Head Fake

Jeffrey deGraaf's ISI Technical Analysis Research:

"The breadth and volume flows yesterday (8/29/07) produced one of the lowest TRIN readings on record. The problem with any of the market's action over the last week has been in terms of volume. Light volume readings are notorious for giving false signals, and with it, we are relying on the weight of the evidence from a more extended time period. Credit spreads continue to widen, and as they do bulls around gold continue to grow. We find the gold bulls interesting, in that they are not being driven by the performance of gold (which has been unspectacular), but clearly by ancillary concerns within the world of finance. To see bulls or bears swell within a commodity without the commensurate move in the underlying basis is truly unusual.

We remain in the camp that this is a tactical bounce off of the lows in mid-August and we believe that initiating shorts into yesterday's strength is an appropriate strategy. Resistance of 1480 - 1500 on the SPX is an appropriate stop depending on one's tolerance for pain on the short-side up to those levels."

Fight the Fed, not credit spreads

You must read these two articles:

Doug Cass - Fight The Fed

Jeremy Granthom - Widening Spreads Hurt Margins and Valuations

Use market strength to reduce equity and add to your favorite shorts.

A new credit chapter begins

I can't believe that I'm thinking about the economy and markets at midnight on a Friday night, but I just shared an exchange with someone who I respect a great deal. We both follow the markets extensively and we've concluded (I think) that the Fed is not going to be able to save this market despite the rally today.

First, read this:

From Bloomberg on CP Market

The asset-backed commercial paper market is in semi-disruption. Companies that rely on this for funding like NCT, NLY, RWT and TMA are in big trouble, yet all those stocks were up big today.

Here is a key point. The problem is not illiquidity in the bond/CP market (something that lowering the discount rate will help). The problem is the bubble in consumber debt (especially mortgage) where defaults are now rising which resulted from years of easy monetary policy, leverage and poor underwriting. Credit issues were masked due to the refi machine and huge mortgage equity withdrawl rate, and now those two mechanisms for getting money in consumers' pockets has shut down. The job market is weakening, asset prices are falling and politicians want to raise income, dividend and capital gains taxes. Where is the consumer going to get money??? Credit is tightening across the board (because of rising defaults and the re-pricing of risk) and major excesses will have to be worked off for years. The ramifications will be significant from the home builders, suppliers, brokers, agents, lenders, appraisers, roofers, land scapers, contractors, retailers, foreign exporters of consumer products, etc.

The easy money and excess consumer spending chapter, long as a trilogy, is now likely over. The new chapter will be "The return of responsible lending"

Goldman Sachs on FMD

4Q2007: Richer mix offsets the impact of an uncertain environment
August 10, 2007


What's changed

First Marblehead reported 4Q2007 diluted EPS of $0.83, higher than consensus of $0.81 but lower than our forecast of $0.87. 1. Management signaled concern about triple-B market receptivity for the transaction anticipated this September; we believe that their concerns may be warranted, and we assume (as we have done since our April 18th note entitled “Potential implications of the proposed Sallie Mae transaction”) an earnings model for upcoming securitizations similar to those reported in FY2006 (pre triple-B tranches). Such a structure should be characterized by lower upfront cash, higher residual fees, and lower blended yields (relative to most recent transactions). 2. Given the current (and anticipated) widening spread environment, we raise our discount rate assumption (forecast for residuals) to 12%, up from 11.59% which the company currently uses. 3. We were surprised by a stark mix shift demonstrated this quarter towards the more-profitable direct-to-consumer (DTC) channel.

Implications

We raise estimates by 2% in FY2008 to $4.03 and FY2009 to $4.57; the benefit of a (presumably tenable) mix shift towards the more-profitable DTC channel more than offsets the impact of a higher discount rate assumption. We introduce our FY2010 EPS forecast of $5.02.

Valuation

We maintain our $41 DCF-derived 3-month price target, implying 29% upside; however, given ongoing uncertainty regarding top line sustainability, we retain our Neutral rating.

