Bond Investors Have a $60 Billion Problem With Student Debt

  • Deutsche Bank analysts make estimate of possible rating cuts
  • Fitch says up to 45% of existing deals could be downgraded

More than $60 billion in bonds backed by U.S. student debt are likely to be affected if Fitch Ratings adopts new criteria for the securities, Deutsche Bank AG analysts said Thursday.

The number of bonds “on review for downgrade by at least one rating agency could increase substantially,” analysts Elen Callahan and Kayvan Darouian said in a report.

Securities tied to government-sponsored student debt have come under pressure this year after rating companies warned that borrowers were struggling to repay. On Wednesday, Fitch Ratings revealed the scope of the problem: Its new criteria could mean that about 35 percent to 45 percent of bond deals it rates will be downgraded. The underlying loans were originated by the now-defunct Federal Family Education Loan Program.

The Deutsche Bank analysts said their FFELP estimate was based on data from Securities Industry and Financial Markets Association. Only $14 billion have been placed on watch by Fitch, the analysts said.

‘Additional Pressure’

“We think this could put additional pressure on spreads,” Callahan and Darouian said.

About $170 billion of these loans are guaranteed by the U.S. government, making a true default virtually impossible, but slow repayments are lengthening the time it takes investors to be repaid.

Just over half the bonds rated AAA by Fitch could maintain their ratings under the proposed criteria, Fitch said Wednesday. But about 15 percent of AAA rated bonds could be cut to below investment grade, and 35 percent could drop to AA or A, the company said.

Some bond investors have warned that in a worst-case scenario, rating downgrades may force them to liquidate their holdings under guidelines maintained by their investment boards. That has led to a higher trading volumes, and slumping prices. It has also invited bets against certain companies active in that market.

Government Programs

Navient Corp., one of the biggest holders of student-loan securities, has been pressured by bondholders to support older bond issues possibly affected by slowing repayment speeds.

The company has bought out $1.1 billion of loans this year from bond deals already issued, Navient’s Chief Financial Officer Somsak Chivavibul said on an Oct. 21 conference call. The problem is deterring Navient from issuing new FFELP securitizations, Chief Executive Officer Jack Remondi said.

All bonds will be repaid by their legal final maturity dates, company spokeswoman Patricia Nash Christel said in a statement Friday. The firm is “working with ratings agencies to resolve their concerns and lift this uncertainty for investors,” she said.

While the bond market is being riled by the prospect of downgrades, students unable to afford their loans are getting extensions or relying on government programs that allow them to make smaller payments. A push by the Obama administration to provide debt relief for student borrowers has expanded use of those options.

A more recent initiative by the Obama administration may entice borrowers to prepay their loans and consolidate debt, lessening the risks of maturity defaults, Fitch said Nov. 9.

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