Will Sallie-Mae's Break-Up End The Cov-Lite Cravings?

Over the past few months we have explained in detail just how ‘frothy’ the credit market has become. Probably the most egregious example of this exuberance is the resurgence in covenant-lite loans to record levels. It seems lenders are so desperate to get some yield that they are willing to give up any and all protections just to be ‘allowed’ to invest in the riskiest of risky credits. With credit having enjoyed an almost uninterrupted one-way compression since the crisis, momentum and flow has taken over any sense of risk management – but perhaps, just perhaps, Sallie-Mae’s corporate restructuring this week will remind investors that high-yield credit has a high-yield for a reason. The lender’s decision to create a ‘good-student-lender / bad-student-lender’ and saddle the $17.9bn bondholders with the unit to be wound-down, while as Bloomberg notes, the earnings, cash flow, and equity of the newly formed SLM Bank will be moved out of bondholders’ reach. Bonds have dropped 10-15% on this news – considerably more than any reach-for-yield advantage would benefit and we wonder if these kind of restructurings will slow the inexorable rise in protection-free credit.



Via Bloomberg,

SLM Corp. (SLM) dealt bondholders a blow as the student loan company prepares to move cash-generating assets out of their reach and rely more heavily on secured funding as it seeks to split into two separate entities.



Sallie Mae is separating its education loan business from its consumer lending operation, following legislation in 2010 that cut companies out of the government-guaranteed student loan market. The lender’s $17.9 billion of unsecured bonds will be serviced by the company housing Sallie Mae’s $118 billion portfolio of U.S.-backed loans that it’s winding down, while the earnings, cash flow and equity of the newly formed SLM Bank will be moved out of bondholders’ reach, according to Moody’s.


Anytime you split a company up like this and some portion of the cashflows that could have been available to support debt payments is no longer available, it is incrementally negative for bondholders,”



“The company is going in the wrong direction in terms of building balance sheet strength with what we consider an over-emphasis on returning capital to shareholders,” Peter Thornton, a credit analyst at KDP Investment Advisors Inc., wrote in a research note yesterday. “Unfortunately for Sallie Mae creditors, all of the current unsecured debt will stay at” a newly formed entity that contains the government-guaranteed debt while the “more promising future businesses” are stripped.



“What they are spinning off is the higher-risk profile business; what is staying behind is the steady cashflow business,” he said.

And so – by slaying bond holders, the firm manages to benefit shareholders. All sounds great for the equity bulls until one realizes that there is a limit to this kind of action – once credit starts to reprice to this more activist perspective, then the capital structure will necessarily reduce the value of future ‘equity’ cashflows and weigh on earnings (interest expense). Simply put there is no free lunch for stocks at the expense of credit – it is a lead-lag relationship – not a win-lose…

and credit has been leading the turn…


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