U.S. Rating Cut May Force Unloading of Student-Loan Securities

A cut in the U.S. government’s AAA grade could force investors to sell asset-backed securities tied to student loans, causing spreads to widen “significantly,” according to Citigroup Inc.

“A ratings downgrade would be a significant blow” to the $250 billion government-guaranteed sector, Citigroup analysts led by Mary Kane said in a July 22 report. “The likelihood of forced selling is elevated.”

Citigroup sees a 50 percent chance of a ratings cut this year as the U.S. struggles to reduce its long-term debt. Many investors buy student-loan securities specifically because they’re so highly rated and a U.S. government credit risk, according to analysts at the New York-based lender. Money managers with rating-based guidelines would be forced to sell into a sinking market, affecting the sector more than other asset-backed debt tied to consumers, commercial mortgages and corporate loans, they wrote.

Securities linked to student borrowings yield 170 basis points, or 1.7 percentage points, more than Treasuries, according to a Bank of America Merrill Lynch index. The spread has narrowed from 186 basis points since Dec. 31.

Citigroup considers it highly probable that President Barack Obama and Congress will reach a deal to raise the debt ceiling by Aug. 2 that doesn’t adequately address the long-term fiscal situation. It’s less likely that the U.S. will breach the ceiling and default on its debt, which would have a “massive impact on numerous markets,” analysts Brett Rose and Siddharth Joshi wrote in the same report.