Fitch Proposes Changes to FFELP-ABS Criteria

Fitch Ratings is proposing changes to the way it rates bonds backed by government-guaranteed student loans to account for the slower pace at which these loans are being repaid.

The impetus for the proposals is the introduction of generous repayment plans for Federal Family Education Loans (FFEL) that base monthly payments on a borrower’s level of income. As these income-based repayment (IBR) plans become more popular, FFEL loans are paying off more slowly, creating a risk that FFEL bonds won’t pay off at maturity, which is an event of default.

Fitch said Wednesday that is could end up downgrading about 35%-45% of FFEL asset-backeds that it rates. These downgrades could be as steep as five notches, bringing some bonds to as low as ‘B.’

Fitch estimates that 10%-15% of bonds currently rated ‘AAA’ could be dunked to junk category.

All the same, the agency said it still expected FFEL ABS investors would receive “full repayment of principal and interest,” just not on time.

Fitch announced its proposed changes five months after Moody’s Investors Service proposed changes to its ratings criteria in early July. Moody’s changes were subject to comment until Oct. 30, a one-month extension of the original deadline. A Moody’s spokesman said the agency was still going through the comments it received and hadn’t finalized changes yet.

Fitch is seeking feedback on its proposed changes from market participants on these proposals until Dec. 31, 2015. Fitch had, in August, placed $8 billion of FFEL ABS under review for a potential downgrade.

During the timeframe of the comment period, Fitch is putting potentially affected tranches on ‘rating watch negative.’ This risk is that these tranches will fail modified stress tests and as a result, get downgraded.

Specifically, Fitch is looking at changing the assumptions of borrower behavior that anchor its analysis. The agency is also considering a new methodology for deals that would reduce the implied rating after putting the new stress tests into effect. 

For its part, Moody’s has $37 billion of securities, most of which are currently rated ‘Aaa,’ under review for downgrades. As with Fitch’s proposal, the downgrades could take bonds into junk territory.

IBR programs make it easier for FFEL borrowers to defer payments or pay a percentage of their discretionary income for up to 20 or 25 years, after which the balance is forgiven.

Servicers, as well as FFEL investors, have been taking steps to avoid downgrades.

Navient and Nelnet, the two largest servicers, have bought back hundreds of millions of loans from the pools backing FFEL ABS. Sponsors of these deals have also called individual tranches at risk of not paying off maturity. 

The FFEL program is no longer making new loans, having been replaced by direct lending from the government.