The world of asset-backed bonds (ABS) is in disarray. While home-equity securities have grabbed the headlines, other types of ABS have suffered as well. Student loan asset-backed bonds are one example of the baby being thrown out with the bath water.There are two basic types of student loan ABS. Some are constructed with private student loans, and these carry risk of those borrowers failing to make payments. Others are made up of Federal Family Education Loan Program (FFELP) loans. FFELP loans are at least 97% guaranteed by the Department of Education (loans made before July 2006 have a greater guaranty).
Despite the guaranty, the yield spread on FFELP student loan bonds has widened substantially, creating an opportunity for investors looking for income securities that are not significantly exposed to credit risk.
A typical FFELP student loan securitization will include about five tranches. The first four will usually be labeled A1, A2, A3 and A4. These are all senior securities. The last tranch is a junior security, commonly called the B tranche. In the most recent Sallie Mae student loan securitization, the B tranche represented 3% of the entire deal structure, exactly the amount uninsured by the federal government. This effectively eliminates credit risk for the senior securities.
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