Demand Rising for Private Student Loan Backed Securities

Until recently private student loans were the laggards in the recovery of the U.S. securitization market, but demand is picking up.

So far this year, Sallie Mae has completed two private student loan asset backed securities (SLABS); the $2 billion SLM Private Education Loan Trust 2013-A in February and the $1.135 billion SLM Private Education Loan Trust 2013-B in April. Notably, the deals are the lender’s first to include subordinated tranches since 2007, an indication that investors are become more comfortable with the risk in these securities.

SecondMarket, the online trading firm that specializes in private securities, thinks there’s an even broader market for private SLABS. In March it launched a platform allowing lenders to distribute new issue SLABS to a new class of investors.

SecondMarket director Mike Moro said that the new product is an extension of the firm’s platform for trading auction rate securities, long-term securities that act like short-term securities because their rates are reset at periodic auctions. Or they did until auctions started failing in 2008, leaving many investors unable to cash out.

Student loan were a significant part of ARS market, representing a third of all municipal ARS issuance in the 10-year period from 1998 to 2007, as well as a third of the total outstanding amount at the end of 2007, according to the Securities Industry and Financial Markets Association.

Since 2008, efforts to restore liqudity to student loan ARS investors, or allow the underlying loan to be refinances, have been piecemeal. 

SecondMarket is the largest independent secondary market for trading student loan ARS, according to Moro. He said that the issuers themselves have been active participants in repurchase their the securities in the secondary market. “They have come to us with the cash they are looking to allocate and we find the ARS bonds for them to repurchase at a discount,” he said.

By comparison, Moro said, the new private student loan platform will help raise capital for lenders by allowing investors to participate in the primary market, as opposed to matching buyers and sellers in the secondary market.

Pitching SLABs to ARS Investors

“Over the last five years, we have developed a brand new investor class – these are buyers that had never invested in private student loan securities before,” he said. “After educating them on student loans and the overall industry, we’re now able to show them investment opportunities through our platform that they simply were not getting from the Wall Street banks.” 

SecondMarket sees an opportunity to tap this network of auction rate investors – many of which are small to medium sized hedge funds or asset managers or family offices. “These newer investors may not be able to commit the $100 million to $200 million orders we see from our more traditional investors, but we can easily collect $10 million orders to get issuers to that $300 million number,” he said.

Moro doesn’t expect that SecondMarket will impact how a securitization is structured or marketed. Instead the idea is that the firm will place its allocation of the bond on the new private student loan trading platform; where investors would have access to the deal prospectus and other information available for them to submit their bid. Initially, SecondMarket plans to play the role of co-manager in the first deals; the traditional investment banks will still be the bookrunners. 

“We will have a bond allocation of 5% to 10% of the deal and we will go out to our investors and sell those bonds and get as many orders as we can at the best prices,” he said. “If the same 20 guys buy the deals, the amount of price tension may or may not be there, but if you bring an extra 30 more investors – you now have 50 guys competing for the same bond.

“Investors are naturally going to have to submit more aggressive pricing to get the bonds allocated otherwise they miss out on the deal entirely.”

Moro said there are a number of transactions coming up. SecondMarket has been engaged already by a few student loan issuers, both by first-time issuers and seasoned Libor issuers.

Karl D’Cunha, a senior managing director at Madison Street Capital, which tracks the ARS market for clients, said that for his ARS investors, there has been a shift in buying that is driven by a search for yield. Still, his clients aren’t necessarily lining up to buy private student loan issues.