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An Unusual Story in Bloomberg About Sallie Mae, with the Usual Dose of Non-Sensical Optimism

Reggie Middleton's picture




 

Sometimes I have to actually read articles twice, because it really
seems that I have somehow missed the point the first time around. Well,
on my third glance at this Bloomberg article, I still don't get it: SLM
Sells Debt at Higher Interest Rate Than Students Pay


March 17 (Bloomberg) -- SLM Corp.,
the largest U.S. student-loan company, raised $1.5 billion in the bond
market, paying more than it charges some borrowers to begin
addressing $11 billion of bonds maturing through next year
.

Sallie Mae, as the company is known, sold $1.5 billion of 8 percent
notes due in 2020 at a yield of 8.25 percent, according
to data compiled by Bloomberg. Stafford federal loans disbursed
between July 1, 2009, and June 30, 2010, have a fixed interest rate of
5.6 percent
, according to the company’s Web site.

 


I know I'm not as good at math and finance as those fancy Wall Street
banker guys, but isn't this a BAD thing? They are essentially borrowing
themselves into a hole. I also don't see any indication in the article
of the potential for a reversal in this trend, either.

 



With $4.51 billion of bonds maturing this year and $6.44 billion in
2011, Sallie Mae is reestablishing access to unsecured debt markets.
The
offering may bolster investor confidence, lowering borrowing costs as
the company will likely need to tap debt markets again, said Matthew

Eagan, a money manager at the Loomis Sayles Bond Fund in Boston.

 


I'm not a shareholder, but this would drain my confidence, not bolster
it. they have a lot of debt to rollover, and thus far they are rolling
it over at a significantly negative spread to their main product! Even
if they were to be able to lower their borrowing costs, it looks as if
they may have to nearly halve it in order to be cashflow positive,
unless servicing is really that profitable or they will be able to raise
the rate they charge their customers. Again, I don't follow the company
so there may be extenuating circumstances of which I am not aware, but
this blurb did seem rather odd to the casual observer.

 


“They’re in a virtuous cycle now,” said Eagan, who helps oversee $18.9
billion, including Sallie Mae debt. “People will see they can raise
money in the market and they’re going to have no problem refinancing
all
these near-term maturities, pushing their cost of borrowing down.”

 


Oh, I see. It really is that easy??!!

 


Sallie Mae hadn’t sold unsecured debt since a $2.5 billion offering of
10-year notes in June 2008. Its sale came after average yields fell to
3.978 percent yesterday, the lowest since Dec. 6, 2004, according to
the
Bank of America Merrill Lynch Global Broad Market Corporate index.

When the company issued asset-backed bonds linked to student loans on
March 3, the debt priced to yield 325 basis points, or 3.25 percentage
points, more than the London interbank offered rate, Bloomberg data
show. Three-month Libor, a borrowing benchmark, was set at to 0.266
percent today.

‘Expensive for Them’

“This will be expensive for them,” said Peter

Thornton, an analyst at KDP Investment Advisors in Montpelier,
Vermont. “When you’re a lender you need to borrow money as cheaply as
possible if you’re going to turn around and lend it.”

 


"as cheaply as possible"!!! Let's try borrowing it a little
cheaper
than you lend it out for starters!

 

Elsewhere in credit markets, the Federal Home Loan Bank system, the 12
government-chartered cooperatives owned by U.S. financial companies,
plan to sell $3 billion of two-year notes tomorrow. BNP Paribas,
Barclays Plc and Deutsche Bank AG are lead managers on the sale,
according to a statement today from system’s finance office in Reston.

Oh, this is rich. These are the banks that lobbied their senators and
congress men to repeal the mark to market rules because they only
foresaw $12 million or so in actual losses although the market was
punishing them as if they were to have $300 million or so in losses.
Let's excerpt from a previous post:
About the Politically Malleable FASB, Paid for Politicians, and Mark
to Myth Accounting Rules

About a year ago, the government-chartered lender [Federal
Home Loan Bank of Seattle
]
blamed accounting rules after it wrote down its portfolio of
mortgage-
backed securities by $304.2 million to reflect how much their
fair-market values had fallen. While those declines counted against
its
earnings and regulatory capital, the bank said they
were “well beyond any
expected economic loss.”

