Friday, July 13, 2007

Run, Morgan, Run!

Here is my quick take on the Sallie Mae news. For those who haven't heard, the synopsis is that J.C. Flowers, Friedman Fleischer & Lowe, Bank of America, and J.P. Morgan have informed Sallie Mae that pending legislation "could result in a failure of the conditions to the closing of the merger to be satisfied."

When the deal was first announced, it was widely reported that the private equity buyers could opt out of the deal if congress cut the subsidy for student loans beyond what the President had already proposed. That now appears to be probable.

I have two thoughts on this. First, if the acquiring group still wants to own Sallie Mae, they will simply use this as a means of negotiating down the price. Bond holders would wind up in a similar spot.

But there might be something a bit more nefarious going on here. Let's say you are Jamie Dimon. Your bank has several bridge loans for LBOs either outstanding or pending, and some of the deals are looking iffy. You had made the loans assuming you'd get taken out by a bond issue, but with high-yield spreads on the rise, that assumption is looking questionable. Ideally, you'd try to reduce your exposure to these bridges, but to renege on a bridge loan, or to try to work some loophole to get out, would damage the bank's reputation. You'd be shut out of the bridge loan business for the next 10 years. You don't want that, all you want is to lighten up.

But you do have one deal, Sallie Mae, where there is a likely change in the legal environment which alters target's basic business. Clearly with a reduced government subsidy, SLM isn't worth as much. If you could convince your partners (one of which, Bank of America, is in the same boat) to cancel the deal, then you achieve your goal of lightening up without damaging your reputation.

Maybe that has nothing to do with the recent communique between the parties involved, but worth thinking about.

Fair disclosure: I own a small SLM position. My goal is to hoodwink the entire bond market by writing this post on my tiny little blog. To throw you off my trail, I'm starting by suggesting that this news won't help bond holders at all. Oh, and I hate puppy dogs.


Anonymous said...

I'm somewhat of a bond newbie, but since I'm holding a few SLM notes, I'm watching this story with interest.

I enjoyed your post and believe that there must be some serious "buyer's remorse" going on. Furthermore, if the buyers believe that they can reduce the price, even by a paltry billion or two, why wouldn't they try?

WRT bonds, it seems that there is a bit of a zero-sum game going on between SLM shareholders and the bondholders. Every billion not paid to the current shareholders in the buyout is a billion that won't need to be borrowed to make the deal. And surely, Moody's and S&P will base their revised ratings on SLM bonds based on the final amount of leverage.

Anonymous said...

How much of a discount to the current asking price would you estimate it would take to help out existing bondholders?

Accrued Interest said...

SLM is a tough story for me. If you get the chance, read my other commentary on SLM.

My feeling is that no price cut is really going to help bond holders that much. Honestly my expectation is that all these LBO deals will go through.

Phillis said...

It will not really have effect, I feel like this.