The Student-Loan Crisis Could Be Even Worse Than We Knew
Another quarter, another shocking new record for debt... The student-loan crisis could be even worse than we knew... Buybacks are booming again... The first signs of 'consolidation' in regional banks...
Editor's note: In Friday's Digest, we published a link to a full replay of last week's TradeStops event with Porter, Steve Sjuggerud, and Dr. Richard Smith. However, due to a technical error, some readers may have been unable to access it.
We apologize for any inconvenience. The problem has been resolved, and you can still access the replay – free of charge – for a few more days. Click here to view it now.
$1.521 trillion...
That's how much debt American students now owe.
According to the Federal Reserve, student loans outstanding rose to more than $1.5 trillion for the first time in the first quarter of the year, less than six years after breaking $1 trillion for the first time.
But it gets worse...
Regular Digest readers know nearly one-quarter of these borrowers are already in default, according to the government's own data. However, according to a recent report from the Government Accountability Office ("GAO"), the real number could be even greater.
In short, the GAO found that U.S. colleges and universities have been inappropriately encouraging alumni who are in danger of default to seek "forbearance" instead.
Why? Because loans in forbearance aren't considered delinquent – even though the borrowers aren't making any payments – which allows the schools to report a far lower default rate than they otherwise would. As the Wall Street Journal reported late last month...
The report examines a decades-old law that assigns each college a "cohort default rate." The law is designed to punish a college if a large share of its students default within three years of graduating or dropping out. Ultimately, if a high rate persists, the school is barred from collecting any federal loan or grant dollars from new students, the schools' main source of revenue.
The law is the government's main tool for cracking down on schools that leave Americans overly indebted and with weak job prospects. The Education Department sanctioned as many 1,000 schools during one year in the 1990s but in the 2000s has punished few, if any, year to year. Last year it sanctioned 11, the GAO report shows.
The GAO report highlights how schools have hired companies known as default-management consultants to help reduce their cohort default rates. The consultants are urging many students to seek "forbearance," in which the government allows them to suspend payments for a period, in many cases 18 months, the GAO says.
Unfortunately, this rarely works out for the borrowers...
You see, forbearance suspends payments, not interest accrual. This means these loans are even bigger and more unmanageable when the forbearance period finally ends.
So it's no surprise the GAO report found far more of these loans default later on. But again, these defaults don't count in the official numbers if they occur after the three-year window.
The growth in student-loan debt is unsustainable...
As the amount of debt that must be serviced continues to grow much faster than wages, it's simply a matter of time before defaults overwhelm the ability of borrowers to pay.
While we can't tell you exactly when that will occur, we can guarantee it won't be pretty. As Porter explained in the Digest last fall...
This massive debt bubble has mostly been created by the 44 million Americans who have student loans. These are the people in our society who are the least able to manage their debts. They are the most likely to default.
What do you think happens next? What happens when the least educated, least "vested," and most violent members of your society... also make up the largest demographic block... and have the largest debts (relative to income) with zero ability to pay back these debts back or discharge them through bankruptcy?
Forty-four million people carry a student loan. Most of them can't afford these loans. Nor can they default. They can't restructure. They're stuck – many with $100,000 loans that absorb more than 100% of their disposable income.
What do you think they are going to do?
Speaking of records, the 'buyback boom' has resumed...
Regular readers know share repurchases have been a huge tailwind for stocks over the past few years. U.S. firms bought back more than $500 billion of their own shares each of the past four years, the most of any four-year period on record. However, buybacks had been trending lower over the past two years.
That is no longer the case.
According to Goldman Sachs, S&P 500 companies are on track to announce $650 billion worth of share repurchases this year. This would trounce the previous all-time record of $589 billion set in 2007. And as financial newspaper Barron's reported this weekend, this could help fuel the bull market a little longer...
If you need a reason to be in stocks right now, you can look no further than the growing tidal wave of share repurchases...
Buybacks usually support stock prices by reducing share counts and boosting earnings per share. And companies that make announcements of big buybacks – like Apple's stunning, new, $100 billion program – tend to be brimming with confidence in their C-suites. Indeed, shares of companies with big buybacks have historically outperformed the market...
Buybacks offer investors an effective "yield" of about 3%, calculated by dividing repurchases by the $23 trillion market value of the Standard & Poor's 500 index. Combine that with the 1.9% current dividend yield and investors should get a nearly 5% combined yield this year. Even as interest rates rise, that combined yield stacks up well against the alternatives, with money-market funds approaching 2% and the benchmark 10-year Treasury note at 3%.
As we often say, share buybacks are a 'double-edged sword'...
Under the right circumstances – when shares are trading at a relatively cheap valuation, and the company has the cash to fund them – they can be great for investors. All things being equal, buybacks reduce the total number of shares
But most of the time, this isn't the case. And today, we're seeing many firms buying back shares at historically high valuations. Worse, most are borrowing heavily to do so. These companies are likely to regret that decision when the next downturn arrives.