The bank’s executives said they expected to lose a mere $12
million 
of principal over the life of the
securities.
That estimate proved far too hopeful, though.

The bank,
one of 12
regional Federal Home Loan Banks that supply low-cost loans to about
8,000 member banks and finance companies, now says itexpects about
$311.2 million of credit losses on its portfolio. And in December, it

filed lawsuits against 11 Wall Street underwriters, including Goldman

Sachs Group Inc. and Morgan Stanley, seeking more than $3.9 billion
of
refunds on the securities, plus interest. You know the losses are
real
when the bank is suing to get its money back.

 As you can see from my table below, FHLB Seattle execs were obviously
engaged in one of those wicked sensimilia
sessions when they came up with that $12 million dollar loss figure,
and over the entire loss of the securities may I add, not even for
just
one quarter.

image019.png


.......


he bank became a poster child for everything supposedly wrong
with
mark-to-market accounting. At a March 12, 2009, congressional
hearing,
U.S. Representative Ed

Perlmutter of Colorado cited the disparity between
the bank’s writedown and its much smaller anticipated [emphasis added] loss as “an
example that really was disturbing.”

The congressman leading the hearing, Paul

Kanjorski of Pennsylvania, pointed to
a
similar instance at the Federal Home Loan Bank of Atlanta. The bank
reported an $87.3 million writedown on its mortgage-backed securities

for the 2008 third quarter; however, it said it expected its actual
losses would be only $44,000.

While that’s roughly equivalent to the losses from a modest
studio condo foreclosure, Kanjorski didn’t question the tiny number,
saying: “I find that accounting result to be absurd.”

“It fails to reflect the economic reality,” he said.
“We must correct the rules to prevent such gross distortions.”
Kanjorski, Perlmutter and other lawmakers told Bob

Herz, the chairman of the FASB, that it needed to change its rules
immediately so banks could show stronger earnings. The board, which
fancies itself as an independent standard setter, complied a few weeks

later.

Changing the Rules

The rest of the story: Last year when the Atlanta bank released
its financial results for the third
quarter
, it said it had raised the credit-loss estimate to $263.1

million. (Here’s the math in case you missed it: $263.1 million >
$44,000.)

No, I didn't miss it. As a matter of fact, I feel the need to
elaborate...

image011.pngEven
before the estimate, it was evident that
the bank felt the need to declare more losses permanent and to
recognize more losses in earnings. Translation, even they realized the

jig was up. But what happened to the $44,000 loss estimate? They only
expected ONE house to be foreclosed upon, right???!!! 

...


Current reporting trends show that:

1. All FHLB banks reported the majority of their credit losses (more
than 70%) for 9M09 to comprehensive income, with only less than 30%
being charged to income statement.
2. Fed Home Loan Bank of Seattle, Federal Home Loan Bank of Atlanta
and Federal Home Loan Bank of Chicago transferred majority of their
credit losses to comprehensive income during 1Q09 and 2Q09. However,
they made a reverse transaction by charging more than 100% of their
credit losses to income statement in 3Q09.

image022.png

 

 

 



 
Alas, I digress - back to the Bloomberg article at hand...

 

 

... Sallie Mae is seeking to raise cash as legislation is
debated in
Congress that would eliminate federal guarantees and subsidies to
private student lenders provided under the Federal Family Education
Loan
Program, or FFELP. FFELP lending has been the “primary driver” of
Sallie Mae’s business and profits since its creation
as a
government-sponsored entity in 1972, according to a March 8 report from

KDP.


“We assume Sallie Mae’s traditional business of originating federally
guaranteed student loans will be phased out over time as the Department

of Education ramps up direct lending to students and parents,” the KDP
analysts said.

If the government starts originating loans, Sallie Mae will be
transformed into a company focused on loan servicing and private
lending
that is not guaranteed by the government.

 


Hmmm, so they will now be competing against the government (who is
currently borrowing at negative real rates) as well as funding their
product at a negative nominal and real margin. Tell me again why those
asset managers are getting optimistic. I must have missed the "good
news" part...

