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"Everybody Benefits By Avoiding Defaults": Citi Explains How To Goalseek Student Loan ABS Ratings
We last checked in on America’s $1.2 trillion student debt bubble a little over two weeks ago.
At the time, we noted that Moody’s had just placed 106 tranches in 57 securitizations backed by student loans on review for downgrade. It was the second such warning Moody’s had issued in the space of just 3 months.
Meanwhile, Fitch was getting worried as well and had also moved to place dozens of tranches in FFELP-backed paper on watch. Our takeaway: The fact that Moody's and Fitch are beginning to reevaluate student loan ABS is indicative of an underlying shift in the market. Between the proliferation of IBR and the Department of Education's recent move to open the door for debt forgiveness in the wake of the Corinthian collapse, financial markets are beginning to see the writing on the wall. Perhaps Bill Ackman said it best: "there's no way students are going to pay it all back."
Moody’s concerns revolve around the likelihood of rising defaults attributable to "low payment rates … persistently high volumes of loans in deferment and forbearance, and the growing popularity of the Income-Based Repayment and extended repayment programs." We’ve discussed all of the above at length and have taken a particular interest in IBR, which we recently dubbed "the student loan bubble's dirty little secret."
Facing shifting market dynamics, Moody’s last week called for comments on its methodology for rating FFELP-backed paper:
Moody's Investors Service has published a Request for Comment (RFC) proposing changes to the cash flow assumptions the agency uses in its approach to rating US Federal Family Education Loan Program (FFELP) securitizations.
Low prepayment rates, persistently high rates of deferment and forbearance, and the growing use of IBR and other similar programs have increased the risk that some tranches will not pay off by their final maturity dates, which would trigger an event of default for the securitizations.
Since the recession, many student loan borrowers have struggled to make their monthly payments. This has resulted in historically low rates of voluntary prepayments, high volumes of loans in deferment and forbearance, and the growing popularity of IBR and other similar programs.
"These trends have persisted despite the economic recovery and improving employment picture, and some levels of deferment, forbearance and IBR will be sustained through the life of the FFELP loan pools. Some repayment plans can extend loan repayment periods significantly, from the standard 10-year term for non-consolidation loans."
And here's more from Bloomberg:
Top-rated securities backed by U.S. government-guaranteed student loans face cuts to as low as junk that may further roil the market for the debt, according to Citigroup Inc...
In terms of ratings on the bonds, Moody’s said that any cuts could lower bonds to either low investment grades or speculative rankings. Fitch said in a June 26 statement that it could also lower top-rated debt to junk as a result of its review over the next three to six months.
“Many triple-A investors would not be able to tolerate downgrades, and barring a cure of the possible maturity default, downgrades would present a significant market disruption,” Kane and Belostotsky wrote in the report.
Rating analysts are likely to attach little-to-no value for future buybacks from a non-investment grade company” such as Navient, the Citigroup analysts wrote.
Got that? No? That's ok. Here's a summary. Some of these student loan-backed deals are going to experience technical defaults in the collateral pool because people aren't paying off the loans in time, which means Moody's needs to downgrade some of the tranches, but downgrades would be bad, and Moody's can't use projected future servicer buybacks as an excuse not to downgrade because the servicers aren't rated as highly as the securitizations themselves (which is of course absurd and suggests the paper never should have been investment grade in the first place). Therefore, someone needs to find another way to make this paper look less risky, and the best option may be to "cure" maturity default (i.e. extend the maturities). Here's Citi with more on how Moody's might go about goal seeking its FFELP-backed ABS ratings:
Controversy endures in the FFELP ABS market amidst another rating agency voicing concern about breaching legal final maturities and some secondary selling activity.
The rating agencies assign ratings based on legal final maturity date. Without additional sponsor buybacks, certain SLMA classes are likely to extend beyond the legal final maturity if they continue paying at a slow rate. Rating agency analysts are likely to attach little value for future buybacks from the double-B rated Navient, thus the cash flow delays that are inherent in FFELP structures are problematic from a ratings perspective.
Yes, "cash flow delays" in the collateral pool are definitely "problematic" and really, it's not a problem that should be "solved" by tinkering with ratings methodology, because after all, if you just adjust the methodology instead of downgrading the securitizations... well, then what good is the rating? Citi continues:
Ironically, it was the rating agencies that required the sponsor to initially assign presently defined legal final maturities. Yet the numerous moving parts endemic to FFELP student loans make setting prepayment assumptions and setting legal maturity dates a virtually impossible task. At cutoff, almost every deal had about 50% of the loans in-school. The pricing prepayment estimates had to incorporate numerous moving parts, including the borrower’s graduation date, payment type (conventional, graduated payment or income-based payment) loan maturity and proportions of loans in grace, deferment or forbearance. In our view, the legal final maturity is meaningless.
See how that works? There are a lot of factors that make it "virtually impossible" to figure out when students might pay back their loans, so really, any estimate of when ABS investors might get their principal back is "meaningless," and because one can't really default on a loan with an indeterminate maturity date, "curing" the legal maturity problem, and thus eliminating the need for downgrades, is as simple as "amending" the bond indentures. "The sponsor could approach bondholders to formally extend the legal maturity date," Citi happily notes.
