Student loan asset-backed securities (SLABS) seemed to end 2023 with promising prospects. Issuance in the sector increased 122% for Q4 2023 compared with the same period a year earlier — the total issuance volume rose to $2.50 billion from $1.13 billion, analysts at Moody's Investors Service said.
A different perspective tells a different story, however. According to the Asset Securitization Report's deal database, student loan origination has been decreasing since 2021 when issuers sold $9.31 billion in student loan-backed debt. That dipped to $6.97 billion in 2022 and dropped even further to $6.51 billion in 2023. At presstime, the ASR database had not recorded any new deals year to date.
Perhaps Moody's data offered an indication of what was ahead. There was no FFELP or refi issuance in the fourth quarter versus refi issuance worth $700 million in Q2 2023, Moody's said.
Yet professionals expect deals to begin soon, with higher production overall for 2024 compared to last year. Banks that had financed warehouse facilities are likely to begin looking for repayment, and investment firms like hedge funds that had bought pools of loans from originators and servicers look for an exit strategy, according to Steve Levitan, a partner at Philadelphia-based law firm Morgan, Lewis & Bockius.
"The loans are still out there, but the lenders want to see an exit strategy being implemented since they were not supposed to finance them forever," Levitan said. "They always look to flip them, and securitization is how they will go."
Watching the Fed
A clogged supply line notwithstanding, new issuance activity would depend heavily on the Federal Reserve's upcoming interest rate decisions, Levitan said. He expects the central bank to start lowering interest rates again, perhaps after the second quarter, if inflationary pressures lift.
Greg Handler, head of mortgage and consumer credit at Western Asset Management, said the firm expects issuance to be flat compared with last year. "The Biden administration continued to try to push out the reinstatement of payments and is finding even more creative ways to offer student loan forbearance and forgiveness that will continue, and that is going to pull back some of the potential supply." Like Levitan, Handler explained that many estimates that predict a supply uptick this year rely on a second-half lower-rate environment where the Fed is cutting aggressively, and there's a potential for refinancing activity to pick up.
Handler said that there was a large FFELP loan portfolio that traded last year that could make its way into the ABS market. However, some banks have just been outright loan sellers instead of securitizers. They were focused on maximizing their proceeds and maintaining flexibility in interacting with the market. To the extent that some large money managers or insurance companies can buy the loans directly from the originators, this can also take the supply that would usually be securitized off the market. "These are some variables that we are thinking about and considering, but overall, we are still pretty constructive on the market and the consumer, so we remain active," Handler said.
FFELP and refinancings
FFELP deals haven't come into the ABS market since 2021. Because of COVID-19, the Department of Education implemented borrower relief, which led to the decline in FFELP revenues and sapped that revenue supply from the student loan ABS space.
"We do not anticipate one until the end of this year at the earliest," said Joseph Grohotoski, vice president at Moody's Investors Service. The rating agency's outlook is unlikely to change due to the uncertain future of income-based relief plans and other loan forgiveness initiatives affecting FFELP prepayment speeds. Of course If interest rates remain high, analysts expect that to put a damper on refinance activity, further constraining supply.
It is little wonder, according to Grohotoski, that 2024 issuance might be on par with 2023.
"It would be surprising if more than one FFELP deal was issued. The market might see more refi deals than 2023 because there has been slightly more origination, and we anticipate about the same number of non-refi deals."
Deepika Kothari, senior vice president at Moody's, said that, in general, for this year, given the market conditions, there is an expectation of some issuance of student loans, predominantly non-refi private student loans. "FFELP remains constrained by policy uncertainty and the resumption of student loan payments, which has been effectively postponed to the end of this year because those borrowers had an extended period to revert to payment status."
SLABS performance
Regarding the performance of non-refi private student loans, Nick Monzillo, vice president at Moody's, said that the market has seen weakening in performance metrics including delinquencies and loss rates in these deals.
Credit losses on underlying loans seen in recent years and SLABS issuance does not preclude the latter from performing well. For instance, in-school private student loans are less sensitive to interest rate movements than refinance among private student loans, so those origination volumes remain consistent over time.
Levitan is optimistic about SLABS issuance for a few reasons, including a strong job market for graduates.
Additionally, student loan debt cannot be discharged in a bankruptcy proceeding absent a showing of severe hardship, generally, so lenders prefer to renegotiate certain repayment terms with borrowers. Some lenders are even willing to discuss reworking the process with the federal government to give some relief, Levitan added.
Meanwhile, Handler said, "When modeling and stress testing, for the most part, we have been assuming a return to pre-COVID trends, and certain parts of the market have already seen that." He added they have been pleasantly surprised by the consumer's resilience and the job market's health. The reinstatement of student loan payments has not impacted borrowers as adversely as people originally feared.
For the rest of 2024 the presidential election will present the most pivotal issue to SLABS origination, Handler said, in addition to the fact that the administration of President Joseph Biden continues to favor a progressive domestic agenda. The banking industry is grappling with how Basel III will eventually be implemented, but student loans do not present banks with the same capital requirements issues as auto loans, mortgages, and commercial real estate loans.
"Student loans are more predictable," considering all the variables, Handler said.
Estimates for new student loan securitizations vary widely among commercial lenders, with a $50 billion delta between the lowest and highest approximations, given some of the uncertainties, he said.
