Fitch Ratings placed 132 subordinate FFELP student loan ABS tranches on Rating Watch Negative.
The actions result from an ongoing review of Fitch-rated FFELP student loan ABS ratings focusing on exposures to basis risk.
The rating agency conducted a preliminary analysis and has determined that subordinate tranches rated triple-A might not have enough protection against basis risk in today's volatile rate environment to support the current rating.
Even though Fitch had included basis risk stresses in its analysis of the deals at the time the initial rating was assigned, the recent rate movements have far surpassed the historical
volatility upon which the prior assumptions were based.
The agency will be conducting a detailed review of bonds placed on Rating Watch Negative over the next several months to find out these bonds' ability to withstand a higher level of basis risk stress.
Rating actions as a result of the review are expected to include both affirmations and downgrades. Downgrades are expected to be limited to one to three categories.
Considering the unprecedented market volatility seen, the rating agency might revise the base case assumptions and stress related to rate movements to conduct this analysis. Important deal-specific factors include current parity level, minimum parity level for a cash release, reserve account amount if excluded from parity calculation, current pool factor, spread on the bonds, and loan breakdown based on type and origination year.
Depending on the loan type and origination year, detailed analysis might reveal that certain trusts benefit from favorable Special Allowance Payment (SAP) spreads or floor income, allowing a significant buffer against basis risk that can support a higher rating than otherwise.
According to Fitch, an effective and significant enhancement level in the form of parity buildup or a reserve account could have the same effect.
Since the start of the market turmoil in 2007, the Libor/CP spread, which is the key component of basis risk in the majority of student loan ABS, has shown increased volatility. Before the economic crisis, SAP rates were based on the average of 90-day double-A financial commercial paper rate in effect for each day in the quarter.
With the lack of data available and other factors, the Department of Education (ED) took a hybrid approach for 4Q08, Fitch said, using the existing method and the Commercial Paper Funding Facility (CPFF) rates to determine SAP. This approach, Fitch said, proved favorable for generating trust income because it narrowed the spread of Libor over SAP rates significantly as the CPFF rate was considerably higher compared with the CP rate.
But, the ED reverted to the original method of using the market determined CP rates to calculate SAP for the latest quarter. As such, the CP index for SAP for the quarter ending March 31 declined to 0.74% from 2.58% in the previous quarter, thereby compressing the trusts ability to generate income.
Considering the compressed SAP rate and continued volatility of rates, student loan transactions are exposed to elevated levels of basis risk. This risk is particularly significant for subordinate bonds since many do not require nor benefit from hard enhancement, and cannot build parity via de-levering, Fitch said. Parity buildup in excess of 100% cannot be viewed as an enhancement if a cash release can bring down the parity.
Cash releases are usually contemplated by the documents and can be implemented if the specified minimum parity level is maintained. Reserve accounts may have been included in the structure to mitigate liquidity risk, but, in many cases, they are not a form of enhancement that can be used to cover shortfalls created by basis risk because reserve accounts are often included in the parity calculation, according to Fitch.