FMD - First Marblehead Corp

[Olmsted]

I have seen FMD discussed on threads here a couple times, but thought it deserved its own thread.

 

The balance sheet looks good, with cash well over the share price and the consolidated securitization trusts not recourse to the company.  This idea writeup does a good job of treating the balance sheet: 

 

http://www.sumzero.com/postings/4304/guest_view

 

The catch, of course, is that they are burning cash quickly while trying to make a new business model work (about 10m most quarters, 15m this quarter with ramped-up marketing).  As PlanMaestro pointed out in our brief discussion at his blog, this is essentially a startup now.  This lending season was the first peak season for their Monogram platform, which is a partner lending model (in contrast to their previous incarnation as a securitizer).  Will it work? 

 

On the conference call, they said they approved ~130m of loans, but only a portion of that was booked so far (with a booking window 60-90 days from loan approval).  Let’s just say that every approved loan gets booked, and see where that gets us. 

 

They said their bank sub, Union Federal, could handle ~30m of volume.  These loans are coming in at 6.1% with 15 year duration.  With the cost of funds, servicing, and defaults, it looks like their bank can make about 3.5% on these.  PV10 is ~5m.

 

The remaining 100m volume then must fall under their partner lending model.  Management was hesitant to give out exact details of what this relationship is, but we do know that it does involve some up-front capital from FMD.  The partner provides capital for the bulk of the loan, and they split the interest.  These loans are coming in at 8%; management said FMD’s cut is 3-4%.  Defaults cut .5%-.75% from FMD’s portion.  So let’s say 3%, all told.  PV10 is ~15m.

 

This means that if every approved loan is booked, FMD’s first peak season is worth $20m.  Since they are burning cash around 12.5m/quarter, FMD needs to increase loan volume to 325m to break even on a PV basis (they would still have financing needs since that interest is coming in over 15 years).  They would have to increase volume a lot more to stabilize their business without having cash problems in the interim. 

 

This leads to another question, can they increase loan volume significantly with the cash on hand?  They do not give precise details of their capital contribution to the partner lending model, but we do know that they put up some capital – maybe 10%?  We also know that the amount of capital they contribute depends on the risk profile of the loans.  (In the conference call they mentioned choosing to approve fewer loans, with those approved being of higher credit quality, and that this meant they had to put up less capital.)  The 10Q claims $245m in cash.  By next year, given the current cash burn, that will be down to $200m.  If FMD needs to keep $100m of that on hand to keep the doors open for the next two years, they might have $100m cash to contribute to partner lending next peak season.  If they must put up 10% to make loans, that’s maybe $1bn of volume that they could hypothetically originate.    If they actually originate this much, or close to this much, they'll be close to cashflow-positive, and tapping capital markets should be easy.  If they can only manage to originate the break-even $325m, they’ll have liquidity needs after a couple more seasons, and I imagine that capital raises in that scenario will be bad for shareholders.

 

So it all depends on how quickly they can ramp up loan origination next season.  A wildcard upside scenario would be their return to the securitization market.    I don’t know how to handicap either.  Any thoughts?

[Kraven]

I spent a little bit of time on them recently and am not sure I see the upside here.  On the surface it seems to be relatively safe.  Once you back out the securitization trusts on balance sheet (but no recourse) they are selling at about 1/2 BV if memory serves me correct. 

 

But I am very skeptical.  The old business model is broken, probably forever, so they are trying to reinvent themselves as as player in the student loan market without any real access themselves to the capital markets.  To be a player in the student loan market you need at least 1 of 2 things:  either good access to the capital markets (and a capital markets open to this type of asset) or a balance sheet.  They have neither.  So they are trying to glom onto other's balance sheets by becoming a facilitatot for other's potential student loan lending programs.  But even in that case, those banks or other type of lender will need access to the capital markets unless they want to warehouse a bunch of student loans and I doubt they do, at least at present time.

 

So without the securitization market I am not sure what the potential for FMD is even in their new role.  They like to play up their bank sub, but it doesn't have the balance sheet to make a dent in this business.  In addition, they seem to have overspent on the TMS acquisition so perhaps not good stewards of capital. 

 

Even those couple of banks that they have gotten to buy into their Monogram program (this facilitation role), FMD has to put up some (all?) of the first loss piece.  I am not sure what kind of sense that makes.  It may get them some business, but it's risky.  If everything goes well, they get their fees.  If it doesn't, they take big losses potentially.  Maybe I don't understand what they are doing. 

 

Given their discount to book, they are probably safe for the moment, but will need to get something to click in relatively short order (a year?  2 years?).  They are not that careful with expenses either.  For example, they seemed to have a ton of expensive leases and pay themselves very nice salaries, etc. 

