Heh, ISM/OSM again

[brewer12345]

Huge volume in both today. I suspect that someone has decided to arbitrage these in size.

 

[FinanceDude]

Why does OSM look better to me than ISM?? Must be a mirage......... :

 

[brewer12345]

Why does OSM look better to me than ISM?? Must be a mirage......... :

Wordplay reasons? Commun-ISM, rastafarian-ISM, etc.?

 

[FinanceDude]

Wordplay reasons? Commun-ISM, rastafarian-ISM, etc.?

You must have a preference??

 

[HFWR]

Hedon-ISM...

 

[brewer12345]

You must have a preference??

Hey, I could have made a Freudian joke instead. After all, you;re a guy, so maybe you are more comfortable with the O than the I...

 

[brewer12345]

So now the NY TImes is reporting a rumor that SLM is in talks with private equity and other groups about a sale. Personally, I find it tough to imagine that such a deal would fly, given that SLM needs to maintain a strong investment grade rating in order to cost effectively fund its loans. I guess I could see a modest amount of incremental holding company leverage being stacked on the company, but nowhere near the kind of ousized debt that is typical in private equity buyouts of industrial companies (who mostly don't have to care about their credit ratings). If a traditional LBO deal were done the rating agencies would downgrade SLM and it would be difficult or impossible for a junk rated SLM to run its business profitably.

So I suppose it is possible that private equity could do a deal for SLM, but I dont think they can do it on a heavily leveraged basis. The securitization markets are deep, but they aren't that deep so as to provide all of SLM's funding needs. More likely, any possible deal would involve a mostly equity-funded buyout of the company, possibly with a financial institution as a partner. There is also a possibility that this flushes out a financial institution buyer, like JPM Chase or Bank of America.

It is unclear to me that the various gummint entities taht would have to approve any such deal would allow it to go through as a private equity deal. Yes, there are precedents (GMAC, most notably), but there aren't the same extenuating circumstances here (SLM isn't owned by a failing automaker that employs tens of thousands of voters). Plus SLM owns an industrial loan company (a lightly regulated variety of bank), transfers of which are technically prohibited right now.

So what to do with ISM/OSM? These are already 84 cent on the dollar bonds trading at spreads over treasuries roughly equivalent to a weak BBB credit (about 170BP). If a deal gets done that involves leverage, ISM and OSM could get downgraded, but I am having a hard time believing that the deal would fly if it were more than a notch or two (to A3 or Baa1). Its also unclear if the deal would actually be approved, ad it would take time to set up anyway.

Bottom line: IMO, these bonds are already priced as if SLM has been downgraded to a weak BBB. The deal is still in the rumor stage. I am inclined to sit tight. If you have an outsized position, it might be smart to let some go, but I wouldn't take a deep discount to yesterday's price to do it. If the market gets stupid and knocks these bonds (or their callable fixed rate cousing JSM) under 20, I'd say it would be the deal of the year.

 

[soupcxan]

I just heard this story on NPR. SLM is up 12% at the moment, so I guess someone thinks that a buyout is possible. Or maybe it's just the merger arbitrage computers going wild. ISM and OSM are both off a bit.

Brewer: when are you going to start your own stock newsletter?

 

[brewer12345]

I just heard this story on NPR. SLM is up 12% at the moment, so I guess someone thinks that a buyout is possible. Or maybe it's just the merger arbitrage computers going wild. ISM and OSM are both off a bit.

Yup, possible. Seems likely that Blackstone or someone else will even try. Not immediately clear what it means for bondholders, although LBOs are rarely a credit positive. But considering the already-low prices of ISM and OSM, I can't see dumping on the rumor. We'll see what happens over the weekend.

 

[wabmester]

Interesting situation. Just goes to show that these issues are not a no-brainer substitute for TIPS.

Brewer, what's the deal on JSM? Is that likely to be called?

 

[brewer12345]

Brewer, what's the deal on JSM? Is that likely to be called?

Right now? Nope. If rates plunge in the next couple of years, yes it could be called away. Not the major concern with that security, though, since it is currently trading at a ~10% discount to par.

 

[wabmester]

Not the major concern with that security, though, since it is currently trading at a ~10% discount to par.

That's why I would love for it to be called. (If I were to buy it.) Ignoring the default risk, how do you calculate YTM/YTC on something that can be called away at any time? Must get pretty volatile after the initial call date.

