NEW YORK--(BUSINESS WIRE)-- Fitch Ratings will begin reviewing ratings on U.S. FFELP student loan asset backed security (ABS) bonds, including subordinated bonds, applying its updated surveillance criteria that incorporate a more refined approach to basis risk. Fitch's Global Structured Finance Rating Criteria and FFELP student loan ABS rating criteria, as well as the refined basis risk approach described in this release will be used to review the ratings. The review will encompass trusts with LIBOR floater bonds only; other structures including trusts with auction-rate securities will be reviewed later when the criteria are expanded to account for the structure.

Ratings on subordinate bonds with no overcollateralization from trusts that release excess spread are expected to be the most negatively affected, with the resulting ratings ranging between 'BBB' and 'BB'. Ratings on bonds that benefit from overcollateralization and cannot release cash are expected to range from 'AAA' to 'BBB', depending on the level of overcollateralization and other factors described below. Bonds with parity less than 100% (i.e. asset deficient) are also at risk for downgrades but the severity may be tempered if the rating was lowered in prior reviews. Senior bonds with parity of 103% or more with a stable or increasing parity trend are expected to remain stable at 'AAA'.

The updated methodology measures each trust's exposure to basis factor volatility, which is the spread between the spot three-month LIBOR rate that determines the liability rate and base special allowance payment (SAP) rate earned on the underlying loans. For each loan, the base SAP rate is the average of either the three-month Treasury-bill or financial commercial paper (CP) spot rates observed over the given calendar quarter. The level of exposure to basis risk depends on the mix of student loans tied to T-bill and CP rate.

For loans tied to CP rate, the base-case basis factor assumption applied for the 'B' rating level is negative 0.1% (all percentages expressed as an annualized rate), and this is stressed up to negative 2.3% for the 'AAA' rating level. With respect to loans tied to T-bill rate, the base case and 'AAA' stress are set at negative 0.4% and negative 4.2%, respectively. Stress levels for ratings in between will be interpolated. The basis factor applicable to the trust will be based on the weighted average of the two loan indices.

As a remedy that can absorb negative basis factor stress, a minimum gross excess spread is projected for each trust, which is based on the predetermined SAP spread over the average rates of CP or T-bill, the bond spread over the LIBOR spot rate, and the trust fees and expenses. The levels of the projected minimum gross excess spread across different trusts are expected to vary greatly depending on the loan distribution by type and disbursement date, bond pricing, and caps on fees and expenses.

The net excess spread applicable to each rating category is calculated as the sum of the stressed basis factor (a negative value when stressed) and the projected minimum gross excess spread. The net excess spread for higher ratings would be negative, as the applicable basis factor stress is going to exceed the assumed level of gross excess spread.

If the assumed net excess spread of a given rating is negative, hard enhancement such as overcollateralization or subordination is expected as an additional remedy to achieve the rating. Specifically, the hard enhancement is expected to cover the stressed level of negative net excess spread for four quarters for 'AAA', gradually going down to one quarter for 'BBB' and lower.

If the calculated net excess spread of a given rating is positive (expected for 'BB' or lower), the bond can achieve the rating with asset deficiency or parity below 100%. The level of asset deficiency the trust can have is calculated by applying the net excess spread over a conservatively set weighted average life horizon.

For bonds exactly at 100% parity, the rating will correspond to the highest basis factor stress level that still results in a positive net excess spread. In this case, horizon is not relevant, as there is no hard enhancement or asset deficiency to measure against.

Additionally, Fitch may apply qualitative adjustment to the rating in order to account for structural benefits such as turbo features that require trusts to trap excess spread.

In addition to analyzing the risk to principal loss as described above, the risk of missing an interest payment (liquidity risk) will be analyzed. The liquidity test will involve comparing the stressed basis factor with spread generated by the trust net of noncash earnings, principal collections, and any liquidity reserve accounts. Noncash earnings and principal collections for any given quarter are assumed to be 0.8% and 1%, respectively. Most trusts are, however, expected to pass the liquidity test at the 'AAA' stress level, so the ratings are likely be driven by the principal risk analysis.

The updated approach was developed based on a review conducted by Fitch to quantify the basis factor volatility. More details of the study and findings can be found in Fitch's report, 'Quantifying Basis Risk in U.S. FFELP Student Loan ABS', available at 'www.fitchratings.com'. The report describes the method by which the spread distribution was measured and the results, along with discussions on key implications.

Additional information is available at 'www.fitchratings.com'.

ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: HTTP://FITCHRATINGS.COM/UNDERSTANDINGCREDITRATINGS. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEBSITE 'WWW.FITCHRATINGS.COM'. PUBLISHED RATINGS, CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE 'CODE OF CONDUCT' SECTION OF THIS SITE.

CONTACT:

Fitch Ratings, New York
Aoto Kenmochi, 212-908-0867
Michael Dean, 212-908-0556
or
Media Relations:
Sandro Scenga, 212-908-0278
Email: sandro.scenga@fitchratings.com

KEYWORDS:   United States  North America  New York

INDUSTRY KEYWORDS:   Professional Services  Banking

MEDIA: