07/27/2012

Angelo Gordon Plays on Student-Loan Fears

Angelo, Gordon & Co. is betting on student-loan securities.

The New York firm recently began building up its holdings of the securities, funneling the purchases into a $575 million fund called AG Mortgage Value Partners that deals mainly in junk-rated mortgage bonds. The reason: It believes that concerns about student-loan performance are creating opportunities for today’s bond buyers.

The play hinges on expectations at Angelo Gordon that even as loan defaults pile up, they won’t eat through the credit enhancement built into many student-loan securitizations. The firm anticipates that as other investors come to the same conclusion, they’ll become more eager to buy into the deals — allowing current holders to cash out at a profit.

The strategy encompasses three components. The first entails purchases of newly issued bonds backed by private loans from Sallie Mae, with a focus on triple-A-rated classes with lives of four or five years. Angelo Gordon expects those deals to hold their values particularly well on the secondary market, thanks to a combination of high yields and strong investor protections. “We believe these bonds will continue to benefit from tighter spreads and anticipate selling these securities after a one-year holding period,” co-founder Michael Gordon and chief investment officer Jonathan Lieberman wrote in a July 6 letter to AG Mortgage Value shareholders.

Private loans are credits without government guarantees. Including a $640 million deal it priced this week with Barclays and Credit Suisse running the books, Sallie has issued $3.2 billion of bonds backed by the accounts so far in 2012, according to Asset-Backed Alert’s ABS Database. The Reston, Va., lender has a few more of the issues in the pipeline for the remainder of the year.

Angelo Gordon’s second line of attack involves secondary-market purchases of junior bonds with ratings of double-A down to double-B that are backed by credits written under the U.S. Department of Education’s now-unwinding Federal Family Education Loan Program. The belief is that those securities could experience some appreciation if prepayments increase among the underlying accounts. That could happen if borrowers refinance. It also could be driven by defaults, as the government steps in to pay off bad accounts.

The final component of Angelo Gordon’s approach calls for purchases of residual interests in deals backed by FFELP loans that have been rehabilitated following defaults. Angelo expects to collect yields of up to 15% on those deals, which have become more frequent in the past two years or so.

The play comes with a certain measure of risk, given projections that defaults will rise as a tough job market and heavy debt loads take a toll on college graduates. In fact, Gordon and Leiberman acknowledge that possibility in their letter. “Our investment team is continuously on the lookout for signs of mass delusional behavior such as the housing bubble . . . In the U.S., we have identified one potential bubble: student loan debt,” they wrote.

Why buy into a bubble? While the values of student-loan securities have been rising at a gradual pace, Angelo Gordon thinks investor nervousness has kept their prices below appropriate levels given the likelihood that bondholders ultimately will get paid. “The timing and catalyst for the student loan collapse are uncertain, as they are for most bubbles that burst. Often delusional behavior provides fertile ground for investment opportunities,” Gordon and Leiberman wrote.

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