Thursday, May 22, 2008

First Marblehead (NYSE:FMD): Upgraded at FBR

The unthinkable has happened - FBR has upgraded First Marblehead (NYSE:FMD):

Rating goes to Market Perform from Underperform on belief that much of the bad news is baked into the stock, particularly with early indications of thawing within the private student loan ABS (SLABS) market. Notwithstanding the company's increased risk to its residual receivables following rising credit losses and TERI's bankruptcy filing, the firm no longer believes the risk/reward warrants an Underperform rating for First Marblehead shares at current levels, especially as derivative benefits might start to form, stemming from governmental efforts to provide funding to the federally guaranteed student loan market. Trading at 43% of stated tangible book and approximately at the cash on hand, they believe the shares reflect a near total impairment of the company's residual receivables. While further operating losses and possible liabilities related to the failure to securitize customer loans could drive the liquidation value to the company lower, we view the potential for acquisition and/or the eventual opening of the ABS market as balancing risks.

Assuming a 100% impairment of the company's existing residuals, thereby eliminating the financial exposure to its outstanding trusts, FBR calculates this will result in a pro forma tangible book of $2.85 per share. Though the company will continue to bleed cash until it is able to access the capital markets, they believe the company becomes increasingly attractive as a target for its loan database and origination platform—along with the nearly $2.95 per share of cash. Furthermore, in the event the securitization market opens up, the stock is set up for a potential squeeze with an estimated 22% of the float short. Balancing the upside, in their opinion, are the risk of cash burn, cannibalization from higher FFELP loan limits, warehouse refinancing uncertainty, and loss of loan volume from JPMorgan Chase, Bank of America, and RBS Citizens—which collectively represented 76% of the company's volume.

Notablecalls: FBR has been negative on FMD since 2006 and rightly so. With the firm stepping back from their negative stance I suspect we may see some considerable short covering (& even buying). The stock can be viewed as a call option here - JPM & BAC may actually return as clients when dust settles. If that happens FMD will be a $10+ stock again. Unless it gets bought in the n-t.

Limited downside and ample upside is what you get here. I'm taking it.

PS: My gut tells me FMD could do $3.25+ today.

1 comment:

Timothy Hussar said...

great highlight!