What's clear from the above is that billions in student loan-backed paper probably should be downgraded because as Citi correctly notes, there's really no telling when or even if any of these loans are going to be paid off given the proliferation of IBR and the prevalence of deferement and forbearance.
But rather than risk a "market disruption," Citi thinks it might be better for Moody's to consider doing away with definitive maturity dates because in the end (and this is the actual subheader for Citi's concluding paragraph), "everyone benefits by avoiding default."
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/ Hmmm...what does Eganay onesJay have to say?
I can't help but wonder if they had similar requests for comment about the Subprime ABS back in 2005/2006. Actually, no, I am certain of it. I was there. I saw it all. I worked for a company that "wrapped" that garbage. We couldn't lose. It was printing money. We went public! And then it all came crashing down. So sad.
"everyone benefits by avoiding default."
Not the Greeks
HURRY, HURRY BEFORE OLD YELLER IS ARRESTED!
FOR A FEW TRILLION MOAR!
Just fucking lie. There next subject
let's guess who is holding the bag...pension funds and insurance companies. They fund manager who bought this crap gets a trip to a strip club and a nice dinner...the crooked bankers gets a $10 Million Dollar bonus...and the stupid taxpayer has to cover all the bad bets. Wake me when they start shooting the bankers!
Who's "they". Do you expect to benefit when "they" take the risks to make the system "right". If you want to remain an outsider when others join the team, don't expect to enjoy the spoils. You'll be treated as an outsider by those who sacrificed.
Too bad Citi did not lobby for Federal Student Loans Debt rollover to infinity just before I went bankrupt.
Oh yeah, I forgot, it's the old Capitalism trick for me, and the old Socialism treat for the Banks, bond holders, and Monetary Heroin pushers in Central Banking, eh.
Everyday is Halloween on Wall Street, oh what joy it brings us all.
Orwell was right and so was Karl Marx.
whats going to happen in the next stress test for citi, their banking reserves in student loans worthless, their gold reserves losing value daily?
So why did the FedGov take the student loans away from the banks? Apparently to turn them into government "assets" that their butt buddies on Wall Street could then turn into more fake shit to dump on the people.
Textbook fascism.
but.....but....but....I've been told we are in our 6th year of recovery. this story must be wrong.there are skittle shitting unicorns, rainbow colored ones, on every corner
Wonder if larry sinclair had any student loans?
Everyone benefits from avoiding defaults??? What good is an unpaid and unpayable IOU? Oh yes, the banks get to loan out the non-existent "money" for interest.
By now it has to be apparent to f - - - ing everyone there is NO going back. The old normal is gone forever. The new normal keeps the final collapse away through the use of limitless debt. People everywhere must be encouraged to borrow money at low rates and buy crap. Anything and everything…just buy stuff. China will have riots in every city if their factories close and they do not bail out their markets over and over again with loose credit. The USA would experience much the same thing as millions get laid off due to plunging auto and consumer goods sales.
The bankers and oligarchs aren’t stupid; they know all this. A trillion dollars in student loans was done to keep unemployment down. There was NEVER any hope the loans would be paid back. When the economy sinks again, there will be more stimulus and more QE.
Bears cannot make a dime in the new normal, and it is engineered to be that way. Earnings are pumped with cheap $ buybacks and layoffs. Ninety-five million Americans are counting on the Fed to support the markets and they will. Why would everyone panic and sell? Bad news just means no rate hikes and even more easy money.
Look at Greece. They can NEVER do austerity and neither can we. The masses demand their entitlements and they vote. Deficits will grow and nobody cares. Flip burgers and drive a BMW with a ten-year no-qual note. Repo man takes it, go buy another. Other than WWIII hard to see the party ending anytime soon.
Why should they care? They make their money from FRAUD.
2016 election year and massive student loan Grexit, bit unlike Greece, no immediate pain which has been postponed until post 2016 depression. New definition of Moral Hazard: Paying back a loan.
Having had the money to pay off my student loans, I actually spent some time pondering whether I should pay them off or wait for the inevitable write off. I easily got on IBR and could have dragged it out, but if I was going to end up continually accruing 6.8% interest per annum, it seemed very risky, so I did pay it off, but I am going to be so mad if that ends up excluding me from a write off. It was literally all the money I had to pay that off, and it only came from inheriting it from my father's death, now my net worth is close to zero, I wouldn't even dream of trying to buy a car.
And I will add that I feel incredibly fortunate at having been able to pay this debt off, my last job had me working 100 hours per week at times. What did I have to show for it after debt payments and rent? Nothing. I am filled with hatred when I talk to baby boomers who bought Mustangs on their earnings scooping ice cream over a few summers, and easily paid their own way through college. I worked in finance in NYC and made way more than most of my friends, I was lucky.
"And if everybody benefits... nobody does!" <cue Syndrome's evil laughter>