 

Maybe I don't understand what they are doing, but I don't see the upside here.  Just my 2 cents.

[Ballinvarosig Investors]

I have looked at FMD but I don't think it's really appropriate to look at this in terms of being a net-net, as it sounds like the business plan is to get rich, or die tryin'. What I mean, is that the whole FMD turnaround is predicated on them putting up capital to generate loans, whether they pump if through Union Federal, or put up the first 10% of a loan to partner banks. From what I can see, the loans originating though their partner program, Monogram, are simply not coming through quickly enough. This is one of the reasons why I think management seem much warmer to the idea of directing capital into the Union Federal sub, which would provide loans directly. Going through this route is much more capital intensive (especially with securitisation still dead); it seems pretty clear to me, that by going down this road, management are admitting Monogram just isn't playing out as well as they expected.

 

There is definitely a big risk of this being a zero. With cash burn at €60 million, minimum capital requirements in place at Union Federal, operating costs either need to fall considerably (unlikely), capital will need to be raised (will be hugely dilutive), or somehow, the student loan market has to pick up significantly (very speculative).

 

Just in case anyone doesn't already know, you can get an understanding of the Union Federal sub by searching for them though this site - http://www.ffiec.gov/

[BargainValueHunter]

Uh-Oh. :(

 

http://online.wsj.com/article/SB10001424052970204224604577030562170562088.html?ru=yahoo&mod=yahoo_hs

 

Historically, investors have assumed 25% to 30% of student loans bundled into their bonds will default. But today they are baking in between 30% and 40% default rates among the current crop of graduates, said Chris Haid, a director in asset backed trading at Barclays Capital. Even those assumptions are a best guess and defaults could ultimately go higher if unemployment rises, Mr. Haid said.

 

This analysis translates into some surprising insights for students and policy makers. For example, in the current economy, it may make more sense to enter a technical college than to go to law school.

 

Not all lessons from the bond market are so counterintuitive. The most important, in fact, is a slight twist on a maxim most students know from childhood: stay in school, just not too long.

 

Failure to graduate is the single most important predictor of whether a student will default on loans, which stands to reason since the unemployment rate is 8% for Americans between the ages of 20 and 24 with four-year college degrees, compared to 21% for those without.

[PlanMaestro]

As PlanMaestro pointed out in our brief discussion at his blog, this is essentially a startup now.  This lending season was the first peak season for their Monogram platform, which is a partner lending model (in contrast to their previous incarnation as a securitizer).  Will it work? 

 

This is the referenced comment:

 

Thanks Olmstead, many people I know are following FMD but I do not have confidence on its future to speculate on it. It does not even have a business model so it is more of a start-up, a start-up that is burning cash at a very high rate. I do not like the sector either … it needs some major reform so it is difficult to argue that it will sustain historic growth rates. And finally, it is not even my type of turnaround as I argued at length here:

 

http://variantperceptions.wordpress.com/2009/10/12/turnaround-lessons-when-the-tough-gets-going/

 

[HJ]

Student loan is kind of like home mortgage, in that the market was largely supported by the government pre crisis.  In the aftermath of this credit crisis, there's a huge amount of uncertainty as to what the industry model will look like in the future.  The government is still in there supporting the market, but clearly the current state of affair can't last in the long term. 

 

The terms and conditions in these two lending markets has been so hugely distorted by the government over the years, that you don't even know what a clearing level really look like anymore.  Without the government, would private mortgage lending for longer than 10 years actually exist?  What would you really charge as an interest rate to lend someone money for 30 years?  Or a student loan with all of its deferment options, etc. 

 

Through the crisis, credit card lending and auto finance are the two consumer finance instruments that have clearly outperformed  mortgages and student loans.  I would just note that they are both much shorter term, which gives the lenders ability to adjust terms or just wholesale withdraw from the market, and the prevailing rates are generally higher than either mortgages or student loans.  Outside of sovereign bonds from G7, bonds longer than 10 years are not that common in corporate world.  Why should consumer finance offer lending terms that are so much more generous?

 

All of this is a round about way to say that even if FMD is successful in ramping loan production, the confidence that these loans, at those terms, are made at the right risk adjusted rates is not that high. 

 

 

[Olmsted]

"First Marblehead Announces Sale of Variable Interests in NCSLT Trusts for $13 Million in Cash, Deconsolidates Trusts and Books $1.2 Billion Non-Cash Gain"

 

http://finance.yahoo.com/news/First-Marblehead-Announces-iw-2735110595.html?x=0&l=1

 

Will clear up the financials, and add cash to the balance sheet for one more quarter of cash burn.  Does not change the fundamental story though.