Finally, we may be seeing the first signs of 'consolidation' in financials...
This weekend, Texas-based Cadence Bancorp announced it would buy Georgia's State Bank Financial. The deal marked the biggest bank deal of the year so far, and it suggests the potential for further mergers and acquisitions activity in the sector in the months ahead. As news
Cadence Bancorp said on Sunday it had agreed to buy State Bank Financial in an all-stock deal valued at about $1.4 billion, signaling a potential rise in regional bank consolidation in the United States...
Investors expect a wave of mergers among mid-sized banks as U.S. lawmakers work to rewrite banking rules enacted after the 2007-2009 financial crisis. These changes would likely raise the limit on what is considered a systemically important financial institution, which had hampered some banks from merging.
Lawmakers also are tinkering with older bank rules, emboldened by President Donald Trump's vow to loosen banking restrictions.
This should also sound familiar to Digest readers...
It's exactly what our colleague Scott Garliss has been predicting for months now. He shared his thoughts on the news with Stansberry NewsWire Premium subscribers this morning. As he wrote...
This could be the beginning of the consolidation wave we have discussed in the regional banking sector.
As Congress rolls back some of the Dodd Frank legislation, easing the regulatory burden on banks, we have anticipated a consolidation wave as they try to gobble up assets.
Raising the Systemically Important Financial Institution (SIFI) threshold is key. Legislation is before the Senate to raise this level from $50 billion to $250 billion. This means financial institutions would be subject to increased regulatory scrutiny and Fed oversight if they have $250 billion or more in assets versus the current level of $50 billion.
Raising this level would likely set off a consolidation wave as banks acquire other banks to gather assets and generate increased fees.
As we've discussed, Scott believes the best "
He also shared the names of the eight specific regional banks that he believes are most likely to benefit from the coming wave of consolidation. Unfortunately, we aren't at liberty to share them all here today... But you can get instant access to these names with a subscription to Stansberry NewsWire Premium. Click here to learn more.
New 52-week highs (as of 5/11/18): Eagle Bulk Shipping (EGLE), Eaton Vance Enhanced Equity Income Fund (EOI), Genco Shipping & Trading (GNK), Okta (OKTA), United States Commodity Index Fund (USCI), and W.R. Berkley (WRB).
In today's mailbag, a subscriber has a bone to pick with Porter's latest Friday Digest. What did you think? Let us know at feedback@stansberryresearch.com.
"40,000 people attended the Berkshire-Hathaway annual meeting. Here is what Porter had to say about the ENTIRE group's level of investing knowledge and intelligence: 'And, although I don't know for certain how many people in the crowd recognized the term 'capital efficient' that the little girl used to describe the great investments that Berkshire made in the past. But I'm willing to bet that several thousand folks at the Berkshire Hathaway meeting are familiar with the term because of my work.'
"Porter takes credit for his subscribers only being as smart as he has allowed them to be. We don't garner knowledge from any other source. We are not smart enough to seek information on our own. Without him patiently trying to 'learn' us (remember there is no teaching, only learning), we would flounder: 'And while only a few people in the audience were smart enough to know what was really at stake at this year's meeting, I'm certain Buffett and Munger knew exactly what that question really meant. It won't be last time they face that question.'
"Porter 'knows' by looking over this crowd of 40,000, that there is little intelligence there. In his daily emails, Porter often
"Anyone else tired of the passive-aggressive thoughts interspersed throughout his messages? Usually, Porter will post comments from subscribers that disagree with him and then use that platform to slam that person and their ideas. Then, he posts
"I have a college degree. I was a
Porter comment: We didn't discover the ideas behind "capital efficiency."
Those ideas were brought into the public's mind by Warren Buffett and his business partner Charlie Munger. They were first described publicly in the 1983 Berkshire letter to shareholders. I'd urge you to read it.
Buffett calls the idea "economic goodwill." Other investors have called these concepts "capital light" businesses.
I don't know of any other investment writers who have focused as much time and attention on this investment strategy as I have, and I don't think anyone else uses that particular term.
So yes, I was proud to see my term "capital efficiency" used at the Berkshire meeting. And yes, I wondered how many people in the room knew that the little girl was quoting my work. I suspect that some of them recognized the term and knew that the girl was quoting someone (me) who has been very critical of Buffett's investment performance.
Is that ego? Was I insulting the members of the Berkshire audience?
I don't follow your thinking.
Perhaps you don't know, but I've been working on a book called Warren's Mistakes. The central theme of the book is that Berkshire has turned away from the investment strategy that made him so incredibly successful.
The book comes from the work I've done on Berkshire over the past 20 years.
Let me give you one quick example of what has changed at Berkshire...
