As vital government support extended to student loan borrowers dries up and inflation lingers, defaults have led the performance of securitized U.S. student loans to a normalization inflection point, according to Fitch Ratings.
Performance deterioration will follow the low delinquency and default levels of 2020 and 2021 in both Federal Family Education Loan Program (FFELP) and private student loan (PSL) asset backed securities, Fitch Ratings noted in its U.S. student loan ABS index Q2 2022. The report shows FFELP and PSL ABS default rates had returned to at or near pre-pandemic levels.
The Q2 student loan data held no specific surprises, as recent delinquencies have not converted into higher defaults.
"We would expect to observe higher defaults in the near term," said Nicole Edwards, a director at Fitch Ratings.
No surprises amid pre-pandemic norms
The TTM constant default rate for FFELP ABS was 2.9% for the quarter, up from 2.4% in 1Q22. Traditional in-school PSL ABS defaults increased to 2.3% in 2Q22, up from 1.6% in 1Q22, and Refi PSL defaults rose slightly from 0.3% to 0.4%.
Temporary government support and payment holidays, including forbearance, helped lower FFELP and PSL delinquencies, a trend observed across consumer sectors during the pandemic, not unique to student loans, Edwards noted.
Summertime student loan ABS performance appeared to reflect pre-pandemic levels. In June 2022, the FFELP Index for the 30+ days, delinquency rate was 13.01%, up from 11.58% in 1Q22 and 8.05% in 1Q21, the highest index increase of the quarter.
By comparison, the traditional PSL Index for the 30+ days delinquency rate in 2Q22 was 3.2% up from 2.3% in 2Q21 but slightly down from 3.4% in 1Q22, with traditional PSL loans 60+ days and the 90+ days delinquent exhibiting the same pattern.
Prepayment mores
Traditional PSL prepayments CPR remain elevated at 22.1% and continue to increase. While refinance PSL prepayments CPR declined from 23.4% in 1Q22, to 16.2% in 2Q22, primarily due to rising interest rates and much lower refinancing activity, nonetheless Fitch expects strong obligor credit profiles should keep refinance PSL performance stable.
Fitch attributed a significant jump in prepayments since 4Q21, to loan forgiveness from the Public Service Loan Forgiveness (PSLF) program.
The FFELP Index TTM constant default rate and TTM constant prepayment rate also increased.
"Higher TTM CDR could benefit certain FFELP transactions that have experienced slower-than-expected borrower payment rates," are a positive development, unlike in other ABS sectors, Edwards said. Ultimately, the U.S. Department of Education reinsures defaulted loans, so risk increases only if "bonds are not paid fully by the legal, final maturity date."
The income-based repayment for 1Q22 (the latest dataset available) fell to 19.4%, from 20.5% in 4Q21, reaching its lowest level since 2Q19 due to a strong labor market and increased prepayment activity.
Why ratings lag default data
Fitch will continue to monitor macro-economic and asset performance, but the recent higher delinquencies may not have an immediate impact on ratings, explained Edwards.
Fitch's default assumptions from a rating standpoint "are generally set through the cycle, at a sustainable level that typically includes a buffer from the expected actual performance," she said.
For transactions more exposed to the assets' credit performance, the impact will depend on how the level of defaults observed in this new economic cycle compares to previous periods, according to Edwards. Currently CDR levels are below pre-pandemic levels despite increasing delinquencies.
In its last Global Economic Outlook, published in June 2022, Fitch forecast unemployment rates of 3.6% for 2022 and 3.7% for 2023, below the 2017-2021 average of 5.1%, Edwards said. Those estimates include the peak unemployment rate observed during the coronavirus pandemic.
