Add this to the list of concerns for investors in bonds backed by federally guaranteed student loans: marketplace lenders are stealing their best collateral.
Two online lenders, Social Finance and CommonBond, have been targeting borrowers with extremely strong credit with loans that allow them to consolidate their existing loans, including those made under the Federal Family Education Plan. They both market to graduates with advanced degrees from prestigious universities.
These borrowers “are the cream of the crop” in FFELP ABS, Debash Chatterjee, managing director at Moody’s Investors Service, said at IMN’s ABS East conference. Remove them from these pools, and there is an even higher concentration of borrowers who are either delinquent, in forbearance, or in an income-based repayment plan.
Moody’s, as well as Fitch Ratings, is concerned that the slower rate of repayment creates a risk that bonds backed by these loans will not pay off at maturity, which is an event of default. Over the summer, the two rating agencies put some $37 billion of bonds under review for a possible downgrade.
Chatterjee said that loan repayments have slowed to such an extent that the weighted average maturities of many bonds backed by these loans is actually trending up, or at least staying flat. Moody’s has coined a term for this: term creep.
At IMN’s panel, Chatterjee noted that the marketplace lenders, while still small, are “growing pretty fast.”
Theresa O’Neill, a managing director at Bank of America Merrill Lynch and another panelist, thinks the impact of marketplace lenders will be limited, however.
“The FFEL program is very broad,” she said. “High-quality obligors are a relatively low percentage of overall deals … I don’t see a significant shift in payments because they are being refinanced.”
Concern that bonds, most of which are rated triple-A, could be cut to low investment grade, or even junk, prompted a selloff over the summer. O’Neill noted that spreads on five-year triple-A FFELP bonds on watch are some 40 basis points wider than similar bonds not on watch.
This spread widening came amid heavy volume. She cited data from TRACE that “at least” $1.5 billion of FFELP bonds changed hands in June, after Moody’s announced it was widening the scope of bonds under review and proposed changes to its rating criteria. (TRACE doesn’t disclose trades over $10 million in size.) By comparison, for September to date, just $600 million has changed hands.
These bonds are now attracting a different investor base, according to O’Neill: people who are looking for higher yield. “We’ve also seen investors who had not participated in the market for a number of years come back because of where spreads are.”
O’Neill said just $7 billion of FFELP ABS has been issued year to date, down from $13 billion in 2014. “I’d be surprised if we see another issue this year,” she said.
Somewhat surprisingly, spreads on bonds backed by private student loans have widened in sympathy with the FFELP market, despite the fact that these borrowers are not eligible for the U.S. government’s generous repayment plans. O’Neill said that spreads on private student loan backed securities with five-year terms have widened by around 20 basis points.
“The bonds are cheap; there’s a buying opportunity,” quipped Leo Subler, senior vice president at Sallie Mae.
He said that, if anything, repayments on private student loans are a little faster lately.
Chatterjee concurred, saying “we do see the opposite trend” in private student loans repayment rates than in federally guaranteed student loans.