Postgraduate student lender Access Group Inc. brought a pair of student loan transactions last week, each incorporating stepdown capitalized interest accounts protecting against shortfalls that may occur at the front end of capital structure, while loans are still in the grace period.

The capitalized interest accounts within these deals are unique due to the multiple release dates over a two-and-a-half year period. This is the first time such a stepdown feature has been incorporated into a capitalized interest account, which typically has had just one release date protecting against interest shortfalls.

Because such a high percentage of borrowers are either still in school or currently in their grace period, there is risk that there may not be enough incoming receivables to cover coupon payments in the short-dated tranches. "The stepdown feature protects against any liquidity drag at the front end," said David Hartung in the student loan group at debt tracker Fitch Ratings.

The 2003-1 offering, backed by 100% FFELP collateral actually has 18.1% of its loans in repayment, a somewhat typical level for student loan ABS pools. Of the remainder, 76.3% are classified as in-school and 2.3% are in the grace period. By contrast the 2003-A deal, backed primarily (79%) by loans to law-school students, has no loans currently in repayment. The lion's share (95.3%) of loans in 2003-A are currently in-school, with the remainder (2.7%) in the grace period.

As a result, the capitalized interest account for the private loan-backed 2003-A is far greater than for 2003-1. While 2003-1 sets aside $42 million at closing to buffer potential shortfalls, 2003-A sets aside $75 million and remains at least 19.5% through April 2007.

Contributing to this increased enhancement in the private 2003-A series is the lack of federally subsidized Stafford Loans. While the federally guaranteed 2003-1 has 36.7% Stafford exposure, 2003-A has 0% Stafford Loans, as legal and medical educations to not qualify. Additionally, of the 18.1% currently in repayment in 2003-1, all but 1.1% are consolidation loans, which have varying degrees of seasoning and cannot be refinanced.

While this problem of interest shortfalls during the formative years of a student loan ABS is not new, previous solutions involved manipulating the landscape of the loan pool. For example, Fitch's Hartung noted that a tailoring the amortization schedule can divert cashflows to short-dated note holders, and boosting the percentage of interest-subsidized Stafford Loans is frequently seen.

In the federally guaranteed 2003-1 deal, the required amount in the interest account starts at the aforementioned $42 million, and decreases semi-annually beginning March 2004 and ending September 2006, which it is scheduled to total $400,000. The more aggressive 2002-A deal, with 0% of loans currently in repayment, starts with $75.7 million in the account and steps down to $28.2 million beginning April 2005 and quarterly thereafter through April 2007, at which time the account is also scheduled to hold $400,000.

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