AUGUST 5, 2008 INVESTING IN ASSET BACKED SECURITIES ABS Research Chris Flanagan AC Head, Global Structured Finance Research (1-212) 270-6515 [email protected]Edward Reardon (1-212) 270-0317 [email protected]Amy Sze, CFA (1-212) 270-0030 [email protected]Brynja Sigurdardottir (1-212) 270-0967 [email protected]
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A U G U S T 5 , 2 0 0 8
I N V E S T I N G I N A S S E T B A C K E D S E C U R I T I E S
As of 1Q08. Other is approximately 90% CDOsSources: SIFMA
Asset-backed Securities Outstanding ($ billions)Asset-backed Securities Outstanding ($ billions) 1Q08 year end outstanding by collateral1Q08 year end outstanding by collateral
Cards
14%
Equip
2%
Home Eq
24%
Student Loan
10%
Other
41%
MH
1%
Auto
8%
ABS outstanding
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Supply ($ Billions)Supply ($ Billions)
U.S. ABS supply: The peak is behind us.
Sources: JPMorgan, IGM CorporateWatch, and Bloomberg.
Outstanding ($1,552bn total as of year end 2007)Outstanding ($1,552bn total as of year end 2007)
Other
$102
7%
Student
Loans
$244
16%
Home Equity
$586
37%
Equipment
$46
3%
MH
$27
2%
Autos
$199
13%Credit Cards
$348
22%
Sources: JPMorgan, SIFMA
224240
272
330402
500
702
874 888
529
116
0
100
200
300
400
500
600
700
800
900
1998 2000 2002 2004 2006 YTD08
2005 2006 2007 2008 YTD
2008 Full Year Proj
Credit Cards 66 66 91 54.6 95
Autos 103 84 62 32.6 50
Home Equity 559 555 224 0
Student Loans 64 65 48 23.8 30
Global RMBS 35 69 66 30
Equipment 9 8 6 2.9 5
Other 39 40 32 3.1 20
Total 874 888 529 116.3 230
“Other” includes Floorplan, Motorcycle, Small Business Loans, Time Share, Aircraft, Franchise, and other miscellaneous assets. As of Aug 1, 2008. Source: JPMorgan, IGM CorporateWatch, and Bloomberg.
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ABS investor base has grown dramatically
Bank portfoliosInsurance companiesTotal return accountsBank trust departments
Phase I: 1985-1989 Phase II: 1989-1993
Phase III: 1993 - 2002
State fundsAsset swap investorsCredit unionsCorporationsGov’t Agencies
BBB spread account example - CHAITBBB spread account example - CHAIT
3-month Excess Spread % Spread Account Funding %
4.50% or greater 0.00%
4.00 - 4.49% 1.00%
3.50 – 3.99% 1.50%
3.00 – 3.49% 2.50%
2.50 – 2.99% 4.00%
2.00 – 2.49% 5.00%
0.00 – 1.99% 5.75%
< 0.00% 5.75%
Source: Chase 8K filing March, 1, 2007Note: The Spread Account schedule is issuer specific. Above for Chase only.
Excess spread first line of defense against lossesAAA and A benefit from subordinationBBB credit enhancement from spread account
Funding schedule of spread account aims to be fully collateralized versus the par BBB bond amount before excess spread drops below zero
Issuer AAA A Advanta 17.00% 8.50% American Express – Charge 7.00% 4.00% American Express - Credit 12.00% 6.50% Bank of America 14.00% 6.50% Cabela 13.50% 6.50% Capital One 17.00% 8.00% Chase – CHAIT 11.50% 5.75% Citibank – CCCIT 12.25% 7.00% Discover 12.50% 7.50% GE 18.75% 9.50% HSBC 20.50% 12.00% HSBC Private Label 24.00% 12.50% National City 12.50% 6.50% Nordstrom 16.50% 8.00% WaMu 27.00% 16.50%
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Structure: Cashflow Mechanics Early Amortization Events Protect Investors
Deals are structured with early amortization triggers to protect investors from extended exposure to deteriorating asset quality. If an early amortization event occurs, deal begins to pay out immediately.
