First Marblehead Price Drop Creates Buy Opportunity

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.

Full Disclosure: I have a position in FMD

FMD 1-yr chart:

Comments

[FIG trader_:]

"Answer a fool according to his folly" has been a maxim of mine for years. But for those fools of this particularly green variety, its hard to contain myself. Revisiting the recommendation after the bounce seems disingenuous. Do you still believe in this "hidden gem". Couldn't find the original FMD reco by Motley Fools , though its a fair bet to assume that it had to be near the highs. See my previous posts including the one in January that suggested this was a short of historic proportions. It still isovervalued and will grind lower as interest rates grind higher. First a bit about SLM. The entry of the big boys in SLM was a fait accomplis, for them to secure some future 20%-plus ROEs at lower risk, hedging some "business risk". SLM's 30% ROE are a thing of the past as are FMD's 40% plus. But BAC and JPM could manage the relationship improving lending spreads and fee structures, while accepting lower equity returns. Leave it to Jamie Dimon's bankers. I'm surprised it took so long, but it came after several years of SLM grossly underperformed the financial sector. He likes to buy as cheaply as possible. Standalone SLM would have continued on a slow decline like its leveraged bretheren in housing FRE/FNM. As for FMD, one can only guess the timing of the next phase of the decline. Selling opp's; perhaps right here, on this "rally".

2007 Jun 04 11:42 AM

[Winston Kotzan:]

What's going to happen when the dems get in office and make government loans more available?

2007 Jun 04 02:38 PM

[Vitaliy Kat...:]

Though this article has been written for The Motley Fool. My views have nothing to do with The Motley Fool or their newsletters.

2007 Jun 04 03:56 PM