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ESG Industry Report Card: Student Loan Asset-Backed Securities

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ESG Industry Report Card: Student Loan Asset-Backed Securities

Analytic Approach

Environmental, social, and governance (ESG) risks and opportunities can affect an obligor's capacity to meet its financial commitments in many ways. S&P Global Ratings incorporates these factors into its ratings methodology and analytics, which enables analysts to factor near-, medium-, and long-term effects--both qualitative and quantitative--during multiple steps in the credit analysis. Strong ESG credentials do not necessarily indicate strong creditworthiness (see "The Role Of Environmental, Social, And Governance Credit Factors In Our Ratings Analysis," published on Sept. 12, 2019).

Our credit ratings on structured finance transactions incorporate ESG credit factors when, in our opinion, they could affect the likelihood of timely payment of interest or ultimate repayment of principal by the legal final maturity date of the securities. However, in most cases, exposure to ESG credit factors in structured finance transactions is indirect or mitigated by legal and structural features already embedded in typical transactions.

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Our ESG industry report cards qualitatively explore the relative exposures (average, below average, above average) of different sectors to ESG credit factors over the short-, medium-, and long-term. This sector comparison is not an input to our credit ratings or a component of our credit rating methodologies; it is based on our current qualitative, forward-looking opinion of potential credit risks across sectors. In addition, the structured finance ESG industry report cards list examples of ESG credit factors for the sector that may have a more positive or negative influence on a transaction's credit quality compared to sector peers or the broader sector.

The qualitative assessment of the relative exposure to ESG credit factors for each sector reflects the potential exposure to ESG risks. It does not consider the presence of structural features that could mitigate these risks (e.g. credit enhancement, short-time horizon of a transaction, insurance, etc.). Therefore, even if there is a material ESG credit factor for a given sector or transaction, there may ultimately be no ratings impact if structural mitigants are present. This is because we assign issue credit ratings to structured finance securities. These credit opinions address the likelihood of repayment of a specific financial obligation, and consider forms of credit enhancement, such as collateral security and subordination. This differs from issuer credit ratings (ICR) that we assign to corporates and sovereigns, for example. Our ICRs are opinions about an obligor's overall creditworthiness, and do not apply to any specific financial obligation, as they do not take into account the nature and provisions of the obligation, their standing in bankruptcy or liquidation, statutory preferences, or their legality and enforceability. Therefore, ESG credit factors that could affect a corporate issuer's ICR may not be material to a structured finance issue credit rating, and vice versa (see "S&P Global Ratings Definitions," published on Jan. 5, 2021).

ESG Credit Factors

We define ESG credit factors as ESG risks, or opportunities, that influence an obligor's capacity and willingness to meet its financial commitments. This influence could be reflected, for example, through reduced ability of the underlying borrowers to repay the securitized receivables, the value of any collateral, disruptions in servicing or transaction cash flows, financial exposures to transaction counterparties, or increased legal and regulatory risks.

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This report explores how ESG credit factors could influence the credit quality of student loan ABS and provides a benchmark for typical ESG considerations in the sector. Specific transactions may be exposed to ESG credit factors that could have a more positive or negative influence on the credit rating than the sector benchmark. These comparative views of ESG risks across transactions are typically qualitative at present, because there are currently limited ESG data points that are widely available to quantify the relative risks. Over time, we expect that a common taxonomy for ESG credit factors across structured finance sectors will emerge, at which point more data will become available to strengthen our analysis of ESG credit factors.

In our published rating rationales, we expect to provide more insight and transparency of any ESG credit factors that are material to our credit ratings in a dedicated ESG paragraph. Our goal is to highlight how a transaction compares to our ESG sector benchmark (where applicable), identify the relative ESG risks and opportunities, and discuss any structural mitigants to these risks. However, if in our view ESG credit factors are not material to the credit risk profile of a transaction, we generally would not make any specific disclosures beyond a reference to our ESG sector benchmarks, where applicable. Through this initiative we aim to highlight how our rating analysis has accounted for specific ESG credit factors and add transparency around which ESG credit factors could drive future rating changes, if any.

Student Loan ABS ESG Benchmark

Our ESG sector benchmark for student loan ABS consists of a static pool of prime, private student loans, originated by a regulated lender with decades of experience in the sector. This pool of loans is highly diversified by obligor and geography.

Exposure to environmental credit factors for the benchmark pool is considered below average, given significant obligor and geographic diversification, and that the receivables are unsecured.

Social credit factors are considered average because private loan originators typically target higher credit quality refinance borrowers or include co-signing parents. Compared to other unsecured consumer loans, interest rates are relatively low for undergraduate and graduate student loan refinance products. For Federal Family Education Loan Program (FFELP) originations, lenders use servicing guidelines provided by the U.S. Department of Education, which also sets the interest rates for these loans. In our view, social risks would be relatively higher for loans with income-contingent repayment features, as in some regions these loans may not include any consideration of borrower credit quality or loan affordability at origination.

Exposure to governance credit factors is below average. Given the nature of structured finance transactions, most have relatively strong governance frameworks through, for example, the generally very tight restrictions on what activities the special-purpose entity can undertake compared to other entities. Given that our ESG benchmark is a static pool with no reinvestment, the originator has a diminished role over the transaction's life, mitigating the risk of weaker underwriting standards or potential adverse selection for additional receivables. Student loan originators are generally highly regulated and have strong internal control frameworks with external audits and oversight in place. In our view, the student loan ABS transactions that would have a relatively higher exposure to governance credit factors would be those that are revolving, include a prefunding mechanism, or include loans from originators with a short track record in the sector or that have weak internal controls, in our view.

