The Motley Fool's CAPS website is a great place to have a discussion about your favorite stocks and hear what other investors think. First Marblehead
First Marblehead provides outsourcing services for private education lenders. In a nutshell, if little Billy just got into Harvard but needs a loan, he might turn to Bank A. Bank A will make that loan, and Billy goes to Harvard. However, private education loans are tricky, and banks don't like to keep such loans on their own books; instead, they sell them to other investors, thus allowing the bank to recycle its capital into more loans.
As a result, the bank often turns to Marblehead for help with underwriting (checking out the borrower's ability to repay) and securitizing services (packaging the loans and selling them). Marblehead has a 20-year database of industry lending information. In fact, the company's track record is so strong that credit rating firms actually allow Marblehead to put in less collateral than the face value of its securitizations, thus allowing Marblehead to get paid cash up front (more on this later). Marblehead also makes money if the securitizations perform properly -- or receives a cut of the residual cash flow.
First Marblehead took a tumble when JPMorgan
Much of the bullishness on CAPS is based on analysis found on hedge fund manager Tom Brown's bankstocks.com website. In general, Brown has several strong arguments, and given his impressive long-term track record, it makes a lot of sense to give him the benefit of the doubt.
Among the bullish arguments are:
Bank of America and JPMorgan have already come out and said that Sallie will be run separately, and that pretty much nothing will change. Also, JPMorgan's contract with Marblehead runs through 2010.
First Marblehead has a robust business model, where it basically helps underwrite private student loan securitizations in exchange for cash. Note that Marblehead doesn't risk its own capital, but merely gets paid for its services. This is a high-return, low-risk proposition.
The most unique part is that Marblehead has a proprietary database of knowledge, so credit rating firms allow Marblehead to undercollateralize securitizations, meaning the company can take out some cash up front and receive some residual cash flow later on if the securitization performs adequately.
Critics argue that because Marblehead reports earnings up front for those future estimated cash flows, this leaves room for trickery and disappointment. Brown counters that Marblehead's assumptions are very conservative and past securitizations are performing as expected.
The private education loan business is a growing one because of the increasing need for a college education, the inexorable rise in college tuition costs, and the fact that the government is less willing to foot the bill.
In fact, Brown wrote an article proposing that even under base-case scenarios -- where Marblehead loses much of JPMorgan and BofA's business, operating margin declines slightly, and the in-house loan division, which has been growing very fast, slows down (albeit to a still-pretty-fast pace) -- Marblehead would still be able to earn north of $5 per share by 2010 (compared to the current $38 share price).
My $0.02 is that at the end of the day, a bet on Marblehead requires three key assumptions. First, one must believe that Marblehead has a moat, because its extremely high margins and robust cash flows depend on it being able to offer something competitors can't.
Second, one must believe that BofA and JPMorgan are telling the truth when they say their relationship with Marblehead will continue as planned. And lastly, one must trust that Marblehead's management is credible and competent -- a key assumption, because much of Marblehead's earnings will be dependent on how accurate its underwriting is and how conservative its accounting assumptions were.
Given the evidence I've seen, although I haven't put any money on the line yet, these are all assumptions I'd feel comfortable making.
- First Marblehead Shouldn't Be Jealous of Sallie
- Sallie Mae Killed My Rich Uncle
- More Good Grades for First Marblehead
- Rounding the Second Curve
Fool contributor Emil Lee is an analyst and a disciple of value investing. He doesn't own shares in any of the companies mentioned above. Emil appreciates your comments, concerns, and complaints. The Motley Fool has a disclosure policy.