Canceled student loans can be beneficial for borrowing


The US student loan waiver demanded by the progressives in Congress may not be a bad thing for investors in bonds backed by this debt, as the owners of those securities receive high returns to offset the resulting early principal payments.

The securities backed by loans secured under a now-discontinued program called the Federal Family Education Loan Program (FFELP) are likely to generate higher returns than other floating rate debt securities, even if the loan waiver results in an increase in dreaded prepayments . The sector would be flooded with liquidity if the government-guaranteed loans are paid off and the most distressed borrowers avoid default, market participants said.

“If the Biden government introduces some level of debt relief – $ 10,000 or $ 50,000 – it can create an early repayment risk and shorten bonds,” said Darrell Wheeler, head of securitized strategy at Cantor Fitzgerald LP, in an interview. “But even in our shortest prepayment scenario, the bonds still offer an attractive spread pickup,” according to a current analysis by the bank.

Similar to mortgages in mortgage-backed securities, investors typically don’t like students to prepay their loans because it shortens the life of the bond and prevents them from collecting interest payments over a longer period of time. If the state repayed the student loans, it would essentially act like a large upfront payment.

The effects of a waiver generally vary and depend somewhat on the price paid for the bond. While the loan waiver would repay bonds early and shorten the average maturity, Cantor’s analysis suggests that this will have little impact on the expected spreads, depending on the price paid for the bond.

The government guarantee on FFELP student loan bonds makes these instruments a compelling product to consider when interest rates rise, especially in an uncertain macroeconomic future, says Cantor. Other variable rate fixed rate products such as collateralized loan obligations do not have such a guarantee.

“Loan waivers could be a boon to ABS for student loans by providing upfront payments and liquidity as soon as they are forgiven,” Joseph Cioffi, a partner at Davis & Gilbert LLP, wrote on Thursday blog entry. “Whether the loans are government or private, the lender would be paid and prepayment rates will rise, but at least distressed borrowers will be less likely to default.”

Until July 2010, the FFELP program funded most of the post-secondary education costs. Private institutions would arrange the loans with nonprofit or government agencies as sponsors, and the Department of Education would essentially top up or reinsure the sponsor. Significant loans were made prior to the end of the program, more than $ 250 billion of which is still outstanding today, according to Cantor, and they are still being packaged in new asset-backed securities.

The new stimulus package leaves the door open for possible student debt relief. Members of Congress want President Biden to enact some level of forgiveness by executive order, but he has said that he would rather do so Congressional legislation.

While there is very little credit risk with FFELP ABS, there is enormous uncertainty about the timing of repayments, which can be problematic.

A loan waiver would shorten the potential term of bonds, while Covid-related deferrals, deferrals and so-called income-based repayment programs delay repayment, creating a renewal risk that can delay repayment of bonds beyond their final maturity. This could mean that senior tranches are not paid out or not paid out on time. This aspect led to many ABS downgrades by rating companies for student loans in the past year.

As in other asset-backed sectors, FFELP student loan spreads widened at the start of the pandemic, but rebounded over the summer and have steadily narrowed since then, particularly as investors realized it was a maturity risk rather than a credit risk . Risk one, said Wheeler.

He believes ABS for student loans from FFELP have recession-resistant value. Investors can get a floating rate spread guaranteed by the Education Department at a time when rates could rise, he said. On the flip side, these bonds still have the government guarantee if we survive the Covid stimulus spending and there is a recession.

“If I wanted to find a product with a government guarantee, variable interest rate, and a range of 50 to 70 basis points, FFELP student loan ABS would be the one,” said Wheeler.

“Moderate economic growth and an inflationary environment should support hotel outperformance while retail property returns are likely to lag,” said Harris Trifon, portfolio manager and managing director at Lord Abbett. “As a rule, hotel owners can reset the prices of their rental contracts (e.g. room prices) on a daily basis, which has a high correlation coefficient with inflation. Additionally, travel demand has fallen well below what we would expect in a normal recession due to travel restrictions and bans related to Covid. We see the potential for a surge in demand as early as the second quarter of next year, which will contribute to upward pressure on room prices. “

ABS deals queued for next week include Pretium Partners (single family home rentals) and Foundation Finance (construction loans).

Previous Some Reasons Dick's Sporting Goods Look Like a Buy
Next FHA down payment requirements: Homeownership without a large savings account