ISM/OSM yet again

[youbet]

Anyone aware of where we can find some detailed info or at least opinions on what the student loan legislation passed last night is going to do to SLM and their bond issues? I've found a number of articles on what the new SAFRA legislation will mean to students, parents, schools, the country, etc., but not directly addressing its impact on SLM.

http://www.washingtonpost.com/wp-dyn/content/article/2010/03/21/AR2010032103548.html

SAFRA Stinks - Forbes.com

 

[FUEGO]

Based on the beating SLM common stock took the last few days, I'd say the market is telling us "This does not bode well for SLM".

 

[FIRE'd@51]

As I see it, it's been anticipated for months that direct lending by the Federal government would likely be implemented. SLM will still be servicing a large portion of these loans. As I understand it, repayment of many outstanding student loans will still be guaranteed by the government should they default. So this should only affect potential new business, which is a negative for the stock to the extent it hasn't already been discounted. In all probability, there will be enough of a revenue stream for SLM to make its interest payments and repay its debt as it matures, without defaulting. The item which kicked off this whole debacle, i.e. the Flowers bid with the subsequent downgrade, would have involved substantially more leveraging of SLM's balance sheet, which was a negative for the then current bondholders.

 

[youbet]

As I see it, it's been anticipated for months that direct lending by the Federal government would likely be implemented. SLM will still be servicing a large portion of these loans. As I understand it, repayment of many outstanding student loans will still be guaranteed by the government should they default. So this should only affect potential new business, which is a negative for the stock to the extent it hasn't already been discounted. In all probability, there will be enough of a revenue stream for SLM to make its interest payments and repay its debt as it matures, without defaulting. The item which kicked off this whole debacle, i.e. the Flowers bid with the subsequent downgrade, would have involved substantially more leveraging of SLM's balance sheet, which was a negative for the then current bondholders.

Thanks FIRE'D. My current position in ISM is about 2% of my total FIRE portfolio, so it would be a painful but not life altering event if SLM defaulted. I'm still enough in the red (down about 15% from my average price - didn't buy very much while it was way down) that I'd prefer not to bail right now. But, if I thought there was a significant chance SLM could default with the final renumeration to bond holders being zero or close to zero, I would. If ISM was likely to be redeemed at par at maturity or default but with a substantial (60% - 70% - 80%) settlement, I"d stay. So, I'm mulling this over. Not knowing the future is such a pita, especially concerning investing!

If the bonds do default, the predominant cause would be the legislation which passed last night. Would Obama/Pelosi/Reid want bond holders to take it in the shorts as a result of this legislation or would they respond with some bailout that makes the bondholders whole? I suppose to answer that you'd have to make some assumptions about how it would impact votes....... My gut feeling is that they'll want to avoid any headlines about layoffs, defaults, severe equity value erosion, etc., directly due to their actions but won't be particularly concerned about keeping eveyone completely whole.

Owning this issue sure has given me something to mull over while taking my morning walk.......

 

[FIRE'd@51]

If the bonds do default, the predominant cause would be the legislation which passed last night.

Wasn't that legislation pretty much anticipated and currently incorporated into prices?

Would Obama/Pelosi/Reid want bond holders to take it in the shorts as a result of this legislation or would they respond with some bailout that makes the bondholders whole? I suppose to answer that you'd have to make some assumptions about how it would impact votes....... My gut feeling is that they'll want to avoid any headlines about layoffs, defaults, severe equity value erosion, etc., directly due to their actions but won't be particularly concerned about keeping eveyone completely whole.
.

Now that's an interesting thought. Maybe our bonds will get redeemed at par early.

 

[youbet]

Wasn't that legislation pretty much anticipated and currently incorporated into prices?

Yes it was. But isn't that a different issue than the bonds defaulting? If next year, or the year after that, or whenever, the bonds default I think there will be a link made by the media between this legislation and the default. The fact that prices were already deflated due to the anticipation of the legislation won't be the primary topic of discussion. At least that's MHO

Now that's an interesting thought. Maybe our bonds will get redeemed at par early.

Well, wouldn't that be a hoot? I doubt that will happen, but somewhere along the way the politicians will likely make a decision whether to meddle with the skeleton of the SLM they're leaving behind or not. Let the stakeholders die on the vine? Bail 'em out? Who knows? Like the bailouts of the past couple of years, it will be as much political shananigans as financial analysis. That's what, to me, will make this so interesting/frustrating going forward. And makes the sell/hold/wait and see decision one big crap shoot.

 

[FIRE'd@51]

Yes it was. But isn't that a different issue than the bonds defaulting?

Yes, it is a different issue. What I meant was that the run up to 17-18 dollars per share occurred while this legislation was being anticipated, so I'm guessing that is where the market thinks a fair risk-adjusted price is. Compare that to PFK which is trading close to par.

