Overcollateralization, excess spread and the presence of cash capitalization accounts (CCAs) on certain deals provide ample protection against prepayment losses on private student loan ABS deals, Lehman Brothers found after a test analysis on a Sallie Mae transaction.
Even under fast prepayment assumptions, loss coverage multiples on bonds across the capital structure are higher than those implied by their ratings, Lehman analysts wrote in a report issued last week. Average lives on private student loan ABS are relatively stable, and they offer compelling value for investors compared to bonds backed by FFELP loans.
Lehman undertook a specific analysis of prepayment risks on private student loans after recognizing the dearth of publicly available cash flow models, thus forcing analysts to rely on what they say are "over-simplified analyses to evaluate the risks inherent in these securities." The bank then used public information to mock up the collateral and cash flow waterfall of SLMA 2005-B, and then applied its own credit and prepayment stress tests to the bonds.
Essentially, analysts derived three major findings from this exercise. First, they found that the loss coverage multiple on the triple-A bonds was well over 5.0 at its base case prepayment speed and over 4.0 under conditions wherein the loans saw very fast prepayment speeds. Also, private student loan ABS bonds are subject to only moderate prepayment risks. Specifically, on prepayments that came in 50% faster than its base case, longer bonds contracted by only 1.0 to 1.5 years. Furthermore, pricing speeds may underestimate actual prepayments beyond the first few years of the deal. Lastly, the analysis showed that private student loan ABS offer attractive relative value across the capital structure. In fact, the deals back by private student loans offered investors spreads that were five to 20 basis points more than FFELP ABS. Subordinates threw off even better yields compared to FFELPs, doing as much as 50 basis points better in some cases.
The test transaction, SLMA 2005-B, uses a senior-subordinate structure in which the four senior classes pay sequentially and receive all principal cash flow prior to a so-called step-down date in December 2010. Then, if no triggers are in effect, the principal payments are allocated pro rata to the outstanding A, B, and C classes, such that target overcollateralization levels are met. The deal had five sources of credit enhancement: OC, a reserve account and a cash capitalization account of $210 million. These played particularly big roles in the outcome of Lehman's stress tests. The deal was set up so that the OC former saw 50 basis points initially, and then accumulated to a level of 2% of initial asset balance. The reserve account equaled 0.25% of the initial loan balance. Other forms of enhancement included subordination and excess spread.
The CCA provides liquidity for the trust to pay bond interest while many of the student loan borrowers are still in school or if the loans are in a grace period before repayment. The bank says the CCA also plays an important role in maintaining credit enhancement. Without the CCA, the deal's bond balance exceeds the loan balance at the deal's inception. The presence of the CCA, however, provides the initial total OC of 50 basis points. As borrowers begin to repay the underlying loans and accrued interest is capitalized, the OC increases, while cash in the CCA is released through the deal's waterfall structure. A portion of the CCA ends up paying down on the triple-A bonds, instead of going directly to the residual bondholder. This, Lehman says, maintains the target OC on the deal, a whole other portion is paid to the residual holder.
Still, Lehman noted, there are caveats to the otherwise encouraging analysis. Although the average lives on the bonds are relatively stable, longer bonds could contract by as much as one to three years, especially if prepayments reach 15 to 20 CPR. Importantly for investors who are WAL constrained, Lehman said, prepayments are likely to be faster than pricing speeds beyond the first few years of the deal, and may accelerate even more than its base case assumptions, owing to the growth of consolidation loans.
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