Rating agencies’ opinions of financial assets isn’t much concern to the New York bankruptcy world, but notably in mid-December both Moody’s and Fitch issued press releases documenting their pessimistic outlooks on a very unique type of financial asset: Federal Family Education Loan Program (FFELP) Asset-Backed Securities (ABS).
The FFELP is the defunct federal program in which the government promised to guarantee student loans issued by private banks. As part of the Patient Protection Affordable Care Act, the FFELP was abolished, and now all federally related student lending comes directly from the Department of Education. The shift to direct loans benefited the government by cutting out the private banks as middlemen. There are still issues of loan servicers not informing borrowers of income-based repayment options, but that’s minor compared to the penalties FFELP lenders could heap on borrowers with defaulted loans.
Nevertheless, many FFELP loans are still out there, packaged into financial securities for investors, and whenever debtors default on them, the government honors its guarantees to the lenders. Defaults occur quite frequently. According to Department of Education data, as of third quarter 2015, 4.3 million out of 21.2 million FFELP debtors’ loans were in default.
So if the creditors are guaranteed their money back if debtors default, why are ratings agencies expressing concerns about the securities? The answer isn’t so much whether the debtors will repay the loans but how quickly. When borrowers default, the investors are repaid in full up front, but when they use forbearance, deferment, and income-based repayment options, the speed at which their loans are repaid slows down. In its press release, Moody’s warned that slow repayments would cause some of the loan pools to default, hurting investors.
Meanwhile, Fitch placed 238 FFELP ABS tranches from 118 trusts on “Rating Negative Watch,” which isn’t a rating downgrade but implies that Fitch is concerned there might be repayment problems in the future. The cause again is repayments coming in more slowly than initially expected due to slower repayment rates.
There won’t be a financial panic due to FFELP ABS not being repaid on time, but the ratings agencies’ pessimism is justified because student debtors fail to find high-paying jobs and use income-based repayment plans as a result. Moody’s and Fitch’s negative watches might be the first indication by the market that not all student loans will ultimately be repaid.
The Moody’s press release can be found here, and Fitch’s here.
I’ve written about student-loan debt in bankruptcy in the past, and increasingly debtors’ experiences are a mixed bag. Sometimes courts side with debtors, sometimes not. As a result, debtors who have defaulted on FFELP loans will have a tough burden to meet to show that their cases have merit. For many, signing on to an income-based repayment plan might be easier than initiating an adversary proceeding against a student-loan creditor, but talking to an experienced New York bankruptcy lawyer can help you assess your options, especially for higher student-loan balances.
For answers to more questions about bankruptcy, the automatic stay, effective strategies for dealing with foreclosure, and protecting your assets in bankruptcy please feel free to contact experienced Brooklyn bankruptcy lawyer Bruce Weiner for a free initial consultation.