All principal collections become allocable to investors immediately and cash on deposit in accumulation account is paid to investors sequentially
Principal is no longer limited to controlled amortization/accumulation amount
Investors get a portion of principal normally allocable to the seller
Typical Early Amortization Events
Seller/Servicer— Failure or inability to make required deposits or payments— Failure or inability to transfer receivables to the trust when necessary— False representations or warranties— Certain events of default, bankruptcy, or receivership of the seller or servicer
Legal— Trust becomes classified as an “investment company” under the Investment
Company Act of 1940
Performance— Three-month average excess spread falls below a minimum level (i.e., zero)— Seller’s participation falls below the required level— Portfolio principal balance falls below the invested amount
Metrics in bold are reported, italics are derived* This metric is calculated based on all accounts in the trust, including those that have a credit balance or zero balance and therefore do not have a payment due.** Reported payment percentages are based on averages from the beginning of the calendar year.Source: Moody’s, Static Pool reports
Chase – CHAIT
BofA (BACCT) Capital One Citi - CCCIT Discover** Amex-
Credit Card National
City % of Accounts Making Min. Payment * 4% 4% 7% 4% 4% 4% 8% % of Accounts Making Full Payment * 18% 8% 15% 21% 15% 20% 24%
% Accounts with No Payment Due 52% 62% 35% 49% 57% 60% 42%
% of Accounts Making Min. Payment (excl. Accounts with No Payment Due)
8% 9% 11% 8% 10% 11% 15%
% of Accounts Making Full Payment (excl. Accounts with No Payment Due)
37% 22% 22% 41% 35% 50% 42%
As Of Date Mar-08 Mar-08 Mar-08 Dec-07 May-08 May-08 Mar-08
GE managed portfolio dataGE managed portfolio data
GE
% of Receivables Making Min. Payment 4%
% of Receivables Making Full Payment 51%
As Of Apr-07
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Credit Card ABS collateral — credit score distribution
Note: S&P deeper-recession scenario coincides with S&P economist’s view of potential loses exceeding 9% by spring of 2009 in such a scenario. In this scenario, excess spread starts trapping in the fourth month and early amortization triggered due to negative excess spread in tenth month.
Over 15 years of S&P credit card performance index history, charge-offs never exceeded 7.6%, and yield never fell below 16.8%. Payment rate never under 15% for 10 years.
Fitch credit card breakeven stress analysis: base case*Fitch credit card breakeven stress analysis: base case*
Change In AAA A BBB Timing
Yield -35.00% -25.00% -20.00% Down One-Month
Monthly Payment Rate -45.00% -35.00% -30.00% Down One-Month
Charge-offs 4.50x 3.00x 2.25x Six-Month Ramp
*Purchase rate 100% assumed in the base case.Source: FitchRatings
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Fitch breakeven analysis example: Chase
Stress Case (starting from 12-month average
actual performance)
Portfolio Wind-down Scenario (no new
receivables)
Steady State Stress Case (starting from 24-month
average actual performance)
Source: Fitch Investors Service
Chase Issuance Trust Break-Even Stress Scenarios
BASE STRESS TimingYield Down One-MonthMonthly Payment Rate Down One-MonthChargeoffs Six-Month RampPurchase Rate —
Loan amortizes principal over their term-to-maturity
Loan may prepay in advance of the scheduled maturity
Voluntary prepayment— Refinancing or sale of vehicle
Involuntary prepayment— Repossession or loss of vehicle
When a prepayment occurs, principal is paid through to the security holders, thus retiring that portion of principal that is attributable to the loan that has prepaid
Prepayments measured by Absolute (ABS) prepayment model— Standard measure of prepayments for automobile loan backed securities, which
calculates monthly prepayments as the percent of the original dollar balance of receivables. Prime auto ABS typically prices using 1.5% ABS assumption.
