Garnet Capital Advisors Blog

As asset-backed securities go, bundles of student loans might seem like a lock for buyers: such debts are nearly impossible to discharge in bankruptcy and besides, the government guarantees almost all of them.

$36 billion in loans in danger of downgrade
And yet there's trouble in the market for bonds backed by student debt, largely owing to the success of a government program that lets borrowers pay back loans based on their ongoing income. Two credit rating companies, Moody's Investor Services Inc. and Fitch Ratings Inc., have flagged $36 billion worth of student-loan backed bonds for possible downgrade, the Wall Street Journal reports.

U.S. Bancorp shelves $3B portfolio sale
It's not that the credit rating firms see an imminent danger of outright defaults, but rather that the spread of income-based repayment programs will extend paybacks past the bonds' maturation dates - a default by other means. The increased perceived risk around these investments has already started to play out in the marketplace. Take the example of U.S. Bancorp, which recently stopped trying to sell a $3 billion student loan portfolio, citing low bids. Another data point showing a slow-down, or even a freeze, of action in this sector of asset-backed securities is that since late June, only one deal has gone through that directly involved student loan assets similar to the $36 billion under downgrade watch. What's more, that one deal amounted to just $203 million compared to 13 deals worth $4 billion over the same period of 2014.

Generous terms
Income-based repayment programs aren't new. But they've only recently caught on. The terms can be generous and hard to pass up: extensions of the loan period from 10 years to a quarter century, plus a minimum income threshold that allows some borrowers to pay nothing at all if their career prospects stay dim. Oddly, a technical snafu may have limited knowledge of the program. It became law in 2007 as part of the College Cost Reduction and Access Act, and went into effect two years later. But a drop-down menu glitch on the Department of Education's website meant student borrowers had to apply by mail instead of having the option right in front of them online.

Borrowers are catching on
Students seem to be making up for lost time as they flock to income-based programs. One metric of recent growth: Among borrowers in the Federal Family Education Loan program who have Direct Loans, 3.9 million have been able to make some type of income-based repayment adjustment. That's 56 percent more than a year before.

The popularity of the programs is playing havoc with market expectations.

"It's very difficult to predict cash flows on these loans," Moody's executive Debash Chatterjee told the Wall Street Journal, "because of the different payment programs that have come up."

Whenever there's uncertainty about loan portfolios, whether because of changing regulatory risks or pending credit rating downgrades, the senior managers at loan sale advisory firm Garnet Capital Advisors have decades of experience to guide clients in making the best decisions for their bottom lines.