Over the past year, threats of steep downgrades have chilled demand for securitizations of federally guaranteed student loans, but two recent transactions suggest that the market is beginning to thaw.
This development could help open the door for banks to resume unloading portfolios of Federal Family Education Loan Program (FFELP) loans. Such loans have become unattractive to hold, because of increased regulatory scrutiny of student lending and loan servicing and because banks see other, more profitable ways to put their money to work.
In February, Navient Corp., the largest servicer in this asset class, sold $1.1 billion of bonds backed by FFELP loans in what chief financial officer Somsak Chivavibul said was the largest such deal in over two years. And this month the company completed a $497 million securitization that, while smaller, was distributed more broadly and commanded far better pricing.
The triple-A rated notes, which have a weighted average life of 5.2 years, were priced to yield 138 basis points over the one-month London Interbank Offered Rate; that’s far more than FFELP bonds yielded before Moody’s and Fitch put the credit ratings of some $40 billion of these securities on watch last year. But it’s also much less than yields at which comparable securities are trading in the secondary market, according to research published last week by Deutsche Bank.
The latest deal “opens the door to future transactions,” Chivavibul said Wednesday on a conference call discussing first-quarter financial results. He noted that Navient acquired the collateral only recently. “There wasn’t that avenue over the past year, to acquire a portfolio, unless you had access to term funding.”
In November of 2014, Navient disclosed it was buying $8.5 billion of FFELP loans from Wells Fargo; three months later, Bank of America moved $2.7 billion of student loans from its investment portfolio to its available-for-sale portfolio. But bulk portfolio sales ground to a halt last year as a result of the rating agencies' reviews.
Moody’s and Fitch have yet to take any ratings actions on the securities under review; both are in the process of revising their criteria for rating FFELP bonds to account for the slower rate at which borrowers are repaying loans. Thanks to the growing popularity of some generous government programs, many FFELP bonds are at risk of not paying off at maturity, even though Uncle Sam guarantees they'll be repaid eventually.
“We believe the final criteria will be more favorable than the initial draft proposals, but we decided not to wait to restart our asset-backed program,” Jack Remondi, Navient’s chief executive, said on the conference call.
Remondi noted that funding costs have fallen, even in the absence of clarity from Moody’s and Fitch; he said financing FFELP purchases will become even less costly when the rating agencies complete the revisions to their ratings criteria.
The cost of financing influences what buyers are willing to pay, so the cheaper financing becomes, the more sellers will emerge, he said.
The two securitizations that Navient completed this year have a feature, unavailable on most outstanding bonds, that reduces the chance of unpleasant surprises. Both have an extremely long final legal maturity – 49 years, in the case of the deal completed this month. By comparison, most FFELP loans have original terms of 10 years and FFELP bonds typically have 20-year terms.
Navient has also extended the maturity on $4.8 billion of outstanding FFELP bonds to date. On the conference call, Remondi said the longer terms are “well in excess of what’s needed” to avoid a maturity default. “This is providing protection to investors … that the ratings will exist through the life of the bonds,” he said.
Maturity extensions are one of several options that Navient and other student loan servicers are exploring to avoid downgrades on FFELP bonds. It is looked upon favorably by Fitch and Moody’s but can be difficult to execute because in some cases it requires the approval of 100% of the investors in a pool.
But other options, including repackaging FFELP bonds into new securities with extended maturities and pledges to call bonds at risk of maturity default, are viewed less favorably by the rating agencies.
The strong reception for Navient’s latest securitization could make holders of older bonds reconsider the benefits of extending maturities, however.
“Given the strong execution on this deal, we think that bondholders of watch-listed FFELP who have thus far ignored calls to amend and extend might take another look at whether having very long maturity dates could improve the value of their securities,” Deutsche Bank stated in a report published last week.