The small collateral balance and relatively short maturity for the typical auto loan contract reduces the incentive to refinance because monthly payment saving would be minimal
FY2007 top originators of FFELP loans ($ millions)FY2007 top originators of FFELP loans ($ millions) FY2007 holders of FFELP loans ($ millions)FY2007 holders of FFELP loans ($ millions)
Rank Lender Origination
Volume
1 Sallie Mae 9,002
2 Citibank 4,764
3 Bank of America 3,262
4 JP Morgan Chase Bank 3,065
5 Wells Fargo Education Financial Services 2,955
6 Wachovia 2,934
7 College Loan Corp 1,493
8 US Bank 1,333
9 EdAmerica 1,304
10 Access Group 1,125
11 Northstar Guarantee 1,062
12 Education Lend Group 1,020
13 Suntrust Bank 948
14 Pittsburg National Corp 891
15 National Education Loan Network (NELNET) 839
16 Citizens Bank Education Finance 716
17 College Foundation Inc. 662
18 Regions 647
19 Pennsylvania Higher Education Assistance 624
20 Fifth Third 567
Others 12,146
Total Industry 51,907
Source: www.finaid.org
Rank Lender Holder
Volume
1 Sallie Mae 128,088 2 Citibank Student Loan Corporation 28,038 3 National Education Loan Network (NELNET) 25,770 4 Brazos Group 14,391 5 Wells Fargo Education Financial Services 11,996 6 Pennsylvania Higher Education (PHEAA) 11,984 7 Wachovia Education Finance 10,964 8 JP Morgan Chase Bank 10,250 9 College Loan Corporation 10,242 10 Education Lending Group 10,130 11 Goal Financial 7,541 12 GCO-ELF 6,413 13 Access Group 5,562 14 Northstar Guarantee 4,959 15 Missouri Higher Education (MOHELA) 4,544 16 Bank of America 4,541 17 EdAmerica/Edsouth 3,334 18 Suntrust Bank 3,170 19 College Foundation Inc. 2,870 20 South Carolina Student Loan Corp 2,653 Other 55,079
Total Industry 362,518
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FFELP loan consolidators
FY2007 top consolidators of FFELP loans ($ millions)FY2007 top consolidators of FFELP loans ($ millions)
Rank Lender Consolidation
Volume
1 Sallie Mae 12,554
2 National Education Loan Network (NELNET) 4,529
3 Next Student 3,021
4 Affinity Direct 2,108
5 JP Morgan Chase Bank 1,825
6 Education Lending Group 1,731
7 Citibank Student Loan Corporation 1,586
8 Wells Fargo Education Financial Services 1,428
9 College Loan Corporation 1,269
10 PA Higher Education (PHEAA) 1,258
11 Graduate Leverage 1,095
12 Pacific Loan Proc 1,090
13 Goal Financial 743
14 Erie Processing 675
15 Missouri Higher Education (MOHELA) 674
16 Wachovia Education Finance 654
17 Academic Loan Group 630
18 FinanSure Student Loan 628
19 Brazos Group 622
20 EdAmerica/EdSouth 557
Others 8,614
Total Industry 47,290 Source: www.finaid.org
Consolidation volume dropped to $47.3bn in FY2007 from $72.4bn in FY2006, a 35% decline
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Ensuring Continued Access to Student Loans Act of 2008
Signed into law by the President on May 7th
Key provisions
ED (Dept of Education) to serve as secondary market for FFELP loans until July 2009 (Prohibits such loan purchases from resulting in any cost to the federal government)
Clarify ED’s authority as “lender of last resort” with capital— Authorizes Secretary of Education to advance funds to guaranty agencies
acting as lender of last resort— Include parent borrowers in lender-of-last-resort program for those unable
to obtain loans
Allow deferment of PLUS loans until 6 months after graduation
Increase annual loan limit by $2k and aggregate limit to $31k/$57.5k for dependent/independent undergraduates
Authorizes lenders, for loans made from July 2008 through June 2009, to determine that borrowers of PLUS, who are no more than 180 days delinquent on their home mortgages, and no more than 89 days delinquent on the repayment of any other debt, meet a specified extenuating circumstances requirement which makes them eligible for such loans despite having an adverse credit history
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Reductions to lenders in the FFELP program (College Cost Reduction and Access Act of 2007)
Eliminate the "Exceptional Performer" status that allows lenders that meet certain requirements established by the Secretary of Education to receive higher insurance rates on defaulted loans