 


Tighter Underwriting

Sallie Mae has cut back on private student-loan originations in
part
because of tighter underwriting standards
, the company said in
a
Jan. 20 statement. The company originated $3.2 billion of
private
student loans last year, down from $6.3 billion in 2008
, the
statement said.

Late payments on student loans are rising as graduates struggle
to
find jobs.
The jobless rate reached a 26-year high of 10.1
percent
in October, according to figures from the Labor Department. It has
fallen since, holding at 9.7 percent in February for a second month.

 


Oh yeah! That must've been the (relatively) good news that I missed. The
markets are now so damn devoid of any correlation to the fundamentals
that I actually expect an Atlantic City slot machine burst out of my
trading screen for my convenience.

 


Delinquency Rate

The delinquency rate on Sallie Mae’s portfolio of private loans

increased to 9.43 percent last month compared with 8 percent in
November
and 9.29 percent a year ago, according to a March 15 report from Keefe
Bruyette & Woods.

 


Hmmm... Maybe that was the good news part.

 

Sallie Mae had been selling debt backed by its student loans through
the Federal Reserve’s Term Asset-Backed Securities Loan Facility, or
TALF. The program, begun last March to jumpstart the market for

securities backed by consumer and small business loans, ends this
month.
The lender sold $1.55 billion in asset-backed debt for the final TALF
round on March 3.

Okay, so maybe this is the good news that is slipping past me???


The Sallie Mae bonds are expected to be rated Ba1 by Moody’s
Investors Service, one level below investment grade, and one step
higher
at BBB- by Standard & Poor’s.

 


Do they really deserve a junk rating???

 


Sallie Mae’s sale and a $2 billion offering from International Lease
Finance Corp., the plane-leasing unit of American International Group
Inc., show investors are receptive to companies closely linked to the
U.S. government that haven’t sold bonds recently, said Timothy

Norman, director of fixed income trading at Thrivent Financial for
Lutherans in Minneapolis.

 


I am at a total loss as to how Sallie Mae will pay these bonds back.
Their volume has dropped about 60%, their existing book of business is
mounting significant and increasing credit losses heading into a
negative looking macro environment that portends even more extensive
losses in the foreseeable future. They are currently borrowing at a
negative margin, and the crux of their business model (government
subsidies) looks to be dismantled. On top of it all, it looks as if they
will have to compete directly with the government. On top of that, the
little bit of government bailout that was thrown to them (TALF) is being
phased out right about now. 

Sallie Mae... Debt offering... Successful... Good news... Non Sequitur

 


‘Wouldn’t Have Believed’

“You’re seeing ILFC and Sallie Mae both do a deal in the same day,
which even six short months ago you wouldn’t have believed,” said
Norman, who helps manage $64.7 billion. “The world has changed and they

have certainly adapted and are making some progress relative to where
they were a short time ago.”

 


Yeah! You're right. The world has changed. In the world I used to live
in, prudent asset managers wouldn't touch this company with YOUR

fingers, wrapped around a 10 foot pole. In today's melt up the equity
market on any good news, bad news, or maybe even just news news, and
report it as something positive in the mainstream media, it sort of
makes one happy to know that independent blogs do exist.

 

A $25.3 billion takeover bid
for Sallie Mae
from investors including J.C. Flowers & Co. collapsed in 2007 when
Congress passed legislation that cut federal subsidies to student
lenders.


The company reported net income of $309.1 million in the fourth
quarter and $159.1 million in previous three-month period, which ended
four straight quarters of losses.

 


I wonder if I were to dig in deep, would I find that the reported income
stemmed from something other than purely economic gains...  

 

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Sun, 03/21/2010 - 11:39 | 271354 poorold
poorold's picture

I see the default rate, but what is the non-performing rate when you add in the loans on "payment deferral?"

 

My brother-in-law is on deferral.  His loans now total $99,000.  He is a teacher earning less than $40k and has a wife and 2 kids, qualifies for medicaid but not food stamps.

It's not even funny.

