Private student loan ABS should experience lower default rates and spreads could potentially tighten on some deals as a result of the implementation of the Bankruptcy Reform Act next Monday, according to Morgan Stanley researchers. Changes to the law and an expected decline in bankruptcies should combine to keep more loans in private student loan pools paying.
While under Chapter 7 bankruptcy, borrowers can be deemed exempt from paying most of their outstanding debt, the new law defines private student loans as non-dischargeable. Morgan Stanley feels that this change alone will mean fewer defaults. "Borrowers are actually going to be forced to pay back their student loans," said Kenneth Lee, analyst with Morgan Stanley. "This will have a direct impact on performance," he added.
To better illustrate this point, Morgan Stanley studied the decrease in defaults that occurred in 1998 when non-private student loans were designated non-dischargeable debt. Default rates decreased from to 5.6% in 1999 from 8.8% in 1997. On average, default rates declined by 0.6% each year from 1995 to 1997, and then began to decline by 1.3% on average each year from 1997 to 1999.
Morgan Stanley shows that default rates on student loan deals, such as SLMA 1995-1, 1996-1 and 1997-1, declined in proportion to the general decline in bankruptcy filings from 1996 to 2000. Even when bankruptcy filings began to rise again after early 2000, the default rates in the above mentioned deals remained relatively unchanged.
In addition, spreads could tighten in private student loan ABS deals without guarantors, as those deals will be most affected by lower default rates, such as all deals from Access Group and certain percentages of deals from KeyCorp, starting with its 1999-B transaction.
Higher demand for post-secondary education as well as increased cost of post-secondary education is expected to cause expansion in the private student loan sector, which already reached over $10 billion in origination volume for the 2003-2004 academic year.
In conclusion, the firm believes that private student loans will experience lower default rates after the law takes affect, behaving similarly to non-private student loans in 1998, and that part of the decline in defaults will be due to a total decline in bankruptcy filings. Furthermore, because private student loans will become non-dischargeable, Morgan Stanley also believes defaults will remain lower than current levels even if bankruptcy filings rise in the future.
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