Moodys Downgrades Sallie Mae Debt to "Junk" Status; Sallie Mae "Strongly Disagrees" (Updated)

Here is the press release from Moody's:Download Moodys_SLM_Downgrade_051409

Here are the highlights:

• Rationale for ratings action includes concerns over earnings, cash flow generation,political risk, liquidity and funding position:
  

"Today's rating action reflects Moody's concerns regarding SLM's earnings and cash flow generation capacity as the company transitions to a post-FFELP lending environment, continued uncertainties facing the company related to the political and consumer lending environment, and its liquidity and funding position. This combination of circumstances is not consistent with an investment grade ratings profile, in Moody's view."

• Profitability to be impacted by new business model where SLM originates and services loans, disclocation of CP/LIBOR spread and asset quality issues with private loans

"This new business model has implications for SLM's future profitability and cash flows because profit contribution from the servicing business is less than that from the current ECASLA model, and is likely to remain so as profits from servicing loans for the US government are likely to be heavily scrutinized. Also challenging the firm's profitability prospects are an ongoing dislocation of the CP/LIBOR spread, which affects the firm's yield on earning assets, and continuing asset quality challenges in SLM's private education loan portfolio."

• Moodys sees "considerable uncertainty" with Sallie Mae's proposal for federal loan program and also concerned about increasing regulatory and legislative focus on private loans:
  

"However, the counter-proposal faces considerable uncertainty, given the strong support of the Administration's original proposal. Moody's is also concerned that the private education lending business could come under regulatory and legislative scrutiny, which could result in greater restrictions and lower returns from this business line."

• As posted yesterday, Sallie Mae's counterproposal is currently being scored by the CBO

• Moody's also maintaining negative outlook on long-term ratings for Sallie Mae and would need to see an effective transition into post-FFELP era, improvement in their funding profile and improving credit trends in private loans in order to return to stable outlook:

"In order to return to a stable outlook, Moody's would need to observe progress in SLM's transition of its government student loan business to an origination and servicing model from a lending-based model, as evidenced by the achievement of a significant role in the post-FFELP student loan era while achieving acceptable profitability and cash flow generation. Moody's would also need to observe further improvement in the company's funding profile, including re-establishing reliable access to the term debt markets to fund private loan originations and generating liquidity to meet unsecured debt maturities. A stable outlook would also require a reduction in SLM's asset quality volatility in the private education loan business, demonstrated by lower delinquencies, credit losses, and provisioning requirements."

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Sallie Mae immediately responded last night with the following press release.  Here are the highlights:

• "This action is both unfortunate and surprising in light of the numerous recent positive developments in the financial strength of the company," stated Albert L. Lord, CEO. Mr. Lord continued, "Moody`s conclusion rests mostly on its predictions of the political process surrounding the Federal Student Loan program. This seems to us inappropriately speculative and very premature sinceany changes made to America`s student loan programs must be legislated by Congress - a several months process not yet started."

• Here are the positive financing activities which we have tracked closely in this blog over the past several months which Sallie Mae cited in their response:

Mr. Lord cited market developments since Moody`s placed the company "under review for possible downgrade" in February. Sallie Mae`s liquidity position has materially strengthened as the company secured liquidity in a variety of transactions, totaling over $11 billion in new sources this quarter alone. Specifically, in April, the company completed three FFELP asset-backed securitization (ABS) transactions totaling approximately $5.1 billion. In May, the company completed a $2.6 billion private education loan (ABS) transaction.  In addition, the organization extended $22 billion of its asset-backed commercial paper (ABCP) facility for one year, paid in full a $2.7 billion private credit (ABCP) facility, and this week announced its initial placement through the U.S. Department of Education-sponsored "Straight A Funding" conduit.

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How did the market react?  SLM's stock was up today by 2.6% to $5.56 in an up day for the market overall.  So, it doesn't appear the market reacted very strongly to the news.  Note however that SLM started the week at $6.64 and is therefore down 16% on the week. 

What does this mean?  Let's review Sallie Mae's recent 10-K to highlight the potential risks they identify should the credit agencies downgrade their debt ratings:

The rating agencies could downgrade our ratings, which could limit our access to financing, increase the cost of financing or trigger obligations under collateralized financing arrangements.

 

Our credit ratings are important to our liquidity, particularly in times when the asset-backed securitization market is uncertain. A reduction in our credit ratings could adversely affect our liquidity, increase our borrowing costs, limit our access to the markets or trigger obligations under certain provisions in collateralized arrangements. Under these provisions, counterparties may require us to post additional collateral, segregate collateral or terminate certain contracts. Termination of our collateralized financing contracts could cause us to sustain losses and impair our liquidity by necessitating the use of other sources of financing.