I also just met someone who has $30,000 in student loans, hasn't completed her degree and works full time in customer service making $25k per year.

 

Start adding in people like this and I think the picture becomes more clear.

 

Sun, 03/21/2010 - 04:21 | 271236 The Lonely Bear
The Lonely Bear's picture

Hi Reggie, one thing to remember about SLM Corp is that it is like a big CDO. The bulk of the funding is done at very tight levels via issuance of AAA/Aaa ABS assets. Funding at the SLM Corp level is done to fund the nasty nuclear bits that can’t be funded via ABS. This effectively allows an even higher gearing ratio for the equity holders. As such, it can still be profitable for SLM to issue even at a yield of 8% as the return on their assets is the net margin i.e. student loan rates minus the tight issuance level of ABS less any losses. Granted I wouldn’t touch it myself given the current market background, default ratios etc. but the thing to remember is that although this may be senior debt, the buyers are effectively investing in mezzanine debt.

Fri, 03/19/2010 - 04:47 | 269977 Bear
Bear's picture

Moral Haphazard

Fri, 03/19/2010 - 02:30 | 269964 Matto
Matto's picture

"If it bleeds, we can short it...

Thu, 03/18/2010 - 22:34 | 269844 three chord sloth
three chord sloth's picture

OK, lemme explain it to you...

It is presented as good news because it makes a certain kind of person feel all warm and gooey inside. You see, these certain people have a warped view of the world.

They noticed that throughout history, many good and noble people suffered for their beliefs, so they think to themselves, "If we suffer, that must mean we are good and noble too." It's a logic flaw in the vein of "all dogs have four legs, a horse has four legs, therefore a horse is a dog". They've never figured out that being good and noble can create suffering, but suffering doesn't create goodness.

To them, the primary purpose of politics is to make themselves feel good, and nothing beats self-flagellation of themselves and their fellow citizens to bring that warm glow to their bellies. Losing money on every student loan makes us suffer, therefore they tingle at the thought of it.

They're easy to spot. Look for a statement that begins "I don't care how much money/many jobs it costs, we should..." Some of the various endings are:

"... give citizenship to anyone who wants to come here."

"... provide the best healthcare available regardless of ability to pay."

"... cut carbon emissions by 90% in the next ten years."

and on and on and on...

All policies that bring suffering without bringing goodness... suffering for suffering's sake.

 

Thu, 03/18/2010 - 21:54 | 269826 torabora
torabora's picture

My college is suffering a 35% default rate. We quit lending before we lose all Federal aid. jig is up

Thu, 03/18/2010 - 21:36 | 269819 Buck Johnson
Buck Johnson's picture

Sallie Mae is having major trouble because people haven't been paying on their loans.  People are using the deferement and other options to keep from paying and hope they find a job that would allow them to pay.  Sallie Mae is trying to get from under this old student debt and give it to someone else to worry about, that is why they are paying the 8.25% over 8%.  Remember when we kept telling Japan the only way to get out of their multiple decade recession is to write off the debt. 

I guess we can't even take our own advice.  American people and govt. and local govt. have to much debt to service pure and simple.  They are trying to keep America from the history books of being a Major country in recorded history to default on their debt, all in HD and on television.  We are trying to save face and appear to be rich whe we are not.  If they want the machine to start again they have to get the debt from out under the people and govt..  They have to allow the debt to be forgiven if they want to have a fresh start and/or a sensible start. 

Thu, 03/18/2010 - 21:28 | 269816 merehuman
merehuman's picture

me, i am going to protest in DC. Commitment to truth and the future of our children. Do we really have a choice? Yes, stay home , say nothing, see what hqppens.

Having looked at the eventualities (war with china) there is no choice if you and yours plan to survive. We must fight back.