Key risks

New legislation and loss of business from customers involved in the SLM transaction pose the biggest threat to our forecasts and price target.

Massive tightening of mortgage credit

All of the big players have severely tightened subprime, Alt-A and even some prime mortgages over the last two weeks. As bad as the housing market looked in late July, it just got a lot worse. The subprime market is all but gone now. This will easily be the worst housing recession ever and like the tech bubble, it will take years to work of the excesses.

Delayed rally in FMD

The press seemed to put a negative spin on the FMD report in the morning. Forbes online even said something to the effect that FMD "warned" that credit spread widening would hurt their business. Umm, yeah, spread widening hurts margins but that doesn't mean that they can't grow earnings significantly in the coming quarters. Margins are certainly a very important part of the earnings equation, but so is volume which absolutely surging.

Management said on the call that there would be "60 bp of revenue impairment for each 10 bp of spread impairment." In other words, for every 17 bp of spread impairment, securitazation margins fall by 1%. Here are the yields on the tranches from the last securatization:

Class A-1 Notes (AAA): one month LIBOR plus .04%
Class A-2 Notes (AAA): one month LIBOR plus .13%
Class A-3 Notes (AAA): one month LIBOR plus .23%
Class A-4 Notes (AAA): one month LIBOR plus .29%
Class A-IO (AAA): 6.7%
Class B (AA) : one month LIBOR plus .39%
Class C (A) : one month LIBOR plus .65%
Class D (BBB): one month LIBOR plus 1.35%

As far as I can tell, it's only the BBB tranche that has significantly widened, but it's only about 5% of volume and I'm convinced that at worst this credit scare just pushes those cash earnings out into future quarters.

FMD Conference Call (take #2)

The call was fantastic and management gave a lot of excellent information. Here are the key points:

1) Four new clients were signed up in the quarter, including ING Direct!

2) Astrive is up to 12% of overall volume and is performing great

3) They are rolling out two additional brands to compliment Astrive

4) 4th quarter securitization was $864 million with $91.6 million in up-front cash

5) They received a favorable tax ruling and will receive a $56 million tax refund in the first half of 2008. Taxes are now paid when cash is received on residuals.

6) The application and loan pipeline heading into Q1 is “very strong”

7) Management is improving transparency and disclosures on all trusts!

8) 1.3 millions shares were repurchased in the quarter! Over 8 million shares left on repurchase plan

9) The BBB sector is in disruption (because of the subprime mortgage crunch) but accounts for only 5% of transaction structure. If management can’t get an attractive price on the BBB securitization, then they will look at alternatives which could include placing the loans of the balance sheet of Union Federal (S&L subsidiary) or Citizens. Banks don’t mind holding these loans on the balance sheet b/c the coupons are good. Then, when credit market conditions improve, they could securitize.

10) Sallie Mae has not been increasing their direct to consumer channel marketing

11) They are looking to get customer concentration down to 35%-40% in 2008.

12) Non big 3 customers grew at 80% in fiscal 2007

What’s not to like? You are getting very strong growth and a 3% dividend yield for 8 times earnings!

FMD Conference Call

Blogger just ate my post!!!

FMD Earnings

They look really good...$0.83 vs estimates of $0.81. Revenues and earnings up 55% and 57% respectively for the fiscal year. Loan volume continues to surge, up 39% yoy in the 4th quarter. I'll be listening to the conference call for color on the quarter and the credit markets.

No need to panic on FMD

JPM downgraded FMD today on worries about the company's ability to keep high margins on its BBB student loan asset backed securities (SLABS). Credit spreads are widening a lot because of the subprime mortgage mess and re-pricing of risk, so I wouldn't be surprised to see a little pressure, but these SLABS are still performing well to the best of my knowledge. The downgrade seems short-sighted because there is still incredible value in this name compared to the earnings and cash flow. Maybe growth will slow a little because of the margin compression, but I don't think it will be much, and perhaps it will be made up by higher margins from Astrive.