Sallie Mae Shocks Bondholders in Asset Strip

Sallie Mae Shocks Bondholders in Asset Strip: Corporate Finance

SLM Corp. (SLM) dealt bondholders a blow as the student loan company prepares to move cash-generating assets out of their reach and rely more heavily on secured funding as it seeks to split into two separate entities.

Fitch Ratings cut the company known as Sallie Mae to speculative grade yesterday, citing the new structure’s weaker credit profile while Standard & Poor’s and Moody’s Investors Service said they may reduce the credit as well. Newark, Delaware-based SLM’s bonds lost more than $200 million in value after the disclosure, according to data compiled by Bloomberg.

Sallie Mae is separating its education loan business from its consumer lending operation, following legislation in 2010 that cut companies out of the government-guaranteed student loan market. The lender’s $17.9 billion of unsecured bonds will be serviced by the company housing Sallie Mae’s $118 billion portfolio of U.S.-backed loans that it’s winding down, while the earnings, cash flow and equity of the newly formed SLM Bank will be moved out of bondholders’ reach, according to Moody’s.

“Anytime you split a company up like this and some portion of the cashflows that could have been available to support debt payments is no longer available, it is incrementally negative for bondholders,” Sameer Gokhale, an analyst at Janney Montgomery Scott LLC, said in a telephone interview. “The question is: how negative?”Shareholder Ownership

The company’s $1 billion of 5.5 percent notes due January 2023 fell 2.88 cents to 96.3 cents on the dollar yesterday, the biggest drop since they were issued in January, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority. The yield on the securities rose to 6.02 percent, or 390 basis points more than Treasuries.

Both companies will initially be owned by existing shareholders, according to a regulatory filing yesterday. Assets under the so-called education loan management business will consist of about $118.1 billion in debt under the government’s Federal Family Education Loan Program, $31.6 billion in private education loans and $7.9 billion of other holdings.

The consumer banking business, to be called Sallie Mae Bank, is projected to have about $9.9 billion of total assets, including private education loans and related origination and servicing platforms, according to the filing.

‘Wrong Direction’

“The company is going in the wrong direction in terms of building balance sheet strength with what we consider an over-emphasis on returning capital to shareholders,” Peter Thornton, a credit analyst at KDP Investment Advisors Inc., wrote in a research note yesterday. “Unfortunately for Sallie Mae creditors, all of the current unsecured debt will stay at” a newly formed entity that contains the government-guaranteed debt while the “more promising future businesses” are stripped.

Sallie Mae expects the separation to be completed within 12 months, following approval from its board of directors and reviews by the Internal Revenue Service and the Securities and Exchange Commission, according to the filing.

The split will “create a better structure for the increasingly different regulatory environment that each of these businesses will operate under in the future,” Jack Remondi, the newly appointed chief executive officer, said on a conference call yesterday with investors. Remondi is replacing Albert Lord, whose departure was announced in November.

ABS Reliance

Sallie Mae plans to increase its reliance on funding in the asset-backed bond market as it reduces its unsecured debt load, he said on the call.

The lender, which issued about $14 billion in securities backed by student loans last year, has sold $5 billion in 2013, Bloomberg data show.

Sallie Mae sold $1.14 billion of bonds linked to private student debt on April 25, Bloomberg data show. The company paid 65 basis points more than the one-month London interbank offered rate to issue top-ranked securities maturing in 1.73 years. Asset-backed bond ratings are tied to the underlying loans, not the company’s ranking.

Fitch, which reduced Sallie Mae’s rating to BB+ from BBB-, said in a report yesterday that refinancing risk exists for the company’s unsecured debt because operating cashflows don’t completely align with its debt maturity schedule.

“Their preference is to fund those loans in the securitization market so there is no funding mismatch,” Janney Montgomery’s Gokhale said.

Future Cashflows

While the crimp in future cashflows may hurt the values of the bonds, the “vast majority” of the company’s assets currently reside with the legacy company, muting that effect, Gokhale said. “From a practical standpoint, it probably doesn’t make much of a difference.”

Sallie Mae’s stock has soared 37 percent this year as the company boosts private student loan origination. The lender made $1.4 billion in education loans in the first quarter, a 22 percent increase from the year-ago period, the company said in an April 17 statement.

Private education loans at Sallie Mae in repayment that were delinquent more than 90 days fell to 3.9 percent as of March 31, according to a May 3 regulatory filing, down from 4.4 percent in the year-ago period.

About 15 percent of the outstanding $1 trillion in student debt comes from private loans, which are not dischargable in bankruptcy.

The part of Sallie Mae that will house the larger portfolio, made up primarily of the government-guaranteed loans, produces steady income, making it a more predictable earner to pay back bondholders than the proposed Sallie Mae Bank, which is aiming for future growth, Brian Charles, a New York-based analyst at RW Pressprich & Co., a fixed-income broker and dealer, said in a telephone interview.

“What they are spinning off is the higher-risk profile business; what is staying behind is the steady cashflow business,” he said.

To contact the reporter on this story: Sarah Mulholland in New York at

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (, the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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