Four months after downgrading U.S. Treasury bonds, Standard & Poor's has lowered or affirmed fewer than half of the highest-rated ABS guaranteed by the now-defunct Federal Family Education Loan Program (FFELP).
However, the concerns market participants had then about potentially facing split ratings on their holdings have not materialized. Additionally, despite the strong possibility of more U.S. Treasury downgrades, government-backed SLABS are still viewed as a safe haven, and certainly safer than ABS stemming from the private student loan market.
Following the Aug. 5 Treasury downgrade, S&P placed 387 FFELP ABS bonds comprising 1,395 rated classes on credit watch negative. So far the ratings for 858 classes, making up 210 FFELP bonds, have yet to be addressed. The slow pace attests to the complexity of the transactions, which often are structured with credit enhancement that can grow as the bonds mature.
On Aug. 30, S&P affirmed the senior ratings of 'AAA'-rated FFELP bonds that had parity levels - essentially assets compared to liabilities - in excess of 140%. Those were the easy pickings.
Subsequently, said Frank Trick, senior director at S&P, the agency analyzed portions of student ABS with parity levels greater than 120% that were issued in 2008 or later.
After applying a 15% haircut to the bonds' cash inflows received from the government under the FFELP program, the agency lowered its ratings on 126 classes and affirmed the 'AAA' status of 35 classes across 77 student loan ABS issued after 2007.
"Given these transactions' higher cost of funds, less excess spread and less cushion, and the application of a 15% haircut, it resulted in a number of downgrades to transactions issued across those years," Trick said.
The remaining classes S&P must address have lower parity levels, making them potentially less able to withstand defaults. However, because the loans are more seasoned, their borrowers are less likely to default, and the securities may have generated additional excess spread to cushion losses.
Investors, however, appear to have come to terms with the continuing ratings uncertainty - Fitch Ratings announced Nov. 28 assigning a negative outlook to U.S. Treasurys - given the asset classes' government guarantee, especially in such uncertain times.
Following S&P's Treasury downgrade, there were concerns that some institutional investors' bylaws would require them to sell FFELP bonds should a split rating emerge.
Ronald Mass, head of Western Asset Management Co.'s 25-strong structured finance team, which manages $2 billion in FFELP ABS, said that none of the money managers' clients that could have been affected - he estimated fewer than 5% - have so far been forced to sell securities.
"When the U.S. government is being downgraded and it's not something fundamental with the security, clients are comfortable making exceptions," Mass said.
Continuing volatility in the financial market and concerns of a 2008 rewind stemming from a possible European sovereign default continued to push up the value of Treasury bonds, despite the ratings downgrade. And FFELP loans are 97% guaranteed by the government, making them a close second in terms of security.
James Grady, head of structured finance at Deutsche Insurance Asset Management, said that the firm's clients were able to change their investment guidelines fairly easily in terms of their Treasury holdings.
"Once the downgrade happened, they said FFELP loans are still a benchmark and still a flight-to quality instrument, so we're simply not going to count them as being subject to those ratings constraints," Grady said. "I'd expect a similar impact going forward."
Grady said he would expect a similar impact on Treasurys in the future, but those guidelines are less likely to be changed for FFELP ABS, despite the same credit risk. And so downgrades could result in forced selling.
Grady added that FFELP ABS is most appropriate for investors - often banks - who don't need 'AAA' ratings and who choose floating-rate assets to avoid interest-rate risk. "It's a relatively high-quality asset that pays a premium compared to Treasurys, but with the guarantee it has a similar credit risk profile."
Mass said Western Asset views the FFELP market as "attractive," given the bonds are "cheap" compared to agency debentures and agency mortgages, even though they carry a guarantee from the same government. He further noted that FFELP ABS issued by less frequent issuers, often state agencies, can offer premiums as high as 50 basis points over mainstay issuers such as Sallie Mae and Nelnet, even though the loans backing the securities carry the same government guarantee.
Mass said 95% of their student loan holdings are invested in FFELP ABS, although the firm does see some relative value in private student loan ABS. "We look at the private side, but we've viewed FFELP ABS as being much more attractive given the higher quality," he said.
The private student loan ABS market all but halted with the start of the financial crisis in 2008 and through 2009, and it has been relatively inactive since then. Although the FFELP program ended last year when the federal government began lending directly, there have been 24 FFELP deals so far this year, mostly stemming from the refinancing of auction rate trusts
FFELP ABS currently makes up 12.8% of the consumer ABS new issue market, behind prime and subprime auto ABS, while private student loan ABS is only 1.5%, according to data from Bloomberg, Informa Global Markets and Wells Fargo Securities.
John Anglim, a director of structured finance ratings at S&P, said that Sallie Mae issued three ABS deals in 2010 and just completed its third this year, and some state agencies have also issued bonds.
Concerns about the private student loan market have emerged recently because of the poor job market and the difficulty many recently graduated students are having in finding jobs - trends that indicate increasing student-loan default rates to come. Anglim noted, however, that following the credit crisis, loan originators have become much more selective and their securitized loans are of much higher credit quality.
"The more recent loan originations have better credit quality characteristics than what was originated in 2007 and prior," Anglim said, adding that more recent transactions have higher senior parity levels, in the range of 125% to 130% compared to 110% before 2007.
Sallie Mae inked a $721 million private student loan deal on Nov. 29 that was split into a $332 million portion holding a 1.5-year maturity that priced at Libor plus 140 basis points, as well as $90 million, five-year floater pricing at 325 basis points over Libor, and a $299 million, five-year, fixed-rate portion that priced at swaps plus 325 basis points.
"The five-year portions otherwise had identical terms," said a banker familiar with the deal, adding that they were aimed at different types of investors. Royal Bank of Canada, Barclays Capital and Credit Suisse led the offering.
The banker said the lead managers worked closely with investors over an extended period, which is typical when there is so much uncertainty in the market. The short-term piece ultimately priced at the high end of the guidance the banks provided of between 125 and 150 basis points over Libor. Guidance on the five-year floater, at between 275 and 300 basis points over Libor, was under the final pricing.
"That reflected the volatility we've seen in the market and the general softening of credit spreads," the banker said, adding that Sallie Mae saw spreads tighten toward mid-year and they've since widened.
The banker also stated that a variety of institutions invested in the deal, including banks, money managers, insurance companies, sovereign funds and pension funds.
