Sallie Mae or may not be the way to go
Dear Mr. Berko:
Sallie Mae recently came out with a new kind of preferred stock in which the dividend is tied to a benchmark like the Lehman Bros. bond index and the interest rate changes as the index changes. Please tell me about this new preferred.
My wife and I are in our early 50s and have accumulated a $335,000 portfolio of preferred stocks for our retirement. We don’t own common stocks because we don’t want to be exposed to risks. We would like to buy 600 shares (at $25 a share) and request that you explain all the moving parts of this preferred issue to us.
E.O., Waukegan, Ill.
Sallie Mae, Fannie Mae’s much younger sibling (a.k.a. Student Loan Marketing Corp.) was organized as a government-sponsored enterprise in 1972. In December 2004, Sallie Mae cut its federal ties and is now officially called SLM Corp. and should be completely privatized by September of next year. Sallie Mae (SLM-$49.89), as some folks know, provides money for federally guaranteed student loans authorized by a befuddling Federal Family Education Loan Program. SLM’s $110 billion in loans has helped many students complete their educations.
That Sallie Mae preferred stock is one of the new breed of debt securities designed by the Wall Street lads to attract income-oriented investors. I think they did a capital job of molding a common, ordinary debt security into a moderately attractive investment. The symbol is SLMJZ. The par value is $25 a share, it’s liquid as water and trades on the Big Board. It’s rated A-2 by Moody’s and single-A by Standard & Poor’s. It matures on March 15, 2017, and is not callable.
Now here’s some of the sex appeal: It’s a Consumer Price Index linked preferred. The CPI linked preferred will pay dividends on the 15th of every month, so that you will get 12 checks a year. The first CPI linked dividend will be 5.25 percent and can change every month. In other words, the coupon on this issue will “float.” The coupon amount is the year-over-year change in the CPI plus a 2 percent base.
So if this month’s CPI is 3.25 percent, then the coupon on this preferred will be 3.25 percent plus 2 percent, or 5.25 percent. If next month’s CPI number is 4.2 percent, then the new coupon will be 4.2 percent plus 2 percent, or 6.2 percent. And there’s no cap on the interest rate. So if the CPI in July 2006 is 17.2 percent, this preferred will carry a coupon for that month of 19.20 percent. This issue doesn’t ring my bell, but if you’re a serious income-oriented investor who requires an “A” rating or better, then SLMJZ may be a consideration.
Because this is a recent issue, I don’t know if this preferred qualifies for the 15 percent dividend tax rate. However, I can tell you that SLM has a 6.97 percent preferred (SLM.A-$55.05) that meets the 15 percent requirement and that almost all Fannie Mae and Freddie Mac preferreds qualify for the 15 percent dividend tax rate.
I would also consider 100 shares of SLM common stock ($49.89), even though the 76-cent dividend provides a modest 1.5 percent yield. You guys are in your early 50s and have a few years until you begin living off interest and dividends. SLM is very nearly an inflation-proof and recession-proof business with good growth potential. Everyone wants to go to college because they’ve been conned into believing that a piece of foolscap guarantees them higher earnings power. Not in today’s job market!
Meanwhile, SLM’s revenue, earnings and dividend records over the past 20 years have been phenomenal and sublime. In 1985, SLM processed $7 billion in student loans, earned $108 million, paid a miserly dividend of 1 cent a share and the stock traded at $32 a share. During the past 20 years, SLM increased its loan business every year, and last year SLM forked out $107 billion in money to students. Share income increased from 9 cents in 1985 to an expected $3.35 this year while the dividend grew from a single penny to 76 cents a share.
A 100-share purchase of SLM in 1985 at $32 is 1,875 shares today worth approximately $90,000. I suspect that 20 years from now, 100 shares of that SLMJZ preferred will still be worth $2,500, give or take a few bucks.
So rather than buy 600 shares of SLMJZ, I suggest that you buy 400 shares and 100 shares of SLM common stock. I think you will be glad you did.
Please address your financial questions to Malcolm Berko, P.O. Box 1416, Boca Raton, Fla. 33429 or e-mail him at firstname.lastname@example.org.