Reduce the insurance paid by the federal government to lenders on defaulted loans from 97 percent to 95 percent of unpaid principal balances on October 1, 2012
Reduce the amount that guarantors may keep through collections on defaulted loans from 23 percent to 16 percent
Reduce the special allowance payments (SAP) from the Department to lenders based on their tax status. For-profit lenders would receive a 55 basis point SAP reduction and non-for-profit lenders would receive a 40 basis point SAP reduction. To ensure that only nonprofit lenders benefit from the increased subsidization, nonprofit lenders that are owned in-whole or in-part by a for-profit entity would not be eligible for the reduced subsidy reductions. Nonprofit lenders that are purchased by for-profit entities would also lose their higher subsidization rateson the date of the sale
Increase the loan fee paid to the Department by lenders - that cannot be passed on to borrowers - from 0.5 percent to 1 percent of the principal amount of each newly originated loan made on or after October 1, 2007
Decrease the account maintenance fees paid by the Department to guarantors from .10 percent to .06 percent on newly originated loans
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Since 1993, securitization has been a cost effective alternative to secondary market financing
With the explosive growth of ABS market and the recognition of student loans as high quality assets, lenders increasingly securitize their portfolios
The relatively low credit enhancement required in student loan ABS has attracted a number of institutions to pursue securitization
In 1993, Society Bank (now KeyCorp) became the first issuer of public student loan ABS and many other issuers have followed suit
Sallie Mae’s emergence in the ABS market, however, redefined student loan securitization. The company is the largest Student Loan ABS issuer (accounting for roughly half of supply)
Established in 1965, the Family Federal Education Loan Program (FFELP) has helped make higher education affordable by providing access to guaranteed student loans
FFELP loans are financed by private lenders, serviced and administrated by the private sector
FFELP volume nationwide total approximately $85bn in fiscal year 2006
FFELP loan benefit from U.S. Government guarantee
97% (initial loan disbursement 7/06 and after), 98% (10/93 to 6/06) or 100% (pre 10/93), guaranteed for principal and accrued interest
Will decline to 95% on October 1, 2012
Borrower benefits
Long term financing (up to 30 years if consolidated)
Interest subsidies during “in school” period on some loans
Deferment/forbearance allows borrower to temporarily stop payments if they return to school or experience financial hardship
FFELP loans are not dischargeable in bankruptcy
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FFELP loan types
FFELP provides the following types of loans
Stafford loans — Subsidized: To students demonstrating financial need— Unsubsidized: To students who either do not demonstrate need or require supplement to
Subsidized loan
PLUS: To graduate and professional students and or parents of undergraduates (in excess of Stafford
Consolidation loans: Consolidation multiple loans under FFELP into one for the borrower
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Stafford LoansStafford Loans PLUS LoansPLUS Loans Consolidation LoansConsolidation Loans
Collateral:FFELP student loan types
Variable interest rate, reset annually, capped at 8.25%
91-day T-bill + 1.7% during in-school, grace and deferment periods; 91-day T-bill + 2.3% during repayment
10 years
Year 1: $2,625Year 2: $3,500Years 3/4: $5,500Graduate: $8,500
Variable interest rate, reset annually, capped at 9.00%
91-day T-bill + 3.1%
10 years
Up to cost of education, less other aid received
Fixed interest rate for life of loan, capped at 8.25%
Weighted average of interest rates of loans consolidated, rounded up to nearest 1/8th of one percent
30 years
Not applicable
Interest RateInterest Rate
FormulaFormula
Max Repayment Period
Max Repayment Period
Max Annual LoanMax Annual Loan
For loans distributed after July 1, 1998 and before July 1, 2006 , subject to a maximum interest rate of 8.25%. The cap is offset by Special Allowance Payments (SAP) by the ED to lenders.
