Fitch: Rehabilitation Loans and Liquidity Risk in FFELP ABS

NEW YORK--()--Fitch believes the increase in rehabilitated student loans in some recent FFELP ABS transactions heightens near-term liquidity risk despite the U.S. government guarantee on these loans.

Rehabilitated student loans are those in which the borrower defaults but subsequently makes nine on-time payments during 10 consecutive months. In these situations, the collection costs (up to 18.5% of the outstanding principle and accrued interest) are built into the loan principal. A loan may be rehabilitated only once after Aug. 14, 2008 under the common manual. Fitch has seen an increase in rehab loans, which typically trade at a discount, in several recent FFELP ABS transactions, as supply has been ample following the crisis. From 2003 to 2010, the inventory of rehab loans tripled. Fitch has also seen some transactions with 100% rehab collateral.

Rehab loans go through the same delinquency and default process as non-rehab loans. After 270 days of delinquency, the loan is classified as defaulted, and the servicer submits a claim to the guarantor. Provided the servicer meets the due diligence requirements, the guarantor will purchase the defaulted loan from a lender within 90 days following the receipt of a claim. However, Fitch assumes a payment lag of 540 days from the first day of default in all cash flow scenarios to account for possible delays in reimbursement to the trust, including those that could be caused by guarantor insolvency.

Given their history, rehab loans are more likely to default and do so more quickly than non-rehab loans. This creates higher near-term liquidity risk for transactions with a concentration of rehab FFELP collateral than for non-rehab FFELP transactions because a significant portion of loans will be non-performing while the delinquency and claims process occur. Based on historical data from servicers and guarantors, we estimate the base case default rate for rehab loans to be in the 40%-60% range versus 10%-15% for non-rehab loans. This higher default risk is largely mitigated by the government guarantee. In addition to higher default assumptions, Fitch also applies a more front-loaded default curve for rehab loans. In Fitch's opinion, the assumptions applied for default level and timing, as well as the payment lag, help mitigate the near-term liquidity risk from a high concentration of such loans in a transaction.

Additional information is available on www.fitchratings.com.

The above article originally appeared as a post on the Fitch Wire credit market commentary page. The original article, which may include hyperlinks to companies and current ratings, can be accessed at www.fitchratings.com. All opinions expressed are those of Fitch Ratings.

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Rob Rowan, +1-212-908-9159
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Cynthia Ullrich, +1-212-908-0609
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Contacts

Fitch Ratings
Rob Rowan, +1-212-908-9159
Senior Director
Fitch Wire
Fitch Ratings
1 State Street
or
Cynthia Ullrich, +1-212-908-0609
Senior Director
Asset Backed Securities
or
Media Relations:
Sandro Scenga, +1-212-908-0278
Email: sandro.scenga@fitchratings.com