Private Student Loan Securitization: A Primer
Posted by YourLoanAdviser Staff
The private student loan asset class is an excellent investment for strong returns as a securitized asset. But this notion is a bit of a secret to small banks, credit unions, financial advisors, portfolio holders, originating lenders and others. The question is… why?
“By way of background, securitization is a common technique for presenting assets such as private student loans to the investor marketplace, securing the investors’ capital with cash flows from the underlying assets,” says Jonathon Albright, Chief Financial Officer, YourLoanAdviser. “Student loan asset-backed securities (SLABS) require that the cash received from interest and the principal loan payments of the base loan pool be used to pay down the SLABS that have been sold, primarily to institutional investors.” Tranches, or the different groups into which SLABS have been divided, have varying interest return rates and maturity dates, and those depend on the underlying asset pool and market demands.
Now back to the question of why. Are some financial institutions not aware of securitization? Are there misperceived risks when it comes to private student loans? Are there government regulations that negatively affect securitization? The financial crisis resulted not just in the collapse of the ABS/MBS market, but also in the common misconception OUTSIDE the financial industry that Asset Backed Securities are structured by bankers to trick unsuspecting investors into buying bad loans for the bankers’ gain. Though that did happen at time, it did so before the crisis as well.
Subsequent regulation has made securitization more difficult from an execution standpoint due to stringent due diligence and auditing rules. Also, the government has also implemented safeguards against predatory lending and strict guidelines to ensure the assets backing a securitization are credit-worthy and true to the representations and warranties provided to investors.
YourLoanAdviser believes that, when it comes to securitizing private student loans, the securitization market creates liquidity for the lending industry and thus gives borrowers access to the funds they need. “When a lender ‘sells’ its private student loans into the market via a securitization, the lender does so at a premium – based on principal plus some discounted interest return – thus ‘earning’ more money with which to continue to lend,” says Steve Pachella, Vice President of Capital Markets, YourLoanAdviser. “So the lender benefits by earning a profit from previously deployed funds and in return has more money to make available to potential students. The borrowers/potential students who couldn’t previously afford to pay for school out of pocket benefit by gaining access to the financial means to higher education not previously available to them.”
According to Pachella, the securitization market is “re-maturing.” That’s to say that while the market isn’t approaching the volume that it was at prior to 2007, it’s gaining traction and expected to grow for the foreseeable future. It’s an opportunity for the FinTech market as securitization provides the best economic execution for non-depository institutions and can accommodate very large volumes of assets.
“The startup phase of securitization can be expensive,” Pachella acknowledges. “Given that the FinTech industry is young, each institution must determine what its long-term funding goals are and whether or not securitization provides the best means to that end. There are other funding options available and for risk management reasons, financially savvy companies will rely on multiple strategies to ensure access to capital in case of market disruption.”