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Has JC Flowers cracked the code? Finance companies are typically thought of as immune from highly leveraged buy-outs because of the capital adequacy constraints they face. But student-loan provider Sallie Mae, the subject of a groundbreaking $25bn deal spearheaded by JC Flowers, is not typical.
First, it has high-quality and highly liquid assets. Second, the deal structure – notably the massive $200bn financing facility provided by co-investors JPMorgan Chase and Bank of America – reduces Sallie Mae’s need for a pristine credit rating. Traditionally, Sallie Mae has needed to have enough book equity to keep the rating agencies happy so it can tap the unsecured markets for some of its funding. But with the five-year financing in effect substituting for capital, Sallie Mae can operate with the negative tangible equity that will result from the deal and not worry about how to fund its business.
Third, Sallie Mae does not gather in federally insured deposits. Those that do, such as commercial banks, are accountable to regulators who insist on capital and leverage ratios as well as constraints on who can legally own a bank. These would be harder nuts to crack for LBO artists. Meanwhile, two other elephantine finance targets, Freddie Mac and Fannie Mae, are not straightforward companies but government-sponsored enterprises, which would surely deter even today’s daredevil private equity buyers.
The irony in the Sally Mae deal is that the investing banks, JPMorgan and Bank of America, have their own student lending businesses. But they presumably cannot replicate the attractions of this deal internally because of the cumbersome amounts of capital they have to hold against their own student loans. It is a strange state of affairs when banks feel it is more attractive to invest in a core business via an entirely separate LBO vehicle.