 

[youbet]

Yes, it is a different issue. What I meant was that the run up to 17-18 dollars per share occurred while this legislation was being anticipated, so I'm guessing that is where the market thinks a fair risk-adjusted price is. Compare that to PFK which is trading close to par.

OK, I see.

I'm just wondering how much of today's $17 price is based on the market's evaluation of SLM as an ongoing business and how much is based on the vision of a new SLM where most employees have been laid off and a skeleton staff is collecting existing loans and paying back debt holders. And if that new business is not successful enough to pay back the debt, I wonder how that will work out? A total loss? Partial payback (common with senior unsecured note defaults)? Some kind of gov't intervention if the media links the default to this legislation with negative overtones?

In terms of the market evaluating the risk, it is encouraging that SLM is actually up a few cents and ISM/OSM only down modestly today.

 

[clifp]

I was listening PBS Newshour last week and they had a debate on between a Sallie Mae VP and a liberal think tank guy.

I was struck by how inarticulate the Sallie Mae VP and what crappy arguments she made.
She should have argued that moving to direct loans was going cost taxpayers money or at least the 61 billion in saving that is projected is illusionary. The student loan business use to be quite profitably but it hasn't since Congress passed the reforms in 2007, Sallie Mae has lost more than billion in the last few years. The legislation will replace jobs at Sallie Mae with more expensive government jobs.

Then talk about how Sallie Mae has competed with the government for many years and the market place has spoken and 75% of the customer prefer working the Sallie Mae than with the direct loan program.

Instead she and Sallie Mae came off as other financial firm making a fortune at the taxpayers expense. (It may be true but a decent PR should be able to spin it better.)

Oh well I am guess I am use to the incompetence of the management.

 

[youbet]

Thanks Clifp. I did read an article which showed that some of the projected 61B in savings has already occured and therefore including it in the 61B is double counting. And there were a few other issues with the way the 61B was calculated. But, frankly, I'm not a big fan of Sallie Mae and not surprised that their rep couldn't battle with a liberal think tank guy. I just want to have them succeed enough to pay interest on my ISM holdings until they redeem in full at par at maturity........ Or come to the conclusion I need to dump what I own and lick my wounds.

Here's some info that came with my Schwab closing report today:

12:51 PM 03/22/10

TEXT-S&P says Student lender rtgs unaffected by FFELP vote



(The following statement was released by the rating agency)
March 22 - Standard & Poor's Ratings Services announced today that its ratings on student-lending firms remain unchanged following a vote this weekend in the U.S. House of Representatives to eliminate the Federal Family Education Loan Program (FFELP).
The legislation is included in the health care bill that passed a House vote yesterday. We expect the U.S. Senate may pass the legislation at some point this week.
If signed into law, private education lenders such as SLM Corp. ('BBB-/Negative') and Nelnet Inc. ('BBB-/Negative') would no longer have the ability to originate federal student loans.
While this could lead to some short-term reductions in their revenues, student lenders will be able to retain their current FFELP portfolios and the cash flows arising from them--still the lion's share of their FFELP revenues.
We will see a greater impact on these firms through longer-term changes to their business models.
If the legislation becomes law, we will monitor how these companies adapt to this new environment.
((New York Ratings Team, 646 223 6318; caryn.trokie@thomsonreuters.com, Reuters Messaging: caryn.trokie@reuters.com@reuters.net))


Thomson Reuters

 

[FUEGO]

I guess a lot of their loan portfolio consists of loans amortized over 10 to 30 years. So the 7-8 year maturities of ISM/OSM may work out just fine.

Don't they have a significant amount of private student loans that they can continue to originate? I'm sure there is some breakdown of revenue and net profit by loan type somewhere.

 

[youbet]

I guess a lot of their loan portfolio consists of loans amortized over 10 to 30 years. So the 7-8 year maturities of ISM/OSM may work out just fine.

Yes, it might work out fine. My main concern is that I read that SLM has a chunk of debt maturing in the near future. They sold $1.5B at 8.25% BBB- bonds a week or so ago as a test to check their ability to refinance this debt. Apparently the offering went well. So, if that holds true and they can refinance the wave of maturing bonds hitting them shortly, they may very well go on for years in some sort of business and paying interest. If something changes and they can't refinance the soon to mature debt, then we'll quickly get our answer about defaulting! I'll dig up details of that again when I can take another break from taxes........

Don't they have a significant amount of private student loans that they can continue to originate? I'm sure there is some breakdown of revenue and net profit by loan type somewhere.

Not sure about that. But reloaning money you obtain by selling bonds where you're paying 8+% interest (remember they're BBB- so paying high rates) doesn't sound like a winner to me. Without the gov't subsidy money, and, in fact actually competing against the gov't, I think they're stuck loaning to high risk individuals willing to pay double digit interest.

