The perfect student loan storm

Ok, the legislators walked student loans up to the gallows. But it was the credit crunch that slid the noose over the neck. [We worked really hard to come up with that imagery!]

As we see it, the credit crunch unfolded like so: mortgages started going bad, which affected the performance of the securitized pools they were sold into, which in turn soured investors on the bonds that supported the securitized structures. As the scope of the mortgage backed securities market came into light, the sale of bonds that were sold for all sorts of securitized assets began suffer.

Student loans are quite often packaged up and securitized just like mortgages. Most monoline lenders rely on this capability to free up their warehouse lines of credit so more loans can be funded. Alas, investors stopped buying bonds (usually commercial paper or auction rate securities) that financed the securitization structures. Warehouse lines could not be refinanced.....and all lending comes to a screeching halt.

What we don't understand is the irrational behavior of the investors. The bond quality is a direct function of the underlying loans in that securitized structure. FFELP student loans are still guaranteed by the full faith of the US Government. FFELP student loans are still in great demand as a tool for students to invest in their futures. FFELP student loans, basically are not to be compared with the sub-prime mortgage mess. But for whatever reason, the investors are gun shy of any investment vehicle that resembles a mortgage backed security.

The problem with the student loan secondary market is purely a liquidity issue, not a credit issue as with mortgages. We firmly believe the liquidity market will return to some resemblance of normalcy at some point....don't know when, but will do so eventually.

Student loans relied heavily on a special securitization structure in which the underlying bonds were auctioned off every month....sort of like commercial paper, but with different terms...the vehicle is called "auction rate securities". Typically a student lenders investment bank would buy issues with their own capital when the auction did not clear all the refinanced bonds. The IB would then sell those auction rate bonds later on during the month. Well, most IB's stopped supporting their auctions. In other words, the bond holder of a maturing note would not get their money back. They were stuck with the position for another month. It should be noted that the failed auction rate markets were a decision by the investment banks due to their inability or aversion to employing their own capital to support their customers -- the underlying quality of the student loan pools did not change one bit during this period. Regardless, student loans are now labeled as an EPA Superfund site.

So, the loans aren't nearly as profitable as they used to be (note: loans funded prior to Oct 1, 2007 are just fine, it's the few loans made since Oct 1, 2007 that will have trouble making money).....student lenders have been frozen out of the credit markets.....and the lending season is just starting to gear up. Yes, folks, there's a real mess brewing down at the Dept of Education, and no one really seems to be too interested in taking control of the situation.