How Technology Mitigated a Crisis in Student Loan ABS

Generous repayment plans have soured many investors on bonds backed by federally guaranteed student loans. But it could have been worse.

These programs slow the rate of repayment on Federal Family Education Loans, putting the bonds they back at risk of technical default if the securities fail to pay off at maturity. When Moody’s Investors Service and Fitch Ratings raised the alarm early in 2015, eventually putting some $100 billion of bonds under review for downgrade, the market sold off heavily. New issuance ground to a halt.

Yet Navient and Nelnet, the two largest student loan servicers, avoided downgrades on some $18 billion of FFELP bonds. They did so using a strategy that, at first, did not seem promising: extending the maturities of the bonds. While simple in principle, this solution was complicated by a requirement that 100% of investors in a tranche approve the change. Without consent from every single holder, no matter how small, an amendment cannot pass.

Their efforts were aided by DealVector, an online registry of asset ownership and messaging platform, which helped the two servicers identify holders and collect votes. Over the past year, the two servicers have sent about 165 tranches out for consent; some 60% of those were successful, and about 10% are still in process. The total original face value of tranches passed to date exceeds $18 billion.

This undoubtedly helped restore confidence in the sector, allowing Navient and Nelnet to resume issuing FFELP bonds, even though some investors, including banks and credit unions, continue to view the asset class skeptically. 

“If we hadn’t been able to extend maturities, it definitely would have been harder to sell FFELP bonds,” said Greer McCurley, executive head of capital markets at Nelnet.

The market revival, in turn, encouraged banks to resume unloading FFELP portfolios. In April, Navient (which did not respond to a request for interviews) reached a deal to acquire $3.7 billion of FFELP from JPMorgan Chase. So far this year, it has issued nearly $3 billion in FFELP bonds. Nelnet completed a single, $426 million FFELP securitization in October; it has yet to come to market this year. The company also completed a private student loan securitization, in December.

Why consent solicitations are hard

Like other kinds of financial assets, FFELP bonds are held “in street name” by a brokerage firm, bank, or dealer on behalf of a purchaser, obscuring their true ownership. This isn’t just a problem for consent solicitations; it also imposes large costs on determining an appropriate price for a security, forming creditor classes, and many other events requiring communication among deal participants.

This is how the consent process normally works:  An issuer sends consent forms to the trustee, which needs to log onto the Depository Trust Company and complete a form, which then goes out through different systems to the custodian. The custodian must process it and send it to the beneficial owner’s back office, which then needs to deliver it to the appropriate portfolio manager.

There are multiple opportunities for delays.

“I talked to one portfolio manager who didn’t see a consent sent through the normal channels for five days, and that was quick,” said DealVector co-founder and CEO Michael Manning. “Ten to 13 days is the typical lag time. Some didn’t even receive it until the day before the deadline, at which point it became a huge fire drill.”

By comparison, when investors register directly with DealVector, “on the same day that Navient provides consents to trustees, they give it to DealVector. We load it into the system, and it’s in a portfolio manager’s inbox within 20 to 25 minutes.”

Investors who register their holdings can also download documents and see what other holdings are registered. When they vote, DealVector can prepopulate information, and it allows them to use an electronic signature.

“From an investor standpoint, it’s been a fairly simple process,” said Tim Sustak, chief credit officer at Vizo Financial, a corporate credit union that has been involved in 10 or 12 consents to extend the maturities of FFELP bonds it holds.

Sustak said that Vizo gets consent solicitations from its third-party custodian as well as from DealVector, and was informed about what was happening to FFELP bonds and why. Still, using an online platform “put some extra grease on the wheel,” particularly for deals that were not extended on the first try.

“It’s another check and balance,” he said.

As in other walks of life, technology offers a bird’s-eye view of the situation.

“For a given deal, I can see how much each custodian has under custody, so I can call one and say, ‘we’re missing [consents on] $100 million, can you send reminders to the beneficial holders?’” Manning said. “These tools allow us to work the investor end, the brokers and custodians all at the same time.”

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