The student loan ABS (SLABS) market's biggest challenges today are bubbling on Capitol Hill, where legislation that would shrink it has been thrown into limbo along with the healthcare bill, threatening the availability of student loans unless an emergency funding program is extended.
Short the 60 votes necessary to avoid a filibuster, the U.S. Senate version of the Student Aid and Fiscal Responsibility Act (SAFRA) has been slated to become part of the 2010 budget reconciliation bill since the House of Representatives passed its version last September. That version would eliminate the Federal Family Education Loan Program (FFELP), in which the federal government guarantees loans provided by private lenders such as Sallie Mae and the National Education Loan Network (Nelnet), and replace it with loans provided directly by the federal government.
Since Democrats have retained the reconciliation bill as a backstop to pass health-care legislation if a filibuster-proof majority of 60 senators became unavailable, student loan legislation has essentially been held hostage by health care.
"The Democrats would have lost tremendous leverage in the health-care debate if they used the reconciliation tool just to deal with student loans," said Dennis Cariello, a counsel at Sonnenschein, Nath & Rosenthal and former deputy general counsel at the U.S. Department of Education in the Bush and Obama administrations.
Despite at-times-ugly horse-trading to bring wary Democrats into the fold, the health-care bill's future was thrown to the wind Jan. 19 when Republican Scott Brown won the Senate seat formerly belonging to Senator Edward Kennedy. His victory broke the Democrat's 60-strong majority, leaving few options except a dramatically pared-down bill. The Senate's Health, Education, Labor and Pensions Committee, chaired by Sen. Tom Harkin (D-Iowa), is currently mulling both bills.
Nicole Edwards, director in Fitch Ratings' student loan ABS group, noted that congressional leaders have given health-care legislation priority over student loans - a relatively small initiative expected to save $87 billion over 10 years. "But given the results of the special election, it's difficult to see what will happen to these bills going forward," Edwards said, adding that, "when the next step in health care is figured out, we'll have a better indication" about where the student loan legislation is headed.
Several Capitol Hill sources last week reported rumors of the Senate's draft bill being submitted to Harkin's committee within the next week or two, although the same sources acknowledged such rumors have persisted for months. Republican staffers complained last week that the Senate Democrats' bill has been drafted in secrecy. Part of the reason for that may be that at least one provision is bound to raise a ruckus among investors in SLABS.
"There was a provision in the Senate draft version of SAFRA that would increase prepayment risk," said John Dean, principal of Washington Partners and special advisor to the Consumer Bankers Association.
The SAFRA legislation already aims to replace FFELP loans entirely with loans provided directly by the Department of Education. The provision would allow borrowers of existing consolidated FFELP loans to reconsolidate those loans into the direct loan program, prepaying loans bundled into existing ABS and potentially upsetting their payment mechanisms.
"I would assume the consolidation provision is true, because the Democrats are trying to destroy the FFELP infrastructure," said one Republican staffer in the Senate's health and education committee.
An aide to Senator Harkin said that, "because the bill is still in draft form, we are not commenting on its provisions."
Student loan prepayments have otherwise dropped, a trend John McElravey, a senior analyst at Well Fargo Securities, attributed to a weak economy prompting households to make minimal payments and the credit crunch impeding refinancing and paying off loans early.
McElravey said that SLABS volume peaked at nearly $66 billion in 2006 and fell to $58 billion the next year, when the Lehman bankruptcy froze all credit in the fourth quarter. It has since plummeted, falling to $28 billion in 2008 and $18 billion last year.
McElravey attributed the drop partly to the SLABS sector's top issuers finding more attractive funding elsewhere. One alternative has been the Ensuring Continued Access to Student Loans Act's (ECASLA) Straight-A Funding conduit which, administered by a handful of major Wall Street firms, buys seasoned student loans. It has accumulated upwards of $30 billion in assets.
McElravey said ABS backed by private student loans, typically used by borrowers to fill in gaps that government-guaranteed loans don't cover, have been practically non-existent over the last year. Consequently, nearly all ABS issuance was backed by FFELP loans.
However, even FFELP loans became nearly impossible to securitize when the credit markets froze, and the market has yet to thaw. Another part of ECASLA, which became effective July 1, 2008, ensures that lenders can make new loans by giving them the option to sell them back to the government.
Approximately 80% of FFELP loans were put back to the government last school year. Shelly Repp, general counsel of the National Council of Higher Education Loan Programs, which lobbies on behalf of student loan market participants, added that he anticipates an even higher percentage in the current school year.
SAFRA, however, would replace FFELP loans with loans offered directly by the Dept. of Education that would be administered and serviced by the same lenders, such as Sallie Mae, that previously securitized FFELP loans. The switch to direct loans would eliminate the bulk of the remaining student loan ABS market, requiring the Treasury to finance the loans directly.
Republicans have unanimously opposed SAFRA, decrying the additional Treasury debt during a time of record deficits, and preferring to retain FFELP and more private-company participation in the student loan market. In addition, they argue that too many post-secondary education schools have yet to implement direct loan programs, and that doing so by July 1, when SAFRA would eliminate FFELP loans, may not be possible. That would leave those schools' students without financial support.
The Dept. of Education says that 44% of schools had the capacity to originate direct loans as of Jan. 14, while 39% of schools are in transition, defined as having taken one or more steps to prepare for participating in the direct loan program. The agency did not provide an estimate as to how many schools would be direct loan-ready by July 1.
ECASLA has been a necessary crutch to support the student-loan ABS market. However, it also expires in July, so if SAFRA fails to pass, or it passes but there isn't enough time for schools to implement direct loan programs, lenders will have insufficient new funding to make student loans for the 2010-11 school year. Senator Michael Enzi (R-WY) sponsored legislation in November to extend ECASLA that has picked up 17 co-sponsors, but apart from being referred to the Senate's health and education committee there's been little action on it.
"Given the president's proposal [to move to direct lending] and the pending legislation, there's no reason to jump the gun, as we do not believe there will be a need for such legislation in order to ensure loan access," said Stephanie Babyak, a Dept. of Education spokeswoman.
Repp said the passage of SAFRA is not expected to noticeably change the private SLABS market, which at its high mark made up 20% of student loans. SAFRA would eliminate securitization of new FFELP loans, but a sizable secondary market would remain. Repp noted that the loans themselves won't change, but the ability to securitize them might. "Will investors view those loans with continued interest, given that it will be a stagnant and diminishing pool of loans, and maybe some of the [market] infrastructure will be dismantled?" he said.
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