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Stafford student loan rates
Stafford loan ratesStafford loan rates
Trigger Date Borrower Rate Maximum Borrower Rate Interest Rate Margin
<10/1/81 7% 7% N/A
1/1/81-9/12/83 9% 9% N/A
9/13/83-6/30/88 8% 8% N/A
7/1/88-9/30/92 8% for 48 months; then, 91-day Treasury + Margin
7/1/95-6/30/98 91-day Treasury + Margin 8.25% 2.50% (in school, grace, or deferment), 3.10% (repayment)
7/1/98 – 6/30/98 91-day Treasury + Margin 8.25% 1.70% (in school, grace, or deferment), 2.30% (repayment)
7/1/06 - 9/30/07 Fixed 6.8% N/A
>10/1/07 Decline to fixed 3.4% by 7/1/2011 N/A
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PLUS student loan rates
PLUS loan ratesPLUS loan rates
Trigger Date Borrower Rate Maximum Borrower Rate Interest Rate Margin
Before 10/01/81 9% N/A N/A
From 10/01/81 through 10/30/82 14% N/A N/A
From 11/01/82 through 06/30/87 12% N/A N/A
From 07/01/87 through 09/30/92 1-year Index + Interest Rate Margin 12% 3.25%
From 10/01/92 through 06/30/94 1-year Index + Interest Rate Margin PLUS 10%, SLS Loans 11% 3.10%
From 07/01/94 through 06/30/98 1-year Index + Interest Rate Margin 9% 3.10%
From 07/01/98 through 06/30/06 91-day Treasury + Interest Rate Margin
9% 3.10%
From 07/01/06 8.5% 8.5% N/A
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Consolidation loans
Consolidation loan benefitsConsolidation loan benefits Maximum term by debt burdenMaximum term by debt burden
Extends loan term from 10 years up to 30, thereby reducing their monthly payments, albeit at a higher total interest cost.
Converts adjustable-rate loans to a fixed-rate, locking in the interest rate for the life of the loan. Interest rate is the weighted average of the rates on the student loans, rounded to the nearest 1/8th.
For borrowers with multiple lenders, allows the borrower to make only one single payment to one lender. Payment to the single lender begins 60 days after disbursement. There is no “grace period”.
Total Educational Debt Max Term (years)
< $7,500 10
$7,500-$9,999.99 12
$10,000-$19,999.99 15
$20,000-$39,999 20
$40,000-$59,999 25
> $60,000 30
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Interest Subsidy Payments and Special Allowance Payments
Dept of Education (ED)
Borrower
SAP and ISP
Paid quarterly
Principal and Interest
Lender
Interest Subsidy Payment (ISP)
Federal government pays for in-school, grace and deferment interest on subsidized loans
Available for Stafford Subsized and Subsidized Consolidation Loans
Special Allowance Payment (SAP)
Provides lenders with minimum returns to either the 91-day T-Bill or 90-day CP plus a spread
Available for Stafford and Consolidation Loans
Available for PLUS loans when borrower hits a cap
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Special Allowance Payment (SAP)
SAP calculationSAP calculation
Date of first disbursement Special Allowance Margin
From 10/1/92 through 6/30/95 3.10%
From 7-1/98 through 6/30/98 2.50% for Stafford loans that are In-School, Grace or Deferment
3.10% for Stafford Loans that are in Repayment and all other loans
From 7/1/98 through 12/31/99 2.20% for Stafford Loans that are In-School, Grace or Deferment
2.80% for Stafford Loans that are in Repayment
3.10% for PLUS, SLS and Consolidation Loans
From 1/1/00 1.74% for Stafford Loans that are In-School, Grace or Deferment
2.34% for Stafford Loans that are in Repayment
2.64% for PLUS and Consolidation Loans
Under legislation effective 10/1/07 55bp cut for Stafford and PLUS (not-for-profit 40bp cut)
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Guarantors
Private non-profit corporations
Act as “middle men” between lenders and the federal government agency
Monitor the compliance of schools that participate in FFELP
Receive fees for insurance, default aversion, account maintenance, etc.
