First Marblehead Should Jump on FBR Reversal

The unthinkable has happened - FBR has upgraded First Marblehead (FMD).

Rating goes to Market Perform from Underperform on the belief that much of the bad news is baked into the stock, particularly with early indications of thawing within the private student loan ABS [SLABS] market.

Notwithstanding the Company's increased risk to its residual receivables following rising credit losses and TERI's bankruptcy filing, the firm no longer believes the risk/reward warrants an Underperform rating for First Marblehead shares at current levels, especially as derivative benefits might start to form, stemming from governmental efforts to provide funding to the federally guaranteed student loan market.

Trading at 43% of stated tangible book and approximately at the cash on hand, FBR believes the shares reflect a near total impairment of the company's residual receivables. While further operating losses and possible liabilities related to the failure to securitize customer loans could drive the liquidation value to the company lower, the Firm views the potential for acquisition and/or the eventual opening of the ABS market as balancing risks.

Assuming a 100% impairment of the company's existing residuals, thereby eliminating the financial exposure to its outstanding trusts, FBR calculates this will result in a pro forma tangible book of $2.85 per share. Though the company will continue to bleed cash until it is able to access the capital markets, FBR believes the company becomes increasingly attractive as a target for its loan database and origination platform—along with the nearly $2.95 per share of cash.

Furthermore, in the event the securitization market opens up, the stock is set up for a potential squeeze with an estimated 22% of the float short. Balancing the upside, in their opinion, are the risk of cash burn, cannibalization from higher FFELP loan limits, warehouse refinancing uncertainty, and loss of loan volume from JPMorgan Chase (JPM), Bank of America (BAC), and RBS Citizens—which collectively represented 76% of the company's volume.

Notablecalls: FBR has been negative on FMD since 2006 and rightly so. With the firm stepping back from its negative stance, I suspect we may see some considerable short covering (and even buying). The stock can be viewed as a call option here - JPM & BAC may actually return as clients when the dust settles. If that happens, FMD will be a $10+ stock again. Unless it gets bought in the near-term.

Limited downside and ample upside is what you get here. I'm taking it.

P.S.: My gut tells me FMD could do $3.25+ today.

Comments

[BxCapricorn:]

Good call.

2008 May 22 10:00 AM

[valuemanager03:]

Well, good for your gut. Glad its so precise. The 'lending platform' is not worth much. It consists of people and relationships with low tier schools, all of which were geared towards volume of low quality loans (whose ultimate pay back will only now come to light since the first few years usually result in very low defaults). Further, the firm has let go about 2/3 of their employees from this time last year. The ones who remain are almost all on the trust servicing side, since there is virtually no volume in the selling 'platform'. So - again - not much value there.

2008 May 22 01:02 PM