Student Loans

Of Forgiveness and Forbearance in Student Loan ABS

May 02, 2021 | By JOSEPH CIOFFI

Last week, I moderated a panel on valuation and trends in student loan securitizations and the secondary market at the iiBig Virtual Education Finance & Loan Symposium. Below are some insights from me and my fellow panelists: Ian Rasmussen, Senior Director, ABS, at Fitch Ratings; Mark Weadick, Managing Director at SL Capital Strategies LLC; and Melvin Zhou, Director, ABS Consumer at Kroll Bond Rating Agency.

Over a year into the pandemic and things have not turned out the way many expected. In the case of student loans and ABS performance, that’s a good thing. As we discussed, performance is strong, buoyed by government stimulus. Even online lending, previously untested in bad times, has fared well.

Going forward, political winds and the quest for loan forgiveness may have a big impact on the market, while legal and practical challenges of LIBOR transition dot the horizon.

Below are five key takeaways to help plan for the future.

1. The current economic crisis is not your father’s financial crisis.

The market is not experiencing the normal negative trends that accompany economic downturns, which most attribute to government stimulus and forbearances. In school, private student loans are benefitting from the presence of co-borrowers and performing well. Refinancing delinquencies are extraordinarily low and ABS offers very attractive funding spreads and collateral performance. Though FFELP delinquencies rose by year end in 2020, they are still below pre-pandemic levels and, given the government guaranty, delinquencies have not been a concern. Even income-based repayment plans are on the decline.

2. Peaks in forbearances may not signal borrower distress.

During the pandemic, forbearances have been used opportunistically by borrowers. Some who could afford to remain current instead chose to maintain liquidity during uncertain times. The true extent of this opportunism will not be known until the economy stabilizes. At that point, we can expect that the distressed borrowers in forbearances may shift to income-based repayment (IBR) plans and payment rates and terms will be negatively impacted. Investors should be aware there will likely be a lag in reporting the transition to IBR.

3. Online lending has matured in the pandemic.

The pandemic has given marketplace (MPL) and online lending a chance to show resiliency and they responded by surviving, even thriving, in the first serious downturn they faced. That’s not so surprising, especially as fintech lenders are starting to look more and more like banking institutions. Online student loan refinance was the biggest sector for origination last year. MPL’s use of technology-driven underwriting has kept performance strong. Going forward, a potential concern is loosening of underwriting standards in response to growing competition.

4. Loan forgiveness can have a positive impact on deal performance.

Any policy changes providing borrowers with greater opportunity to discharge their student debt in bankruptcy would be credit negative, as it could cause borrowers to de-prioritize payments and increase the likelihood of defaults. However, loan forgiveness (likely at the $10K level) could have positives effects for investors, lowering both default and maturity risks. Some expect forgiveness to apply at least initially to Direct Loans, rather than FFELP loan, which are commercially held. Ultimately, the details of any forgiveness plan will be what matters to deal participants, including servicers and administrators, which stand to earn fewer fees.

5. LIBOR transition is on the horizon and requires planning.

New York’s resolution of pending LIBOR transition issues has been helpful to provide certainty to the market by providing a statutory replacement benchmark rate where agreements contain no fallback language (or a fallback that is dependent on LIBOR) and safeguards to prevent litigation. However, a uniform approach is still needed at the federal level to capture the full spectrum of agreements that may be impacted. It appears the uncertainty over whether the transition will be addressed by legislation or bondholder consent is drawing to a close. Bondholders are optimistic legislative action is forthcoming, but it may not come, if at all, until fourth quarter, so planning is still necessary.

Looking Ahead

As we near the end of the pandemic, trends in forbearances and IBRs will be tell-tale signs of the market’s strength. Refinancings should continue to remain strong and grow and MPL will continue its inevitable march toward maturity, which will help achieve desired ratings. Perhaps the biggest wildcard going forward is the impact of policy changes at the federal level. In the last several years, much of the public discussion regarding student loans revolved around numerous creative debt relief ideas, but more recently the conversation has settled on loan forgiveness above all other options. The pressure is on President Biden to act. Whether he does so or it is left to Congress, the level of forgiveness granted and the terms of any program will change the market and participants’ expectations for years to come.

If you’d like to learn more about the panelists and the services they offer, please visit the websites below:

Nicole Serratore, an attorney in the Insolvency, Creditors’ Rights + Financial Products Practice Group of Davis+Gilbert, contributed to this post.