December 4, 2013
When the U.S. government stopped paying banks to originate guaranteed student loans at the end of 2010, an expiration date was slapped on an enormous and highly attractive asset class.
That has refocused attention on new ways to play the business of securitizing these loans. One of them is the residual interest, which is anything left over once a securitization trust has made all of the required payments to the relevant parties in a transaction.
The Federal Family Education Loan Program (FFELP) was launched in 1965 and for the next 35 years, some 60 million Americans used it to pay for eduction expenses. There is now about $445 billion in FFELP loans outstanding (see pie chart, p. 15). That is roughly 40% of all student loans as of the first quarter.
Less than half the FFELP figure — $191 billion — were held in securitizations at that time.
Now that the U.S. Department of Education is the only entity making government guaranteed loans, banks have focused on making private loans. There are still portfolios of whole FFELP loans that have yet to be securitized, but, with no more supply on the way, many players have found that their time is better spent on other asset classes, particularly those with growth potential.
So when Sallie Mae priced a deal backed by the residual interest on existing student loan asset-backeds (SLABS) on June 10 of this year, it generated buzz, not least because it followed an aborted attempt two months earlier, in April. Then Credit Suisse followed up on June 27 with its own residual deal.
Sallie’s transaction, SLM Student Loan EDC Repackaging Trust 2013, was for $225 million. The coupon was 3.5% and weighted average life (WAL) was three years. Bank of America Merrill Lynch was the lead.
Credit Suisse ABS Repackaging Trust 2013-A, meanwhile, amounted to $178 million. With a WAL of 2.5%, the transaction had a 2.5% coupon.
The residual piece in a SLAB is fundamentally the equity tranche, the flows that are left over in a transaction after all payments have been made to investors and other relevant parties. SLABs that are seasoned enough to be releasing that excess cash, or close to be doing so, are particularly good candidates for residual securitization.
The low-yield environment also makes residuals’ juicier yields vis-à-vis higher-rated SLABs a major draw for investors.
Since Sallie’s deal, subsequent indications from the company — the largest issuer of SLABs and thus the big hope for more resid deals — was that their transaction was more strategic than part of any programmatic issuance.
Still, resids remain one of the few ways to play FFELP SLABs, —which observers say produce more attractive resids than private SLABs — before this segment of the asset class disappears.
So while this market may never produce massive volumes and even though it depends largely upon an asset class with a limited shelf life, the Sallie and Credit Suisse deals this year only whetted the appetite of investors that are now familiar with the asset class.
And while there haven’t been more public securitizations, players say for a host of reasons there have been private dealings in resids that are unrated and not necessarily packaged in a bond.
“I expect more residual activity,” said Mike Moro, a director at SecondMarket, a marketplace for alternative and esoteric assets. “While we’ve seen two deals sold publicly this year, there are many others that have been done privately post-crisis.”
The most active fixed-income securities traded over SecondMarket are the auction-rate variety such as munis and student loan deals. The company also hosts trading in other ABS and mortgage deals.
Moro said there weren’t reliable volume figures for trading in the residual SLAB market.
The holder of the residual piece — at least initially — is the sponsor of the SLAB. Many SLABS transactions allow for excess cash to be released to the residual interest holder while bonds are still outstanding, provided certain conditions are met, according to an October report on the asset class by Fitch Ratings. These conditions are typically set in the form of credit enhancement targets in terms of parity ratio (the ratio of trust assets over liabilities) or overcollateralization (the trust’s assets less its liabilities).
The holder of the residual interest can pledge it to a repackaging trust. Securitizations can be based on a single trust, or as was the case with Sallie’s transaction this year, multiple trusts.
Bonds issued off this repackaging trust would normally bear a fixed-rate coupon, with principal amortized on a schedule determined by the pool balance of the underlying trusts.