In case you haven’t been keeping track, Moody’s Investors Service downgraded about half of the guaranteed student loan bonds that it had put under review this year.

The review of 504 tranches of 194 transactions was concluded on Dec. 6, but the results have been dribbling out since late August in 27 separate press releases.

The process was set in motion nearly two years ago, in the spring of 2015, when analysts took note of a marked slowdown in the rate of repayment of the loans used as collateral. The primary reason for this is the growing popularity of generous repayment plans, which allow borrowers to spread payments out for as long as 25 years, instead of the standard 10. This creates a risk that bonds backed by the loans may not pay off at maturity. This prompted Moody’s to revise its rating methodology. It now derives the expected loss and weighted average life of each tranche by running 28 cash flow scenarios and using the weights associated with each scenario.

After releasing a draft and responding to comments, Moody’s published the new methodology in June 2016.

Under this new methodology, Moody’s put some $90 billion of student loan bonds under ratings review. The final tally was released this week: it downgraded the ratings on 262, confirmed the ratings on 133 and upgraded the ratings on 109.

The average downgrade magnitude was 5.2 notches and the average upgrade magnitude was 2.8 notches, with the largest magnitudes for tranches maturing in less than 10 years

Approximately 61% of outstanding FFLEP ABS that Moody’s rate now carry a triple-A rating, down significantly from nearly 90% prior to the methodology update.

Interestingly, most of the tranches that were upgraded are subordinate in payment priority, and so would normally be considered riskier than securities first in line to be repaid. It was their long-dated maturities that gave Moody’s a higher assurance that they would be repaid upon maturity. (Bonds last in line to be repaid typically remain outstanding longer than bonds that are first in line to be repaid.)  By comparison, most of the tranches that were downgraded had close-dated maturities and slow pool amortization.

However, Moody’s also expect to see losses in some transactions with auction-rate securities and reset-rate notes, even if the maturity dates are not a near-term concern. The coupon on these notes have increased since issuance as a result of failed auctions or failed remarketing. As a result, their excess spread – the difference between interest paid on notes and interest collected on the collateral – has declined considerably.

“While many auction-rate securities have a net loan rate cap to protect against negative spread, this cap does not provide perfect protection,” the rating agency stated in its report. “Most net loan rate caps are designed to limit the coupon on the notes by the interest earnings on the pool less expenses, not protecting against net loss. Anytime net loss causes the deal’s parity to drop below 100%, the net loan rate will not protect against negative spread. Slow repayment will cause this negative spread to erode subordinate notes over time.”

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