 

[brewer12345]

That's why I would love for it to be called. (If I were to buy it.) Ignoring the default risk, how do you calculate YTM/YTC on something that can be called away at any time? Must get pretty volatile after the initial call date.

Usually, you calcuate yield to call as well as yield to worst (scheduled maturity in this case). At the current price, YTC is 14.09%, YTW is 6.88%. Bond is callable at 12/15/08. This is the sort of thing that can be attractive t o buy at a deep discount and if the credit sorts itself out you end up with good returns even if it gets called away.

 

[FIRE'd@51]

Must get pretty volatile after the initial call date.

No more volatile than before the call date, probably less volatile if rates have declined from its initial coupon rate. If rates have gone down, the bond will trade right around par (the market will assume it will be called). If rates have risen the bond will trade at a discount (the market will assume it won't be called).

 

[brewer12345]

No more volatile than before the call date, probably less volatile if rates have declined from its initial coupon rate. If rates have gone down, the bond will trade right around par (the market will assume it will be called). If rates have risen the bond will trade at a discount (the market will assume it won't be called).

Ayuh. Take a look at PFX, a very similar security. The issuer had some credit problems and the bond went to a hefty discount to par. They recovered and so did teh bond. Now it is callable at 25 , so it basically hugs 25 plus whatever accrued interest there is.

 

[clifp]

I am trying to understand why the spread between OSM and ISM is so large currently (1 hour before market close) OSM is 21.32B 21.33A
and ISM is at 20.89B and 20.99A. ISM pay an extra $.0125 year interest payment but mature 9 months later than OSM, without whipping out my calculator I thought the YTM on both issue should be very close.

 

[wabmester]

If rates have gone down, the bond will trade right around par (the market will assume it will be called). If rates have risen the bond will trade at a discount (the market will assume it won't be called).

That's why I assumed it would be volatile. It'll trade some days like a 35-year bond and other days like a 1-year bond with the market always trying to predict the potential call date.

BTW, anybody else who thinks that those large blocks that traded the other day were insider trades? Retail investors are always the last to know.

 

[brewer12345]

I am trying to understand why the spread between OSM and ISM is so large currently (1 hour before market close) OSM is 21.32B 21.33A
and ISM is at 20.89B and 20.99A. ISM pay an extra $.0125 year interest payment but mature 9 months later than OSM, without whipping out my calculator I thought the YTM on both issue should be very close.

Unsettled market and relative illiquidity of ISM (Smaller issue).

I note that the prices of both are rising as the market starts to figure out what I thought: SLM is a better target for a large, creditworthy bank rather than a private equity shop. If a AA-rated bank buys SLM, it would be a definite positive for bondholders (look at the spread on WFC debt vs. SLM, for example).

 

[FIRE'd@51]

That's why I assumed it would be volatile. It'll trade some days like a 35-year bond and other days like a 1-year bond with the market always trying to predict the potential call date.

Doesn't work quite that way. The bond won't trade above the call price by more than the accrued interest because investors fear it will be called. Take a look at a chart for PFX as Brewer has suggested.

If rates have risen so that the bond trades at a discount, it will trade pretty much like a non-callable bond.

 

[wabmester]

I note that the prices of both are rising as the market starts to figure out what I thought

ISM is back down again. The market hasn't figured anything out. The volume indicates it's just a few retail traders like us.

 

[brewer12345]

ISM is back down again. The market hasn't figured anything out. The volume indicates it's just a few retail traders like us.

We'll see. I still cannot see how his would work as an LBO. That's one of the reasons I bought the bonds in the first place.

 

[brewer12345]

Heh, and now the bid is back up, in size.

 

[wabmester]

Heh, and now the bid is back up, in size.

Yeah, that was me. (Kidding. I'm not interested in speculating on bond ratings.)

 

[wabmester]

We'll see. I still cannot see how his would work as an LBO. That's one of the reasons I bought the bonds in the first place.

Rumor is now that Blackstone is the buyer. That means LBO, right?

 

[FIRE'd@51]

Well, one thing this does help explain is why PFK has been trading at a significantly lower YTM, even though it is a single A rated piece of paper just like ISM/OSM. The "market" must have known something.

Nevertheless, those who bought this for the inflation-protected payment stream will probably be OK (unless the LBO were to lead to a default). The real question is do you add to your position (assuming it isn't already too large) if these puppies trade significantly lower.