Are reinsured by the Department of Education for amounts paid on defaulted claims
Make recoveries on defaulted loans (currently 50% to 75%) on behalf of federal government
Guarantee timelineLender must submit default claim after at least 270 day delinquentGuarantor must review and pay claim within 90 days after the lender filed itGuarantor will pay the lender accrued interest for up to 450 days delinquentGuarantor must file reimbursement claim with Dept of Ed within 30 days of paying default claim to lender
Student Pays
Guarantor Pays
Yes No
Yes No
Rejected Claim
US Dept of Education pays
claim or reassigns guarantor
Claim “cured”
Credit enhancement absorbs losses
Yes
No
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Servicer Guarantor
Claim Package
98% reimbursement
Collect payments
Process deferments
Reinsurance claim
Reinsurance $
US Departmentof Education
Apply for ISP
Apply for SAP
Collection on delinquent loans
Submit claim package to guarantor
Capable servicing: a key component in ensuring the Department of Education (ED) guarantee
Adherence to ED servicing guidelines is critical to maintain guarantee
Servicers are audited regularly by an independent firm to verify servicing quality and compliance with ED procedures
Rating agencies also review servicer’s ability to meet all compliance requirements
Assuming quality servicing, the predominant risk is liquidity – timing of claim filing and receipt of guaranty
ED guaranty remains valid in event of Guarantor failure
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Cash flow dynamics of FFELP student loans
Department of Education
State and private guarantee agencies
ABS investors
Securitization trustOriginator/holder of loan
Servicer
Defaulted loan claim package
Claim $$$
$$$
Normal payment scenario
Student default scenario
ED reinsurance of 95-100% of principal and accrued interest
Loan payments
Student borrower
Interest subsidy payments are paid on qualifying loans to the loan holders while students are in school
Special Allowance Payments are paid to holders of student loans to ensure they receive a market interest rate of return
Loans remain eligible for ED guaranty so long as servicers follow specified diligence guidelines
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Most issuers utilize similar senior-subordinate structures
100% consolidation collateralUnderlying collateral indexed to 90-day CP (98.6%) or 91-day T-Bills (1.3%)Interest rate is capped at 6%. The cap matures in 1 yearCredit enhancements include:
3.00% subordination0.25% reserve fund Capitalized interest account of $10 millionExcess spread available
100% FFELP collateralUnderlying collateral indexed to 90-day CP (90.2%) or 91-day T-Bills (9.8%)The securities were not subject to a cap, and as a result of the underlying CP collateral, the uncapping was achieved structurallyCredit enhancements include:
3.0% subordination0.25% reserve fund Excess spread available
SLM 2005-3SLM 2005-3 SLM 2005-1SLM 2005-1
Senior and subordinate notes backed by government guaranteed student loans Class A notes and Class B notes are rated ‘Aaa/AAA/AAA’ and ‘Aa1/AA/AA+’ or greater by Moody’s/S&P/Fitch, respectively10% clean-up calls and auction calls are used
Student Loan Trust
Capped ‘AAA’Class A-1 to A-6
Notes
Capped ‘AA’Class B Note
Investors
Swap
Student Loan Trust
Uncapped ‘AAA’Class A-1 Note
Uncapped ‘AAA’Class A-2 Note
Uncapped ‘AA’Class B Note
Investors
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Basic credit card securitization cash flows
Interest income
Net recoveries on charged off assets
Interchange
Fee income
Servicing fee to servicer (typically 2.00%)
Interest payment on Class A Notes
Interest payment on Class B Notes
Interest payment on Class C Notes
Deposit to the spread account
Excess spread to residual holder
Available finance charge collectionsAvailable finance charge collections Priority of distributionPriority of distribution
Available principal collectionsAvailable principal collections Priority of distributionPriority of distribution
Principal collections
Cover interest shortfalls on each class of Notes
Cover servicing fee shortfalls
Make targeted deposit to Class A principal funding account
Make targeted deposit to Class B principal funding account
Make targeted deposit to Class C principal funding account
Excess paid to residual holder74S
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Credit EnhancementGovernment guaranty
FFELP loans benefit from a 95-100% guaranty ultimately backed by the DOE.
