In the last four weeks, subprime auto and FFELP SLABS have tightened five basis points to 10 basis points, which is the most of any asset class in that period, Wells Fargo analysts said in a report released this afternoon.
FFELP student loan spreads have performed well in the past several weeks, even though analysts think that there is room for added tightening. The market has not only accepted the possibility of rating volatility, but has moved on to examining SLABS fundamentals and valuations.
Analysts think that FFELP student loan ABS still offer good relative value. Four weeks ago, they said subprime auto ABS and subordinated bonds provided better relative value in a low-rate and flat-yield curve scenario. In terms of the coming month, they are maintaining this outlook.
They explained that good credit performance as well as robust structures should lessen the consumer ABS credit risk. They also like the carry provided by these higher-yielding bonds.
The risk of wider spreads in most asset classes is probably going to come from outside the consumer ABS market, analysts said. The potential for financial instability from what's happening in Europe appears to be one possible source of market risk, Wells Fargo analysts said.
SLABS Regulatory Update
Meanwhile, JPMorgan Securities analysts said that student loans have been given a lot attention this year. In March, the Consumer Financial Protection Bureau projected that the total student loans outstanding had exceeded $1 trillion, and has surpassed credit card debt.
Last week, the market was focused on the topic of the number of student loans increasing as the House of Representatives had passed a bill on Friday to stop the interest rate rise on subsidized Stafford loans.
According to JPMorgan analysts, as it is currently drafted, the bill extends the terms of the College Cost Reduction and Access Act for a year. The act sets interest rates on Subsidized Stafford loans at specific levels based on the year the loan was disbursed.
Based on the schedule, subsidized Stafford student loans given out between July 1, 2011 and July 1 have a fixed 3.4% interest rate. The subsidized Stafford loans taken after July 1 are set to revert back to the original 6.8%.
The bill passed by the House proposes that the interest rates on loans offered between July 1 and July 1, 2013 not rise to 6.8% and stay at 3.4%. As currently drafted, it is unclear if the bill will pass as it pays for the rate freeze by taking money from the Provision and Public Health Fund, which is a measure that President Obama has threatened to veto, JPMorgan analysts stated.
Under current loan limits, students can utilize a maximum of $23,000 in subsidized Stafford loans for their undergraduate degree. So if a student borrows this maximum amount under a 10-year repayment plan, the proposed reduction in interest rate from 6.8% to 3.4% means a savings of $40 per month or roughly $5000 over 10 years.
Even though the savings from the President's proposal can help students, it will have no effect on SLABS investors, analysts said.
The proposed reduction in student loan interest rates just impact subsidized Stafford loans, which are on the government balance sheet and are also not securitized. However, even if legacy FFELP ABS have Subsidized Stafford loans, the proposed lower rate is only available to new loans. Thus analysts said that ABS investors have no direct stake in the political debate in Washington about student loans.
But, the broader context around the proposed legislation is one that could probably affect ABS investors in the future. The legislation is borne out of a general concern about the debt burden's sustainability on students and their parents, they said.
From an ABS investor perspective, the high unemployment rate together with rising college tuition costs are still a source of concern as any legislation passed to lessen student loan debt could affect both securitized and non-securitized loans. But, no such legislation currently exists and when and if it is drafted, JPMorgan analysts would think that the regulators will get feedback from all industry players.
Meanwhile, ABS investors who want exposure to the asset class should continue to look to new-issue private credit student loans. Since the crisis, issuers have been tightening underwriting standards, JPMorgan analysts said. FICO scores have risen to close to 740 from 715 and loans are more seasoned, which means shorter remaining terms, JPMorgan analysts said.
Additionally, analysts noted that all new-issue deals benefit from the "full turbo" feature that traps excess spread in the deal to build up overcollateralization (OC) and then uses it to pay off the bonds. This feature can give a lot of value in recent offerings where target OC can be as high as 40%, they explained.
