC.

I also didn't see anything mentioned about the delisting of the other securities anywhere. See also Sallie Mae Transaction Facts:

Regulatory
• Sallie Mae will continue to have publicly traded debt securities and as a result will continue comprehensive financial reporting about its business, financial condition and results of operations.

- Alec