NorthStar Education Finance, a Delaware non-profit, is marketing $90 million of bonds backed by private loans to medical and law students.

The deal, dubbed NorthStar Student Loan Trust III, will issue two classes of notes: an $86 million senior tranche maturing in May 2036 is rated ‘Aa1’ by Moody’s Investors Service and a $4 million subordinate tranche maturing in October 2037 is rated ‘A1.’

RBC Capital Markets is the initial purchaser.

The senior notes are expected to benefit from 18.2% hard credit enhancement, consisting of 13.7% of over-collateralization, 3.8% of subordination provided by the subordinate notes, a 0.2% reserve fund and a 0.5% capitalized interest fund.

The subordinate notes benefit from 14.4% hard credit enhancement, consisting of 13.7% of overcollateralization, a 0.2% reserve fund and a 0.5% capitalized interest fund.

The senior and subordinated will also benefit from expected excess spread ranging from 1% to 4% per annum.

The proceeds will refinance two facilities currently used to fund the loans, which were originated by University National Bank on behalf of NorthStar:  a bank loan facility dubbed NEF Series 2011-A-L, and a variable rate bond issue, NorthStar Student Loan Trust II, Series 2012A.

All of the loans are private, meaning that they are not guaranteed by the U.S. Department of Education, although they were made via program that bundled private loans with federally guaranteed loans.  

NorthStar is the servicer; Great Lakes Educational Loan Services is the backup master servicer.

According to Moody’s the quality of the collateral is high: 99.7% of the loans were made to borrowers enrolled in four year and graduate degree programs. As of Jan. 20, these borrowers had a weighted average FICO score of 759.  “The loans were made via the school origination channel, and were marketed to a select groups of schools with historically low cohort default rates,” the presale report states. “Borrowers had to have exhausted their federal and institutional funds before applying for a loan, limiting over borrowing.”

Of the loans in the pool, 93.7% are in repayment. 5.4% are in deferment and 0.5% are in forbearance.

However the report cites a legal risk to one type of loan in the pool, which is made to borrowers who have graduated from law school and are studying for the bar. Loans characterized as “education benefits” cannot be discharged in bankruptcy, but in March the United States Bankruptcy Court, Eastern District of New York Court ruled that a bar loan is “a product of an arm’s-length agreement” and so can be discharged.

“This ruling sets a precedent and, if other courts were to rule similarly, borrowers with such loans who struggle to make timely payments would have an incentive to default on their loans and file for bankruptcy,” the presale report states. “If securitized loans were to become dischargeable in bankruptcy court, the trusts they collateralize would experience higher defaults and receive less total recoveries on defaulted loans.”

Moody’s net loss expectation for the loan pool is approximately 6.3%. It expects cumulative weighted average defaults of approximately 7.0%, after adjusting for seasoning credit. Its recovery assumption, based on NorthStar's managed portfolio data, is 11% for medical, allied health, law/MBA and other loans. However, it assumes that 25% of bar study and residency relocation loans will default and have no recoveries to account for the potential dischargeability of such loans in bankruptcy court.

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