Dominion Bond Rating Service (DBRS) reported an increase in European participation on U.S. student loan securitizations (SLABS). DBRS said that in the first half of 2006, issuance of euro-denominated SLABS grew to approximately 2 billion ($2.5 billion), up more than 100% from 2005's total issuance of 735 million. Investors can look forward to increased participation from issuers like Sallie Mae, which has historically dominated Euro issuance, as well as newer entrants Nelnet and Goal Financial.
There are two types of SLABS - private and Sallie Mae's Federal Family Education Loan Program (FFELP). FFELP student loans have an explicit guaranty from the U.S. government and, as such, are of very high credit quality. The guaranty only covers 98% of principal and interest losses, the rest is borne by the loan holder or the transaction. As such, SLABS transactions are structured as 97% triple-A and 3% double-A. "This makes them almost risk less," said Steve Levitan, a partner at McKee Nelson LLP. "There is also a steady stream of product available (both the guaranteed and non-guaranteed variety), using some novel investor friendly structures not seen with other asset classes, and one that traditionally has provided good returns with low to no losses."
According to DBRS, Sallie Mae has issued over 8.1 billion Euro SLABS - 14 tranches across 11 deals. All Sallie Mae non-U.S. dollar-denominated issuance has been from consolidation loan deals and are typically longer-dated tranches, largely due to the better bid for longer dated paper by European investors. Collateral payments are received in U.S. dollars, while debt service on some of the SLABS tranches are made in euros, which creates a foreign exchange risk, DBRS explained.
To hedge this risk and manage excess spread, a SLABS trust typically enters into a currency swap. The trust is required to pay U.S. dollars and receive euros in return. The conversion ratio from dollars to euros is based on the prevailing exchange rate at the time the agreement is executed and remains fixed throughout the duration of the swap. Therefore, the currency swap effectively converts the euro tranche into a synthetic U.S. dollar-denominated bond.
"Although spreads are relatively tight on the paper, these are justified on credit quality and liquidity (particularly U.S. dollar denominated) grounds, hence the interest from European investors," said Harpreet Parhar, who is part of the ABN Amro ABS research team. "However, most euro-denominated tranches are usually the longer dated ones which tend to be in reset rate format because the bid at this part of the curve tends to be better than on the U.S. dollar curve; this also helps the issuers to diversify their investor base."
However, Parhar added that although the market has seen increased issuance in euro student loan tranches, there has arguably not been enough to satisfy demand, which is predominantly the result of funding costs. Issuers will only tend to tap the euro market when it makes sense for them, such as when the price of the swaps on the deals results in favorable funding costs.
DBRS said it expected origination volume for both FFELP consolidation loans, and SLABS backed by these loans, to spike through the third quarter. This would be driven by the elimination of in-school consolidation, and the increase in coupon rates (approximately 200 basis points) for FFELP, Stafford and PLUS loans at the reset date, changes expected to come into effect on July 1. "In the past, prepayments were more predicable, which changed (i.e. spiked) in the last year or two, but this should revert to historical levels post July 1st when the amended laws go into effect," Levitan said.
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