[BargainValueHunter]

http://www.reuters.com/article/2011/11/11/idUSWNA337520111111

 

The CreditWatch placements reflect the higher than we expected pace of realized defaults in each monthly period since we downgraded 107 classes across the same 20 First Marblehead transactions on March 31, 2010. The current rating actions exclude classes that we have either downgraded to 'D (sf)' or have paid off since March 31, 2010.

 

As of the October 2011 distribution date, cumulative gross defaults, as a percentage of the respective cumulative repayment balances, ranged between 16.74% and 21.21%, compared with cumulative defaults ranging between 12.81% and 18.88% as of the October 2010 distribution date. Because of the faster pace that defaults are being realized, total parity for all classes in each transaction is lower than what we expected at this point in the life of each of the respective transactions.

[BargainValueHunter]

http://finance.yahoo.com/news/FMD-First-Quarter-Making-zacks-4129866299.html?x=0&l=1

 

FMD has had an auspicious launch to its first peak origination student loan season since the beginning of the credit crisis in 2007. Including the Monogram-based loan programs at Sun Trust and Kinecta that began in July and September 2010, respectively, as well as at Union Federal Savings Bank (:UFSB), which began on July 1, 2011, the Company has processed over 53,000 private student loan applications representing $557 million in loans, of which it has approved $129.4 million, or almost one-quarter of the $550 million total. Of the total $129.4 million amount approved, $43.6 million has been booked to date.These metrics demonstrate that loan demand is quite strong and that FMD is accepting only the cream of the crop, the top 23% of all loans submitted.

[Sportgamma]

FMD went up 18% today for no apparent reason. So, does anybody have a clue as to why?

[Olmsted]

Not sure why the spike yesterday.  I stopped following the company closely after it became clear to me that, with the amount of capital they had to put into loans in their new partner lending model, they would not be able to get to a break-even level of loan volume without raising money.  Comments from others above were extremely helpful.

 

One wildcard that was still in play was a return to securitizing loans - which would allow them to really pump up the origination volume.  I am thinking that though, that the sale of their trust administration services is a signal that they do not think this option is likely.

 

http://finance.yahoo.com/news/first-marblehead-sells-legacy-trust-210300330.html

[BargainValueHunter]

Update:

 

http://markets.financialcontent.com/ir/?Module=MediaViewer&GUID=21237103&Ticker=FMD

 

The First Marblehead Corporation (NYSE: FMD) today announced its financial and operating results for the third quarter of fiscal 2012 and the nine month period ended March 31, 2012. Results for the quarter reflect the sale of the Company's legacy trust administrator, First Marblehead Data Services, Inc. (FMDS) on March 2, 2012 for $13.7 million in cash as well as the deconsolidation of the GATE Trusts effective March 30, 2012. The deconsolidation of the GATE Trusts completes the removal of the variable interest entities originally consolidated by the Company upon the adoption of ASU 2009-17 on July 1, 2010.

 

For the third quarter of fiscal 2012, the Company recorded net income of $9.9 million, or $0.09 per common share on a fully diluted basis, compared to a net loss for the third quarter of fiscal 2011 of $39.3 million, or ($0.39) per fully diluted share. The improvement in earnings of $49.2 million was largely driven by a $26.4 million decrease in the loss from operations combined with an increase of $23.4 million in other income.

 

The lower overall loss from operations was principally due to the exclusion of the deconsolidated NCSLT Trusts for the third quarter of fiscal 2012, which had the impact of increasing net interest income after provision for loan losses by $11.3 million and decreasing general and administrative expenses by $9.1 million. The increase of $23.4 million in other income was due to the $12.5 million gain from the sale of FMDS and a $10.9 million non-cash gain from the deconsolidation of the GATE Trusts.

 

and...

 

Company Liquidity

 

As of March 31, 2012, the Company had $210.5 million in cash, cash equivalents and short-term investments compared to $267.4 million at June 30, 2011. The decrease of $56.9 million resulted primarily from the purchases of $62.6 million in mortgage-backed securities, the funding of $31.7 million of Monogram-based loans at Union Federal, and $41.6 million used to fund operations, which were partially offset by $26.7 million in proceeds from the sales of certain service revenue receivables and FMDS, and $53.3 million in deposit growth at Union Federal, including $40.0 million from TMS.

