In this article I made an argument that despite high uncertainty surrounding First Marblehead's (FMD) business at nine times earnings, it is a very attractive opportunity. Here are some additional points that I omitted in the article:
- It's not your friendly subprime lender. FMD has been painted with the same subprime brush as the rest of the financial companies. However, student loans never touch its balance sheet, even for a second. They go directly from banks that originated them to securitized trust. There is also nothing subprime about these student loans. For instance, the weighted average FICO score of the latest securitization was 712 and 83% of the loans had a co-signer. FMD has no debt and has about 10% of market capitalization in cash.
The only way we’d see recently originated loans on FMD’s balance sheet is if secularization markets shutdown. In this case FMD is required to buy originated loans from the banks. I put this risk in the same category with a risk of a nuclear meltdown. Securitization markets are the lifeblood of this financial system. FMD securitized successfully loans during the September 11th crisis.
- A flat yield curve may not flatten FMD’s earnings. I have no idea how long the slope of the yield curve will remain flat, however, historically the yields have not stayed the same for longer than six month. I am aware that history is only there to guide us. Just because they did not stay flat for long it doesn’t mean that they won’t in the future. The flat yield curve in this environment is unlikely to be as negative to FMD as one would think as declining housing prices and increased lending standards by lenders will make it incrementally difficult for home owners to tap into (declining) home equity.
- Cash flows are about to increase substantially as FMD will be receiving a differed (residual) component from the loans it originated years ago.For full disclosure: I have a position in FMD