Just as one segment of the student loan ABS sector seemed to get a lifeline from federal authorities, the private side of the market took another hit. Last week, The Education Resources Institute. (TERI), filed for Chapter 11 bankruptcy after a downgrade from Moody's Investors Service tripped a trigger on a loan contract that resulted in the company having to post cash to cover its student loan guarantees.
The initial downgrade, to B2' from Baa3', happened on March 26, after Moody's expressed concerns regarding TERI's asset quality, liquidity position and adequacy of capital reserves. Making matters worse, TERI's subsequent Chapter 11 filing resulted in two downgrades. Moody's and Fitch Ratings, dropped TERI's rating down to Ca' and C', respectively.
TERI provides guarantees to private student loans and counts First Marblehead, a company that frequently securitizes private student loans, as one of its biggest clients. First Marblehead's transactions, issued under the name National Collegiate Student Loan Trust, receive protection via a fully funded TERI pledge fund, which is available to be drawn upon as private student loans in the trust default, according to Barclays Capital.
If the pledge fund is depleted, the trust would ordinarily look to TERI to make payments on defaulted loans it insured. The bankruptcy, however, raises the possibility that reduction or delays in the amounts of payments on defaulted loans in the trust are likely, because the guarantees would probably be treated similarly to general creditors.
Therefore, payments on the notes would have to rely on collections from borrowers and the TERI pledge fund.
As for what the downgrades would mean for private student loan trusts with guarantees by TERI, Moody's placed 93 notes from 12 National Collegiate transactions under review for possible downgrade.
Aside from that, Barclays noted that some student loan trusts have sustained higher losses, resulting in declining TERI pledge funds on outstanding National Collegiate deals. Also, defaults have been accelerating for some of the more recent vintage deals, after underwriting standards in the direct-to-consumer loan channel and which were favored by First Marblehead, began to loosen.
The direct-to-consumer lending methods bypass school financial aid offices, and avoid the certification that generally occurs for loans generated through school channels.
"As a result, there tends to be a higher incidence of fraud," Barclays said. "In addition, economic conditions are at least partially responsible for the performance deterioration."
The news about TERI and First Marblehead followed several days of positive news on the FFELP side of the SLABS market. House representatives proposed legislation to clarify the Education Department's procedures for FFELP lender of last resort, and authorize the department to buy FFELP loans directly from lenders. In the Senate, Ted Kennedy (D-Mass.), proposed several changes, including increasing certain Pell Grant limits and allowing parent PLUS loan borrowers to defer payments.
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