Fri, 03/19/2010 - 00:41 | 269920 delacroix
delacroix's picture

merehuman, washington DC is a waste of time, and no place, for an honest man. you can  do a lot more good, spending some of that gas money on flyers, aimed at informing the average joe about the things the MSN don't tell him. then spend some of that time distributing them locally. that's a long drive, and a lot easier, when we were young. be smart, listen to your wife, she loves you. you don't need to drive 3000 miles to  make a difference. EROI   theres plenty, to do locally, and thats where you'll be living, when the cookie crumbles. you are a resource, allocate yourself wisely. I sympathize with your frustration, but don't let emotion cloud your good judgement.  good luck, whatever you decide.  Delacroix

Thu, 03/18/2010 - 18:17 | 269736 goldfreak
goldfreak's picture

There's got to be a way people can come together and stop this insanity already. HOW?

Thu, 03/18/2010 - 17:28 | 269701 viahj
viahj's picture

just roll it into the health care bill

Thu, 03/18/2010 - 17:23 | 269698 Gimp
Gimp's picture

Great article as usual Reggie.

No mystery here, this is how Ponzi schemes work. It helps when the government and the  (no credibility left) FASB issuing new accounting standards when the scheme gets out of control.

Rinse, Wash and Repeat.

Thu, 03/18/2010 - 16:48 | 269669 InstantWinner
InstantWinner's picture

The kids won't pay back the loans.    More extend and pretend.  But 8% looks good on paper.

Thu, 03/18/2010 - 15:40 | 269606 37FullHedge
37FullHedge's picture

I guess the good news is some overpaid fund managers are prepared to risk hard earned cash in this bond issue, Well our hard earned cash,

I wouldnt lend a student money anything like 8% and possibly neither does this company so maybe a good chunk of loans are around 12% or so making this company ok.

On the face of things it looks like a ponzi scam and the suckers will be the taxpayers. How long can these shenanigans continue?

Thu, 03/18/2010 - 14:21 | 269518 Catullus
Catullus's picture

Aren't student loans indexed to prime? I'll give you the spread is the margin, but the spread is not fixed. It seems like a bet that interest rates can't too low for much longer. They'd have a really big problem if employment and interest rates correlated, but that's Keynesian craziness.

I'd like to see what their interest rate swap activity has been.

Thu, 03/18/2010 - 13:33 | 269476 KidDynamite
KidDynamite's picture

reggie - someone commented on my blog that SLM's private loan biz (ie, non gov't guaranteed) has rates of higher than 8%, and thus still generates profits vs this debt issue.  do you have that data?

 

i think the bigger issue is the "virtuous cycle" of ponzi finance

Thu, 03/18/2010 - 14:01 | 269500 Reggie Middleton
Reggie Middleton's picture

I don't follow the company, thus I don't have the data and can't comment one way or the other. The article simply struck me as odd. Even if their private loan business has higher margins, does it have the volume to make up for the credit losses on the subsidized sized, its own credit losses as well as the negative spread to the subsidized business no to mention the severe drop in revenues? 

I am still at a loss to see the good news here.

Thu, 03/18/2010 - 14:33 | 269534 KidDynamite
KidDynamite's picture

i'm with you. it's a ponzi scheme in action

Thu, 03/18/2010 - 11:41 | 269325 pragmatic hobo
pragmatic hobo's picture

offer something at 8% and it gets scopped up by the pension funds ...

Recent NYT article had suggested that these funds are not only chasing yield but using leverage as well. I wonder how this will all end up when shit hits the fan yet again ...

 

Thu, 03/18/2010 - 10:39 | 269240 Cyan Lite
Cyan Lite's picture

Reggie,

 

They borrow with a negative spread to have positive operating earnings.  As long as they can service the debt, then they're okay and Wall Street will let them do this till they can no longer service the debt.  Which at that point, they will either:

A) Sell it off as some ultra high-yield for a pension fund

B) Use it as collateral at the Fed window

or C) Sell CDS's against it at 400bps and then allow them to roll the debt again.

 

Rinse. Repeat. Recycle.

Thu, 03/18/2010 - 12:29 | 269396 Reggie Middleton
Reggie Middleton's picture

They borrow with a negative spread to have positive operating earnings.

Well maybe for a widget manufacturer, but this is a lender. The spread IS their operating earnings! I don't care what their 10Q says, run the real math and their is no way around it (that is, agian, unless their servicing business is really that strong, which I doubt).

