A Barclays Capital report examined the increasing possibility that FFELP student loan ABS will experience rating volatility in the upcoming months. As a result, the bank shifted its position to neutral from overweight on FFELP-backed SLABS.
Barclays analysts stated that there are two driving forces behind the potential ratings volatility. These are the end of the transition period on July 18 for Standard & Poor’s new counterparty risk criteria and the action by Moody’s Investors Service of placing the U.S. government’s sovereign debt rating on negative watch in light of the “debt ceiling impasse.”
On July 11, S&P placed 80 additional classes of ABS that were predominantly SLABS on negative watch as a result of its new counterparty risk criteria. In total, there are now 249 student loan ABS classes on watch by the rating agency, 226 are related to counterparty risk while 23 are because of other reasons. Barclays analysts think that the potential rating action is imminent given that S&P is likely to resolve the credit watch placements related to its new counterparty risk criteria soon after the end of the transition period.
In terms of the negative watch actions on the U.S., S&P's made a separate decision last night to also place the U.S. government's debt rating on negative watch. While this action by S&P exacerbated the impact of the previous action by Moody's, S&P actually left out related ratings such as those on FFELP-backed ABS for now.
Moody's, on the other hand, placed the 'Aaa' ratings of all FFELP-backed student loan ABS on review for possible downgrade along with the review of the 'Aaa' on rating of the U.S. government. According to Barclays, the ratings of FFELP-backed ABS and the U.S. government are linked because of the subsidies and guarantees offered by the government that lessen borrower defaults, improve liquidity and limit interest rate and basis risk.
Barclays analysts have moved to a neutral weighting in FFELP student loan ABS from an overweight position. They moved to a neutral weight on senior FFELP student loan ABS while maintaining a neutral weighting on subordinates in light of the potential for ratings volatility in the next several weeks. They recommended that investors hold off on adding more FFELP ABS positions until there is more clarity on the outcome of the rating watch actions against U.S. government ratings.
If either rating agency follows through with a downgrade, Barclays analysts recommended that ratings-insensitive investors buy FFELP-backed senior notes based on the potential resulting weakness. They added that downgrades on the senior notes would probably cause selling by ratings-restricted holders, which should provide attractive entry points for other buyers. Additionally, they do not anticipate a significant change in the true credit risk of FFELP ABS in the event of a downgrade of the U.S. rating by either rating firm. Meanwhile, in the private credit student loan space, analysts suggested current- and next-pay classes.
Fitch’s View
Fitch Ratings released a report today stating that any rating action taken against the U.S. sovereign rating would directly impact all fully or partially backed FFELP loans. This is due to the fact that every FFELP loan is at least 97% guaranteed by the U.S. Department of Education, and any downgrade of the U.S. would threaten the “full faith and credit of the U.S. government” guaranty.
Fitch analysts said that any downgrade of the U.S. sovereign rating would result in a similar action taken against FFELP-backed SLABS. So if the U.S. was placed on RWN, FFELP-backed SLABS would also be placed on RWN.
The report stated that about $230 billion worth of Fitch-rated FFELP SLABS is currently outstanding in the market.
The report also revealed that certain ABS, RMBS, CMBS, and structured credit transactions may be directly linked to the U.S. government as a result of a formal guaranty. Fitch said that should the U.S. sovereign rating be placed on RWN, the ratings on these types of securities would similarly be placed on RWN.
