Is Fitch Ratings going easier on bonds backed by federally guaranteed student loans than Moody’s Investors Service?
That’s the conclusion of analysts at Barclays.
Two weeks ago, Fitch proposed changes its criteria for rating bonds backed by Federal Family Education Loans
This followed a similar proposal by Moody’s in July.
Both are concerned that a slowdown in the repayment of these loans puts the bonds at risk of not paying off at maturity, which is an event of default. This is largely because of the growing popularity of generous repayment plans that tie monthly payments to a borrower’s income level, though increased forbearance and deferment are also taking a toll.
Among the most crucial changes proposed by both of the agencies are to assumptions on prepayment and forbearance rate, deferment and the number of loans in so-called income-based repayment (IBR) plans.
They differ in three areas, according to Barclays. Moody’s assumes that forbearance rates will not fall below a certain level for each ratings category. When modeling cash flows for the triple-A trances of deals, it applies a 20% forbearance rate. Fitch has no such floor any ratings level. Instead, the agency takes a securitization deal’s 12-month forbearance rate and applies it to the “entire life of the transaction.”
The rating agencies also differ on their assumptions about the percentage of loans in deferment. Both have a floor but Fitch’s is lower—5% at all ratings levels—as opposed to Moody’s floor of 15% at the AAA level.
Barclays analysts also pointed to another difference between the agencies: Fitch is proposing to factor into a deal’s rating the years it has left to mature. If a tranche passes the highest stress case and has more than seven years to maturity, it could see a two-notch upgrade. Deals maturing in 2-7 years could get a one-notch bump up. Any ratings uplift from this effect, though, is capped at AAA.
In the release on its proposed changes, Fitch said it could end up downgrading about 35%-45% of FFEL asset-backeds that it rates. These downgrades could be as steep as five notches, bringing some bonds to as low as ‘B.’
Fitch estimates that 10%-15% of bonds currently rated ‘AAA’ could be dunked into junk category.
Moody’s, for its part, rates $37 billion of securities, most of which are currently rated ‘Aaa,’ under review for downgrades. As with Fitch’s proposal, the downgrades could turn investment-grade bonds into junk.
Spread on FFEL deals blew out this summer on fears that they wouldn’t pay off as quickly as thought thanks to the government’s more generous IBR plan. More recently, they’ve stabilized somewhat.