US: Credit Market

Student Loans Securitization Braces for A Blow


The market for U.S. student loan asset-backed securities -- rattled already by the troubled mortgage-backed securities market -- expects another hit soon from legislation being finalized in Congress.

Lawmakers will begin trying to reconcile Senate and House bills this week after months of scandals in the $85-billion U.S. student loan industry involving kickbacks and conflicts of interest.

The biggest impact of the wide-ranging reforms is likely to be cuts in federal subsidies to student lenders such as Sallie Mae, Citigroup, JPMorgan Chase, Bank of Americaand many others.

Student Loan Providers

"There will definitely be some cuts ... It's just a question of how deep the cuts will be and how many unintended consequences come out of that," said Tom Deutsch, associate director of the American Securitization Forum.

Other industry groups said last week that several new student loan financings have been put on hold and that loan financing costs are up. Analysts said a recent securitization deal went off at a higher spread than usual, a sign of skittishness among institutional investors.

Subsidy cuts would pare the profits of lenders and make the securitization deals they do with Wall Street less attractive, particularly if Congress, as expected, cuts default insurance coverage for federally guaranteed loans, analysts said.

Some lenders may exit the business or merge, according to David Hartung, senior vice president of U.S. structured finance at credit rating group DBRS Inc.

"While the number of student loan securitization issuers may, too, shrink, the dollar volume of student loan securitization should not. The market may simply see more or larger transactions from fewer issuers," Hartung said.

Loan volumes are unlikely to shrink as demand is strong, Hartung said. Fueling demand are factors such as steady college enrollment increases, tuition inflation, and the unique government backing behind most, if not all, student loans.

Wall Street Ties

Others are not so sure. They wonder what a student loan asset-backed securities (ABS) market crisis might mean for students who increasingly depend on loans to pay for college.

Since 1998, more than $350 billion in student loans have been bundled and sold as securities, including a record-setting $79 billion last year. More are in the pipeline but may not be completed for a while until markets stabilize, analysts said.

A study by RBC Capital Markets said subsidy cuts and related changes being considered by Congress would "eliminate the incentive for private capital to flow" into the federally guaranteed student loan system.

Supporters of the cuts say the system furnishes lenders with more than enough profit to absorb the changes. Lending money to students has been big business since the early 1990s, when college costs began far outpacing inflation. At the same time, funding for other aid, like grants, stagnated, while a wave of innovation swept world debt markets.

The big change was securitization. The process lets banks -- which traditionally kept loans on their books through maturity -- instead bundle the loans, transfer them to trusts and sell securities in the trusts with the loans as collateral, mostly to institutional investors.

The largest securitizer of student loans is Sallie Mae, accounting for almost 40 percent of total volume in 2005. Other big ABS players include First Marblehead Investorsin ABS get income through loan repayments by the borrowers and profit if the repayments exceed the purchase price of the securities. Lenders benefit by moving loan risk off their books. Wall Street middle-men take their cut in fees for managing the process.

Borrowers benefit as well, say securitization's backers, by being able to access pools of capital not previously open to them. In the same way securitization helped put home ownership within reach of many who before could not get a mortgage, it has helped many students attend college.

Critics of securitization say it has undermined lending standards by diffusing accountability and extending too much credit to people who cannot handle it. Some blame it, in part, for the turmoil in today's mortgage market.

The student loan ABS market is much smaller and differs importantly from the mortgage market. Loans are smaller and the government stands behind most of them, up to certain limits, through the federally guaranteed student loan system.

But analysts have begun questioning credit quality in student loan ABS. In addition, a growing number of student loans are not federally guaranteed, but are private loans made by banks directly to students.

Many private loans are co-signed by parents and have state guarantees. So far default rates appear to be lower than in the federally guaranteed loan sector, but information is still sketchy. The picture may clear up as new federal disclosure rules for all types of ABS, not just student loans, take hold.

In a recent study predicting "choppy and uncharted waters" for student loan ABS, rating agency Standard & Poor's said the sector "will continue to grow despite the significant legislative changes ... and any near-term turmoil."