It’s now been roughly eight years since the bursting of the housing bubble nearly tanked the U.S. economy. With collective student loan debt now above $1.3 trillion, Navient (NAVI), SLM (SLM) and Nelnet (NNI) could soon be in big trouble.
Traders who shorted Fannie Mae (FNMA), Countrywide and AIG (AIG) back in 2007 made a killing when the housing bubble burst. If the student loan bubble is the next to pop, the three stocks below could be the best shorts in the market.
Things are so bad at NAVI that the stock may not even need the housing bubble to collapse to become a profitable short. Remember how banks relied heavily on income from mortgage-backed securities created from pools of terrible mortgage debt during the peak of the housing bubble? NAVI funds roughly 75% of its operation from the sale of student loan-backed securities. The loans these securities are comprised of yield about 2.5%, and NAVI’s asset-backed securities (ABSs) yield 1.25%.
Much like the banks selling mortgage-backed securities during the housing bubble, the problem arises for NAVI when student loan borrowers stop making their payments. Earlier this year, the Wall Street Journal reported that more than 40% of Americans with government-backed student loans aren’t making timely payments on those loans.
“If you read the covenants of the bonds on these federal loans, they say that if the debt isn’t properly managed, the government doesn’t have to pay,” hedge fund Pine Capital founder Taylor Mann explains.
Mann has been outspoken about Pine Capital’s short position in NAVI.
With a minuscule P/E of only 5.3, NAVI stock may look like a dangerous short. But if the student loan market collapses, there is no question NAVI will be dragged down as well.
SLM now produces private student loans that are not backed by the government. Even the company’s banking services, insurance products and credit cards are all geared toward college students.
SLM has become a popular short among traders betting on a breakdown of the student loan market. One of the biggest student loan bears is hedge fund FlowPoint Capital Partners.
“Once this bond market breaks, colleges aren’t going to be able to raise tuition, and that’s going to hit a variety of businesses,” FlowPoint founder Charles Trafton says.
SLM and NAVI are two of the stocks that Trafton predicts will be hit hardest.
From a value perspective, SLM has both the highest P/E (10.7) and the highest price-to-book (1.8) of the three potential student loan stocks to short.
NNI is another pure-play on student loans. The company makes money by managing a portfolio of student loan assets, servicing student loans and processing payments with its software. If you think the student loan market will soon come crashing down, NNI is coming down too.
“The company’s unsustainable business model has been propped up by misaligned government contracts, cheap money from government-backed credit facilities, and most importantly, the strategic underperformance of their customer base,” Mann said in a report on NNI earlier this year.
With a share price currently above $35, NNI offers short sellers the most potential downside of the three stocks. However, at a P/E of only 6.1, NNI is also very cheaply-valued and is a risky short at this point.
Disclosure: As of this writing, Wayne Duggan had no positions in any of the stocks mentioned.