Your explanation sounds as if you have been around the fixed income sales department of a few banks :-)

Thu, 03/18/2010 - 20:31 | 269800 Squid-puppets a...
Squid-puppets a-go-go's picture

haps their earnings on interest is minimal in comparison to their penalty fees - overdue fees, transaction fees, servicing fees, predator levy, parasite tax

Thu, 03/18/2010 - 10:28 | 269221 bingaling
bingaling's picture

Sally is the ugly stepchild of fannie and freddie -In the end the gov't will bail em out -

 

But KidDynamite is right they will just do what everybody is doing. Push the debt til'2012 then pray the Mayans were right where they never have to pay it .

Who would have thought in a million years that the US gov't/Fed could sell so many t-bills last year and are on their way to do even more .

With all of this debt being sold refied by corps munis countries reit's etc. etc .etc and with these type of forward looking articles pointing out the dangers ahead who the hell is buying all of it? The numbers are crazy( the US bond sale numbers have got to be the craziest )yet somehow it is getting done .Though it makes no sense

Thu, 03/18/2010 - 10:16 | 269208 Monday1929
Monday1929's picture

The good news that you missed, Reggie, is that the size of the bail-out won't be unlimited like Frannie. It will be quantifiable as the spread between their borrowing costs and what they lend at and should remain well under 5 trillion dollars. Don't you see what good news that is?

Get with the program. 

Thu, 03/18/2010 - 10:31 | 269229 lins216
lins216's picture

lol....you could replace Sallie Mae with CRE....same story....

Thu, 03/18/2010 - 14:41 | 269538 Inspector Asset
Inspector Asset's picture

http://wallstonion.blogspot.com/2010/03/it-is-officail-obamas-2012-slogan.html

The Drudge Report recently confirmed from official unofficial sources that the Obama re-election team for 2012 has officially changed their strategy from "HOPE" to "COPE." Key players on the administration have been quoted as saying "We have reason to believe that there is no way in hell, the American public is going to go for that bullshit of "hope" and "change" this next time around." We really need to get in their heads and sympathise with the people and their troubles, because it's no joke, times are hard during this depression.

 

Obama's administration was quick to point out that even though we didn't deliver on pulling out the troops in the middle east, and we gave Wall St a bunch on money, we still did a pretty good job of giving the people that feeling of hope and change. Even though the stock market crashed, that was not are fault, and yea , that was not the "change" we expected, but hay it works. " All people have left is the "change" in their pockets, so they will be really appreciative of us using the word "COPE" in the reelection in 2012.

Off record some officials have privately said that the chances of Obama winning the election are pretty much non-existent. We realize now, but didn't know then that his a one term er President. "We had no idea that the stock market was going to crash right before the election said Obama. " "In fact, it kind of pisses me off says the President as he reached for a cigarette out of a brass case." Sometimes the President feels like this was some kind of prank from the south; to put him in the White House right when the stock market crashes.

So Cope is the charged word of choice for the next election and DOPE will also be dispensed and given out as MEDICINE to help people COPE with their new problems of CHANGED economic status. Yes , I did did say DOPE; marijuana (for you old timers) will be used to lure in youth to vote and "rock the vote." Obama had told the Feds, "let the people, grow their medicine, it will abundant; help them COPE with the "CHANGES" that the future hold.

When Obama was questioned as to why are we in Afghanistan when he promised us no more wars,? Obama adeptly described the DOPE game and said "that's where the DOPES at, so if we want to help the American people to be able to COPE we need to supply and protect those resources and pathways. It's simply in the best interest of the consumer, and therefore we will stand by the Afgan and Pak a Stan police and assert any terrorists who fuck with our DOPE!

In the mean time get your T-Shirt here and right now, and be one of the first to show you are down to smoke some DOPE with President Obama!

 

Thu, 03/18/2010 - 08:16 | 269126 KidDynamite
KidDynamite's picture

it's easy, Reggie.. they will pay back these bonds by issuing MORE bonds later.

 

see: C. Ponzi

Thu, 03/18/2010 - 12:25 | 269391 knukles
knukles's picture

Socialist Paradise Come True! 

Do NOT follow this link or you will be banned from the site!