Hiring a third credit rating agency, S&P Global Ratings, paid off for CommonBond as it was able to offer much lower risk premiums on its latest student loan securitization, which closed Thursday.
The tighter spreads should help offset a rise in the underlying benchmark rates for the securities, keeping the lender’s funding costs low — and helping it compete more effectively with banks.
"There’s a longstanding view that large banks have an advantage in terms of cost of capital," David Klein, CommondBond’s chief executive, said in a telephone interview. “The size of this advantage is being eaten into with every passing securitization. And when combined with other costs like marketing, operations, and credit, that advantage is completely neutralized."
S&P Global assigned an AA rating to the senior tranche of notes issued in the transaction, CommonBond Student Loan Trust 2017-BGS; that was in line with the Aa2 and AA (high) ratings assigned by Moody’s Investors Service and DBRS, respectively.
The $176 million fixed-rate senior tranche pays 72 basis points over swaps, compared with 90 basis points on the comparable tranche of CommonBond’s previous deal; the $43.7 million floating-rate senior tranche pays Libor plus 65 basis points, inside 85 basis points for the previous deal. Both tranches of notes are expected to be repaid within four years.
An additional credit rating (notably from another one of the Big 3) expanded the market for the bonds and increased competition, Klein said. Some asset managers have investment guidelines that require securities to carry more than one credit rating, and some require a specific rating agency. More generally, investors may take comfort from having an additional pair of eyes on a deal.
Investors submitted $1 billion in orders for the $248.9 million deal, making it more than four times oversubscribed, CommonBond said in a news release.
The spread tightening was even more notable on the subordinate tranches of notes, which were rated by Moody’s and DBRS alone.
The $17.7 million tranche of class B notes, which are rated A3/A and expected to be repaid within six years, pay 115 basis points over swaps, down from 170 basis points for the comparable tranche of CommonBond’s previous deal.
The $11.5 million tranche of class C notes — rated Ba2/BBB and expected to be repaid within four years — pay swaps plus 255, down from swaps plus 375.
Goldman Sachs served as structuring agent, co-lead manager, book-runner, and co-sponsor; it contributed a portion of the loans used as collateral after previously acquiring them from CommonBond.
CommonBond and its fintech peers compete for refinance loans with several banks including Wells Fargo, Citizens Financial Group, and Darien Rowayton Bank, that can fund lending with cheap deposits.
SLM Corp., the biggest student lender, only offers in-school loans. Last week, the company’s CEO, Raymond Quinlan, dismissed concerns about getting its best borrowers cherry-picked by refi lenders. On a conference call with analysts, he suggested that margins for nonbank lenders like CommonBond were narrowing, and would soon force them to raise interest rates on their refi loans, which would reduce their addressable audience.
To the extent that CommonBond can expand the investor base for its securitizations, however, this margin pressure is reduced. Klein said he expects that banks’ funding advantage over the company will be reduced even further once it builds a longer track record, making rating agencies comfortable enough to lift a ratings cap on the senior notes of its deals.
S&P, Moody’s and DRB all cited CommondBond’s limited operating and performance history — it has been making loans only since 2013 — as a concern.
By comparison, Social Finance, which has a similar business model but has been in business longer and has a higher volume of originations, earns triple-A ratings on the senior tranches of its deals.
“Once we make the jump from double-A to triple-A, one would expect to see further spread compression," Klein said.