For more than 40 years, Buffett preached that CEOs who couldn't beat the market shouldn't be allowed to reinvest their profits, they should be required to pay them out as dividends. But when Berkshire could no longer routinely beat the market, (defined as any rolling five-year period), Buffett "moved the goalposts," claiming that benchmark didn't really matter.
I bring that up because it's one of the clearest examples of how, in the last 20 years, Berkshire has done a bunch of things that are the OPPOSITE of what it did for the previous 40 years.
The Berkshire formula was to own high-quality property and casualty (P&C) underwriting companies that would generate a lot of cash. This gave Buffett a large and growing pot of money to invest. ("Float" is the term in the insurance world for this capital that Berkshire controls.) This capital was then reinvested in conservative businesses that were highly capital-efficient – or as Buffett would say, possessed a lot of "economic goodwill." These firms, in turn, would grow and greatly increase the dividends they paid to Berkshire, which would then buy still bigger insurance companies.
You can think of this system as a kind of capital compounding machine, where money from insurance-company float was piled into capital-efficient businesses capable of long-term growth... whose escalating dividends could be used to buy still larger insurance companies... providing still more capital to invest... again and again.
No better model for generating wealth ever existed in all of capitalism.
Between the late 1960s and the late 1990s, this strategy grew Berkshire's already-large amounts of capital by about 25% every year. Berkshire's book value never grew less than the S&P 500 in any year, ever. That record of unblemished success will probably NEVER be repeated.
But then... after about 2000... Buffett moved away from this strategy.
Two things happened simultaneously. First, the amount of capital in the Berkshire compounding machine exploded, especially following the purchase of General Re, a massive reinsurance company. Float grew into the tens of billions and then into the hundreds of billions.
Secondly, virtually all of today's big and growing capital-efficient businesses are technology product or service companies, like Microsoft (MSFT), Google's parent company Alphabet (GOOGL), Facebook (FB), and Apple (AAPL).
Buffett and Munger stubbornly refused to analyze these companies or consider them for investment, despite being close personal friends with the leaders of these companies. (For many years, Buffett would only use a computer to play a game – helicopter – or to play online bridge.)
So rather than invest in these firms or similar companies with a lot of economic goodwill, they made huge bets on companies that could absorb a lot of capital (like oil companies, railroads, and electric utilities) but would never generate the kind of returns Berkshire had earned in the past. In short, Buffett and Munger gave up their greatest investment advantage: their appreciation of economic goodwill/capital efficiency.
But... the poor performance of Berkshire isn't the real point.
The problem isn't only that Buffett and Munger haven't bought any good businesses for almost 20 years (the exception being their recent large purchase of Apple). The problem is that they've abandoned their strategy while claiming they can't buy good stocks anymore because of
That's just malarkey.
If Berkshire genuinely has too much capital to manage properly, then it could easily declare a dividend and distribute capital to its shareholders. Problem solved.
That's what good business ethics would demand – and it's the same demand that Buffett previously made to many other CEOs.
Or Berkshire could simply do a much better job reinvesting its capital. That would require a more honest evaluation of what has gone wrong.
How is it possible that between 2008-2012, when almost every world-class, capital-efficient business was on sale, Berkshire bought NONE of them? Huge companies with massive moats and extremely capital-efficient business models – like Visa (V), for example – were available for Berkshire to purchase. But it didn't buy any of them. Not a single one.
What happened? And why won't Buffett and Munger address this question?
What did Berkshire do instead? It invested more money in the BNSF railroad than in any business it had ever bought before. In fact, Berkshire put more capital into BNSF than into all of the other companies it had ever invested in before, combined. I don't believe most shareholders understand how much Berkshire's portfolio has changed because of its huge investments into BNSF (the railroad) and its utility businesses.
Worst of all, Berkshire issued stock (40% of the purchase price) to buy the railroad.
These assets offer a woeful, sub-5% return on assets, and require tremendous amounts of capital. Berkshire, for example, has never taken a single penny in dividends from any of its utility businesses, some of which it has owned since 2003. These low-growth businesses are supported by a lot of debt – something Berkshire, as a major insurance company, can't afford. Berkshire used to be rated "AAA." It's now "AA." As a result, it has smaller profit margins in its insurance companies.
My writings about Buffett and Berkshire's relatively poor performance isn't about my ego.
Berkshire is one of the most important businesses in the world. Investors should understand how it has been mismanaged.
Investors should also know that Berkshire will continue to struggle to beat the S&P 500 until it corrects these problems.
As I mentioned on Friday, the simplest solution is to split the company into two pieces. One would be the Berkshire of old – an insurance company with a great investment portfolio. It wouldn't hold any debt. It would hold a ton of cash. And it would be rated "AAA." The other would be a big, slow-growing, heavily indebted industrial company that would pay an attractive dividend.
I
Regards,
Justin Brill
Baltimore, Maryland
May 14, 2018