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Fitch: Student Loan Defaults Rise but ABS Remains Solid

NEW YORK--(BUSINESS WIRE)-- Recent performance statistics reinforced the pressure on student loan borrowers, given the current economic situation. Last week the Department of Education reported that the two-year national cohort default rate rose to 9.1%. When calculating the impact on Federal Family Education Loan Program (FFELP) ABS pools, we exclude the portion of the loans that can be put back to the Education department through Ensuring Continued Access to Student Loans Act. This brings the default rate experienced in the pools to 6.5%.

Should these levels rise, one stress test we performed on FFELP ABS trusts ("U.S. FFELP Student Loan ABS Stress Test," published Sept. 20, 2012) may become particularly valuable in gauging the impact on bondholders. Our moderate scenario assumed an increase of 10% in gross defaults and a 50bps annual decline in excess spreads for the remainder of the transactions. Under this scenario, 84% of current 'AAAsf' ratings would stay the same, 10% would migrate to 'AAsf', 6% would migrate to 'Asf', and 2% would migrate to below investment grade. However, we would expect the majority of notes currently rated 'Asf' or 'BBBsf' to drop below investment grade.

Our severe scenario is much less likely and would only occur in an environment that performed far worse than any previously observed. In this scenario, we assumed gross defaults approaching 100% and excess spread declines of 100bps. We project this impact to migrate 43% of 'AAAsf' rated notes to below investment grade.

The increase in the two-year national cohort default rate and other measures have brought these issues into the forefront, and several plans have been proposed for how to deal with them. One act proposes forgiveness of federal student loans after 10 years of income-based repayments. Borrowers who work in public-service jobs would be eligible for forgiveness after five years. Currently, loan forgiveness is only available to borrowers who are not in arrears. In our view, this could provide short-term relief to borrowers. Until more details are provided, it is unclear how these proposals could affect bondholders.

Additional information is available on www.fitchratings.com.

The above article originally appeared as a post on the Fitch Wire credit market commentary page. The original article, which may include hyperlinks to companies and current ratings, can be accessed at www.fitchratings.com. All opinions expressed are those of Fitch Ratings.

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Source: Fitch Ratings