When it comes to relative value in student loan pools, analysts with Lehman Brothers say the more seasoned the better. Student loan prepayment rates, driven by consolidation, are expected to skyrocket for 2Q05 as the interest rate on Stafford loans was reset upward by 193 basis points last Friday, and the U.S. Department of Education recently allowed borrowers to consolidate loans while still in school.
This combination of factors means that student loan ABS with a lower percentage of borrowers currently in school will be buffered from the pre-reset consolidation craze, and will likely experience lower prepayments than more recent vintages. A 2005 vintage, for example, will have a far greater number of "fresh borrowers," or those who have had less of an opportunity to consolidate, than a 2000 vintage, said Lehman analyst Dan Mingelgrin. Borrowers who have been out of school for five years or so are considered more "burnt out," he added.
According to a Lehman report on student loan prepayment measures, 2002 SLMA Stafford vintages still have 17.3% of borrowers currently in school. Those percentages are 20.5% and 16.5% for 2003 and 2004 vintages respectively. Mingelgrin stressed that it is important to consider other factors than prepayments, and to examine them on a bond-by-bond basis, as prepayment speeds will have a greater effect on bonds that are priced at a premium.
The reauthorization of the Higher Education Act, expected sometime later this year, will also likely prompt more consolidation, as the Act is expected to change consolidation loans from a fixed to a floating rate. The Act may also grant borrowers in grace and deferment periods a 60 basis point discount if they consolidate during those periods.
The report suggests using a combination of three different prepayment measures to gain a more accurate picture of the individual deal's prepayment exposure. The first, adjusted CPR, is a measure based on estimating the true scheduled balance of a deal, accounting for the nonamortizing loans, or those that are in-school, in the grace period or in deferment.
The other two measures are cohort prepayment measures addressing the fact that prepayments vary greatly depending on the payment status of the loans. One of the measures is CPR assuming that only loans in repayment and grace period are prepaying. Since in-school borrowers were only recently allowed to consolidate, this is an accurate measure of future prepayments of seasoned deals. The other measure is CPR assuming only loans in repayment prepay. This measures the prepayment propensity of borrowers in active repayment by assuming all prepayments are from that group.
Mingelgrin said the three measures should be used in conjunction with each other to obtain the best picture of specific deals. "Each one gives you a two dimensional view of a three dimensional world," he said. Mingelgrin noted that deals from other issuers have structural features that will impact prepayments differently from SLMA deals.
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