Securitizations backed by portions of the $1.28 trillion student debt market could become riskier in the coming years as more borrowers enroll in income-based repayment programs — a trend that could accelerate if a repayment plan proposed by President-elect Donald Trump during his campaign goes into effect.
Selling student loan asset-backed securities is a key fundraising business for Navient Corp. and Nelnet Inc., which service student debt, and Sallie Mae, which is also the largest originator of new loans. Through Sept. 30, Sallie Mae has raised about $1.12 billion in gross proceeds through two private loan securitizations, according to its most recent quarterly filing. In the same period, Navient issued about $3.9 billion in ABS tied to federal loans and $488 million backed by private loans. Nelnet completed a $426 million securitization in October.
Moody's, which rates student loan securitizations, in June said it had placed $44.9 billion in federal student loan ABS tranches on review for downgrade after revising its rating criteria. The agency cited a rise in income-based repayment plans allowing borrowers to make lower payments as part of its reasoning.
"The elevated risk of failure to repay a tranche by its maturity date is a result of low payment rates" on the underlying loans, driven by high numbers of borrowers in non-standard payment plans, including income-based repayment, the agency noted. Defaults on the loans, made under the Federal Family Education Loan Program, are falling, Moody's said, but "the level of loans to borrowers in [income-based repayment] has increased by approximately the same amount."
Navient, the largest student loan ABS issuer, did not respond to a request for comment. But its CEO, Jack Remondi, said during an Oct. 19 earnings call that the modeling used by Moody's and Fitch Ratings, which also rates ABS, is "complex and we do not always agree with their predicted impact on cash flows."
"We remain committed to working with the rating agencies and investors to minimize ratings impact," he added, according to a transcript of the call.
Income-based repayment plans allow a borrower to pay much less per month by capping the repayment at a percentage of discretionary income and to stretch out a repayment schedule beyond the standard 10-year period to 20 years and, in some cases, 25 years. Some also provide loan forgiveness after the full schedule of repayments, which by the end may not have totaled the principal and interest of the loan.
Encouraging enrollment in the plans has been a hallmark of the Obama administration's efforts to lower student loan default rates by keeping borrowers in repayment, even if those payments are lower. The side effect of that policy, the Government Accountability Office wrote in a November report, is a substantial reduction in repayments. Of the $355 billion in direct federal loans made between 1995 and 2017, about $74 billion, or 20.8% of the total, will not be repaid, the office said.
Toward the end of his campaign, Trump revealed a student debt reform package that would allow borrowers to roll both federal and private student loans into an income-based repayment program that caps payments at 12.5% of a borrower's income, then forgives the remainder after 15 years of full payments. About 24% of all borrowers are already in income-based plans as of June, according to the GAO.
"If borrowers work hard and make their full payments for 15 years, we'll let them get on with their lives," Trump said in October at a campaign rally in Columbus, Ohio, according to The Washington Post.
A current loan forgiveness program for borrowers who went into public service about a decade ago is also beginning to come due, Compass Point analyst Michael Tarkan said in an interview. "We're starting to see loan forgiveness coming through on the government's tab," Tarkan said.
While the campaign proposal could impact the companies' securitization business, the broader deregulatory stance of Trump and his nominees for key government and advisory positions has enthused investors. For the month of November, Sallie Mae's stock soared 42.8%, Navient rose 34.8% and Nelnet gained as much as 34.2% before settling somewhat lower. Sallie Mae Chairman and CEO Raymond Quinlan has said he expects "more opportunity" for private vendors during Trump's term.
Implementing a new repayment program may also sit further down the new administration's list of priorities. Trump and his Cabinet nominees have pushed a massive infrastructure spending plan, repealing the Affordable Care Act and Dodd-Frank financial reforms, as well as housing finance and broad tax reform, as the focus of their early efforts come 2017, with no mention of student debt reform.
However, introducing a plan similar to what Trump proposed during the campaign could be accomplished administratively, without congressional action. In 2015, the Department of Education established a revised income-driven repayment plan in response to a presidential memorandum asking for new repayment options.
The nominee for Secretary of Education, Betsy DeVos, is known as an advocate of K-12 public school voucher programs but has said little about the debt levels of college graduates.