 

[clifp]

Actually, I thought they were getting out of the private lending business having loss a ton of money on it. There is a several hundred million charge off on their income statement due to discontinued business.

 

[youbet]

Actually, I thought they were getting out of the private lending business having loss a ton of money on it. There is a several hundred million charge off on their income statement due to discontinued business.

Well, as I mentioned above, with no subsidies and no source of cheap money to lend out, it's hard to see how they could be porfitable in the private lending business. Borrowing at 8+% and trying to mark that up and re-lend it wouldn't be a business I'd want to jump into.......

 

[Texas Proud]

Wow... my JSM has been going up a lot lately...


Seems the same for these two...

 

[brewer12345]

Wow... my JSM has been going up a lot lately...


Seems the same for these two...

Man, is it ever hard not to mentally insert the "I."

 

[RustyShackleford]

This is interesting ....

The Fed's IOER Approach; Laissez-Faire, Laissez-Passer? -- Seeking Alpha

I sold all of my 5y and longer TIPS yesterday, and will invest the proceeds in OSM, short-term TIPS, commodity indices, iShares S&P GSCI Commodity Index (GSG), possibly PowerShares DB Base Metals Fund (DBB), and cash.

 

[FIRE'd@51]

We haven't done this for a while, so here goes.

The year-over-year change in CPI-U for October (released yesterday) was 1.17%. The current yields (on par) for OSM for the next three months are:

Dec 3.15%
Jan 3.14%
Feb 3.17%

For ISM, the yields are 5 basis points higher.

This morning I was able to sell OSM at the bid and buy ISM at the ask and take out 0.55 per share. I calculate that the break-even inflation rate for this swap is 1.2%. Above 1.2% there is a pick-up in YTM.

 

[youbet]

We haven't done this for a while, so here goes.

The year-over-year change in CPI-U for October (released yesterday) was 1.17%. The current yields (on par) for OSM for the next three months are:

Dec 3.15%
Jan 3.14%
Feb 3.17%

For ISM, the yields are 5 basis points higher.

This morning I was able to sell OSM at the bid and buy ISM at the ask and take out 0.55 per share. I calculate that the break-even inflation rate for this swap is 1.2%. Above 1.2% there is a pick-up in YTM.

Thanks.

A few weeks ago I went in the opposite direction. At a point where ISM and OSM were selling at close to the same price and swapping back and forth as to which was higher, I was able to sell ISM and buy OSM for a few pennies less 2 - 3 days later.

The current price is close to breakeven for me and I'm still considering dumping it all. I don't trust the gov't to leave the rules intact to allow SLM to have a viable business in the mid or long term. But I've been saying that for a couple of years now........

 

[RustyShackleford]

Time for those of us who didn't panic-sell ISM/OSM back when the price was down in the single-digits (in late-2008 and early 2009) to give ourselves a big pat on the back ?

Or a kick in the rear if we didn't buy more ?

(Prices for both are around 21 today).

 

[FUEGO]

Time for those of us who didn't panic-sell ISM/OSM back when the price was down in the single-digits (in late-2008 and early 2009) to give ourselves a big pat on the back ?

Or a kick in the rear if we didn't buy more ?

(Prices for both are around 21 today).

I'm feeling pretty good. I think I got in for a bit more than $20/sh on 5/6 of my holdings, and I bought another 1/6 of what I own at $13/sh IIRC. Too bad I didn't get a ton more at $8-9 - then again the world was falling apart at the time and who knew if students would ever be able to repay their loans??

I have arbitraged ISM/OSM many many times and made some decent change each time. Now that I have a big ST cap gain if I sell, I may just hold on to it for a while.

 

[clifp]

My ISM/OSM has been in my IRA. 3/5 I got at $21 and the remainder at $11, I've sold some along the way. I sold TIPs bonds to buy the darn thing, and since I am still worried about inflation I am planning on holding until maturity. As I know I've said before who knew bonds could be so exciting.

 

[FIRE'd@51]

Yep, I hold these in my Rollover IRA, so no tax liability is incurred when "arbing" them. Even at a price of 21, the real YTM is about 5% if inflation averages 2%, and I am fearful that inflation could be considerably higher, so I'm holding on to these with both hands (with fingers still crossed).

 

[FIRE'd@51]

Anybody still long these puppies?

The year-over-year change in CPI-U for May (released today) was 3.57%. The current yields (on par) for ISM for the next three months are:

July 4.73%
Aug 5.21%
Sep 5.62%

 

[FIRE'd@51]

For anyone who still holds these, today I was able to sell OSM at the bid and buy ISM at the offer and take out 0.60 per share plus pick up about 20 basis points in YTM.