Just as the student loan ABS sector was digesting proposed cuts to federal student loan subsidies proposed by Congress, it was hit with a Bush administration proposal to cut lenders' special allowance payments (SAP) by 50 basis points in the 2008 budget plan. If Congress sanctions the changes, then it could change operations at several student loan providers. Future student loan ABS structures might experience declines in excess spreads from their existing levels, say industry observers.

Although the president's proposal did not specify which federal student loans would be targeted for the reduction, the expected cuts might be applicable to all FFELP types, Claire Mezzanote, a managing director at Fitch Ratings said during an industry conference call on Thursday morning about the student loan sector.

"From a credit enhancement perspective ... transactions that utilize premium proceeds structures may take longer to reach an asset parity of 100%," Mezzanote added.

A 50 bp reduction in yield will directly reduce consolidators' premiums by 4%, which will most likely eat into their marketing costs, said one market professional.

"Nobody is going to get out and spend 2% or 3% on marketing and try to sell these products, when they might lose that," he said. "I think the larger companies, such as Sallie, Citibank and Nelnet, will stay in business. For the smaller players, the economics will make them go away."

The budget proposal also includes a provision to reduce the exceptional performer guaranty rate to 95% from 97% and to 97% from 99%. It also follows a couple of plans now making their way through the House and the Senate, which could also act together to negatively affect the student loan business, industry professionals say. In the House, the College Student Loan Relief Act would make several changes, including a reduction in borrower interest rates, decreasing the lender SAP rate by 10 basis points for loans granted after July 1, 2007 and increasing consolidation loan rebate fees. On the latter, the 1.05% consolidation loan rebate would be increased to 1.3%, but only for institutions whose holdings are made up of consolidation loans by 90% or more.

On the surface, the reduction of guarantees for exceptional performers would likely "result in higher losses that would need to be covered by credit enhancement," Mezzanote said.

Without a doubt, say professionals, lenders are expected to reduce borrower benefits to compensate for the lost subsidies. The changes could also have a chilling effect on the student loan consolidation business, as well as that of providers who focus heavily on federal loan products. Some might be forced to drastically change their business strategies to maintain profitability at thin margins. Some lenders might be forced to put more private student loans on their books, while others could be put out of business altogether, industry professionals observed.

"It may cause some to say are we doing enough volume to make it efficient," said one market professional. "I would say to Congress that this hurts everybody."

Shares of Nelnet Inc. and SLM Corp. were hit for days after the announcement, closing down 0.49% and 0.07%, respectively, last Thursday afternoon from the previous trading session.

Yet, the long and often contentious legislative process will likely prevent these changes from happening anytime soon, observed market professionals, who said they only expect final changes to impact securitizations backed by loans originated after July 1, 2007.

"HR-5 and the president's proposals both have an extremely long way to go," one market professional said. "Regardless of what happens legislatively, there is no precedent for retroactive changes in the law."

(c) 2007 Asset Securitization Report and SourceMedia, Inc. All Rights Reserved.

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