[Sportgamma]

A few thoughts on FMD:

 

1. Last quarters income statement look aprox. like this:

 

Net interest income after provisions   2,600

Total non-interest revenues               10,070

Total revenues                                     12,670

Total non-interest expenses               25,732

Loss from operations                         (13,062)

 

Total other income                               23,436

 

2. Next quarter will include peak lending season and further cost cuttings.

 

3. The company had $140m in cash at the end of last quarter (approx. $1.4 p.s.) and trades for $1.12 at the time of this writing.

 

4. If you back out $20m in goodwill, the company has $420m in assets (thereof $70.8m are classified as assets held for sale), $220m in equity and no non-operational liabilities.

 

5. Lets assume they are able to sell the assets held for sale (mainly government secured bonds, if think) for $50m and turn the operating results to a $5m profit per quarter. That company would be earning a 13.3% return on its invested captial.

 

In any case it will be interesting to see next quarter´s results.

[Sportgamma]

Have not begun reading, but the CFPB white paper is out:

 

http://www.consumerfinance.gov/reports/private-student-loans-report/

[Sportgamma]

3Q2013 conference call

 

http://seekingalpha.com/article/1382781-the-first-marblehead-management-discusses-q3-2013-results-earnings-call-transcript?page=6&p=qanda&l=last

 

Christopher R. Donat - Sandler O'Neill + Partners, L.P., Research Division

Dan, I want to revisit something you said on last quarter's conference call about not wanting to do any demonstration projects. I think that was a phrase you used as far as securitizations go, because I think there's a view out there that maybe in these market conditions, maybe the right thing to do for First Marblehead is to get out with a securitization. But I just wanted to get a sense of your thought process on weighing sort of -- or trying to optimize what's the best transaction for sort of the near term and then longer term for the company on -- based on the conditions we've seen, particularly this past quarter in the private student loan ABS market.

 

Daniel Maxwell Meyers - Co-Founder, Chairman, Chief Executive Officer, President and Member of Award Committee

Sure. Well, let me try and break that into -- this is a little bit stream of conscious, but let me try and break this into kind of 3 general areas. First of all, we're stewards of our shareholders' equity capital, and we take that responsibility very clearly. So in terms of doing things just on a demonstration basis where we want to prove that we have the ability to take, what I call, an ultrahigh quality portfolio and monetize it or securitize it just for that specific period -- purpose, I remain in thinking that that's not a good use. The second is, is that in front of me, I have some indicated spreads for the industry and the benchmark issuer that go back a year. Now clearly, for the last year, I've been saying that the markets are becoming either actionable or are actionable. If we looked at the class B and C bonds, a year ago, they were trading at relative indicative spreads over LIBOR somewhere between a little over plus 500 and plus 600. And they have now dropped to, well, the exact number that I have in front of me is for the B bonds, which would be AA rated bond, just under LIBOR plus 200; and for the C bond, just over around 237 over -- so you've seen that those spreads have declined by as much as almost 400 basis points over the time period. At the same time, the AAA rated tranches have generally gone from the plus 150, 200 area to the plus 50, plus 70 area. So if we had done a securitization a year ago, even though we thought it was actionable, it would still yield a positive ROE across the life of the loan portfolio for the company and its shareholders. We would've left an awful lot on the table. And if anything, we have seen that the subordinated bonds, the A and AA rated bond spreads in the secondary markets have come in the most in the last 3 to 6 months, as the benchmark issuer's last deal was tremendously oversubscribed. As a matter fact, the largest oversubscription I've ever seen in my career. So item number 2 could be summarized as, if we had gone prior to this drop in spread, we would've left a lot of our shareholders' money on the table. The third is that it's not our only option. Through a partnered lending in our banks own balance sheet, in our own use of capital, we look at those leverage ratios and those capital cost ratios essentially every single day. We target things, as Ken mentioned, that it was a small uptick, very small uptick in cost of funds at Union Federal, but that's because of a good thing because the bank's balance sheet was growing, and the ratio of new deposits to TMS float deposits had increased. So overall, for the company, not a bad thing, actually, probably a good thing. But still, more efficient than executing even in this diminished spread environment that we're seeing now. So for those 3 reasons, I think we remain aware and vigilant, and we're watching this on an everyday basis. But I think the one thing that nobody's going to accuse us of is being stylish.

[Sportgamma]

Does anybody know if HC2 Investment Securities, Inc is in anyway related to Phil Falcone´s HC2 Holdings?

 

http://www.snl.com/Cache/c30704015.html

 

[edit: just looked at the address in the filing, which is Herdon, Virginia where HC2 Holdings is headquartered]

 

And since there are quite a lot of Canadians on the board, is there anybody familiar with John Carter Risley?

 

http://www.snl.com/Cache/c30765623.html

 

TIA