Environmental Credit Factors

ESG Benchmark: Below Average Exposure

Environmental Factors
Greenhouse gas emissions Natural conditions Pollution Other environmental factors Environmental benefits
Generally not a potential material exposure for this asset class. Concentrations by obligor, industry, or geography may increase exposure to potential natural disasters or other physical climate-related risks, such as hurricanes, wildfires, earthquakes, and flooding. Generally not a potential material exposure for this asset class. Generally not a potential material exposure for this asset class. Generally not a potential material exposure for this asset class.
The servicer's operations may be exposed to physical climate risks, potentially resulting in a disruption in collections.
The rating on the sovereign where the securitized assets are domiciled can cap structured finance transaction ratings. The sovereign rating may be affected by natural disasters or other climate change-related risks.

Social Credit Factors

ESG Benchmark: Average Exposure

Social Factors
Health and safety Consumer related Human capital management Social benefits
A pandemic could result in cash flow declines that affect required credit enhancement levels and increase liquidity risks. For example, mandatory payment holidays may be offered to consumers who are affected by the pandemic. The allowance of student loan debt to be included in personal bankruptcies may increase credit losses. High turnover of collections staff or labor disputes/industrial action at the servicer could lead to a disruption in collections, increasing liquidity risk and extending recovery timing. Programs that help provide access to higher education, such as government guarantees or incentives, may reduce loss severities. However, failure to follow prescribed servicing guidelines could void the guarantee.
Credit scoring methods applied to lend to underserved communities may be untested in stressed economic environments. This could lead to higher defaults than expected. Loans that contain income-contingent repayment features aim to address concerns regarding student loan affordability. However, this feature may result in negative carry and higher losses if borrower's earnings do not exceed the repayment threshold.
Consumer credit legislation and regulation, including affordability considerations or aggressive collection practices, could increase legal and regulatory risk.
Interest rates deemed usurious could result in reduced yield or could challenge the validity of the loans in securitized pools.

Governance Credit Factors

ESG Benchmark: Below Average Exposure

Governance Factors
Strategy, execution, and monitoring Risk management and internal controls Transparency Other governance factors
For management teams with a limited track record in the sector, there may be higher defaults or increased operational risk. Revolving collateral pools, or transactions with a prefunding mechanism, may be subject to deterioration in underwriting or adverse selection. Concerns on data quantity, quality, and timeliness may affect our ability to rate a transaction, or potentially cap the rating. Compensation structure and incentives of different transaction parties can result in conflicting interests, which may not have a strong alignment of interest with noteholders.
Increasing risk appetite of the originator, aggressive growth, or expansion into new products may result in higher defaults than the historical performance data reflects. Bankruptcy risk could be heightened for key transaction parties that exhibit weak governance and internal controls. The lack of a third-party audit, limited scope, or material due diligence findings may increase uncertainty of the credit quality of the collateral.
Key man risk and a lack of succession planning at the originator or servicer may increase operational risk. Several governance-related factors could increase the likelihood of a special-purpose entity entering insolvency proceedings. This might include weak documentation regarding restrictions on an issuer's objects and powers, debt limitations, and independent directors; restrictions on a merger or reorganization; and limitations on amendments to organizational documents, separateness, and security interests over the issuer's assets. Lack of transparency in loan documentation could increase legal and regulatory risk or result in potential set-off.
A successful cyberattack on the servicer could disrupt collections or result in a loss of borrower data that exposes the issuer to legal or regulatory risks.
The lack of a transition plan for a backup servicer, or inability to replace a key transaction party, may increase operational risk in a transaction.
A weak compliance culture of the originator and servicer could increase legal and regulatory risk.
Failure of a transaction counterparty to comply with documented remedies if their credit quality deteriorates could increase counterparty risk.
Failure of an originator and servicer to comply with applicable regulation could increase legal and regulatory risk, including the enforceability of the loans.
The lack of replacement provisions for interest rate benchmarks could lead to basis risk, reductions in cash flows, and increased legal and regulatory risk.
Weak representations and warranties provided by transaction parties may increase uncertainty of the collateral's credit quality.
Extensive use of manual overrides or exceptions to automated underwriting scorecards may increase uncertainty of the collateral's credit quality.
Flexibility of key transaction counterparties with respect to definitions, covenants, and performance triggers in the governing documents could lead to release of credit enhancement. For example, the ability of the servicer to amend the time period that defines when loans are considered defaulted.

This report does not constitute a rating action.

Primary Credit Analysts:Romil Chouhan, CFA, New York + 1 (212) 438 3512;
romil.chouhan@spglobal.com
John Anglim, New York + 1 (212) 438 2385;
john.anglim@spglobal.com
Secondary Contacts:Matthew S Mitchell, CFA, Paris +33 (0)6 17 23 72 88;
matthew.mitchell@spglobal.com
Kate R Scanlin, New York + 1 (212) 438 2002;
kate.scanlin@spglobal.com
Erin Kitson, Melbourne + 61 3 9631 2166;
erin.kitson@spglobal.com

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