Consolidation is again the buzzword in the asset-backed market, and this time it has nothing to do with the Financial Accounting Standards Board. An Illinois Congressman has proposed an amendment to the Higher Education Act of 1965 that market pros say could affect the student loan market by introducing significant prepayment risk into securitizations of these government-guaranteed assets.
Rep. Danny Davis, (D-Ill.), wants to modify the law to allow borrowers to reconsolidate their student loans into floating-rate liabilities, according to Congressional filings. Currently, borrowers are only allowed to consolidate their loans once, at a fixed rate. The proposed change would benefit borrowers that had consolidated their loans in years past, with some paying fixed-rates of as high as 9%, by allowing them to repay at variable rates, says Richard Boykin, Davis' chief of staff. He adds the amendment would also boost the economy. "For people who are paying 9% when they could be paying 3.42%, they are going to take that additional money and go buy something, like a television or a couch," he notes. Davis represents Illinois' 7th Congressional District, in Chicago, with some 25 universities in it. The bill was introduced last month.
Although still in the preliminary stages, student loan bankers and rating agency analysts say the bill could have a significant impact on the securitization market. "This would create a lot of prepayment risk; in general, student loans don't have the volatility of prepayment risk that mortgage-backeds and home equities have, and that's been one of the advantages of student loan [ABS]," says Harry Apfel, managing director in the education loan finance group at RBC Dain Rauscher in New York. Apfel, a veteran of the asset class, recently joined from a similar role at Citigroup.
The bill comes as student loans have emerged as one of the few growth spots in the ABS market, with consolidation loans fueling the growth. Student loans accounted for 9% of all ABS sold during the first half, up from 6% for all of the last year, according to research from Morgan Stanley.
David Hartung, a director at Fitch Ratings, says changing consolidation loans to variable rate could strain excess spread levels in securitizations of triple-A collateral. This would affect deals from issuers that sell trusts comprised entirely of consolidation loans. Although there are a lot of variables, "in a low-rate environment, you could have a situation where there could be an excess spread drag on a trust that contains a high percentage of consolidation loans," he notes.