Excess spread available to cover losses not covered by guaranty
Excess funds from the interest paid on the student loans after expenses
Ranges from 75-125bp.
Reserve account
Cash deposited and/or captured
Subordination
Interest and principal that would have otherwise been distributed to subordinate classes is re-directed to more senior classes
Overissuance, driven by the rating agencies, is further evidence of the superior collateral quality.
Deals with large amounts of ARS will build parity more slowly than expected due to higher funding costs; some deals will be unable to build parity if ARS market does not recover
Asset spread— Funding cost
— Servicing = Excess spread
Parity exampleParity example
Initial Parity 97% End of Year 1 parity 98%
Asset Liability Asset Liability
97 97 AAA 94 93 AAA
3 A 3 A
97 100 94 96
97.57%97.60%97.51%
97.66%
97.0%
97.2%
97.4%
97.6%
97.8%
98.0%
Apr-07 Jul-07 Oct-07 Jan-08
College Loan Corp 2007-1 (low initial parity of 97.4%, high ARS funding of 59% )
College Loan Corp 2007-1 (low initial parity of 97.4%, high ARS funding of 59% )
Note: Term ABS 41% at weighted average spread of +6bpSource: Deal documents
100 bps in year 16 month spikes up to 300 bps for 5 years, reverting back to 100 bps
60 days60 days
19%
75.0% yr. 112.5% yr. 212.5% yr. 3
97% on 98% loans99% on 100% loans
Historical
Historical
Capitalize all interest on balance
75 bps in year 16 month spikes up to 120 bps for 5 years, reverting back to 75 bps
60 days60 days
DefaultsApplication
DefaultsApplication
ReimbursementsReimbursements
ForebearanceForebearance
DeferralsDeferrals
Unsubsidized loans
Unsubsidized loans
TED SpreadTED Spread
Payment LagsStudentSAP & ISP
Payment LagsStudentSAP & ISP
Rating Agency Stress Tests
All scenarios are designed to test the transaction’s liquidity rather than credit
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Structure:Factors affecting prepayments
Student loan prepayment may be broken down to three main segments
Voluntary prepayment
Loan consolidation prepayment
Involuntary prepayment (default)
Loan type (e.g., Stafford, PLUS, consolidation) and payment status (e.g., in-school, deferral/forbearance, in re-payment) also affect speeds for each segment
For example, a Stafford loan just entering into re-payment will exhibit higher initial prepayments than other loan types. This would be the case of a student graduating and choosing to prepay/consolidate his/her loan or cannot find a job and defaults
School type (e.g., vocational, 2-year, 4-year), borrower age/indebtedness and seasonality (the school year) are some other factors
Excess spread is first line of defenseExcess funds from the interest paid on the home equity loans after expenses
OvercollateralizationUtilization of excess spread to accelerate principal payments to bondholders
SubordinationInterest and principal that would have otherwise been distributed to subordinate classes is re-directed to more senior classes
Financial GuaranteeTypically a surety bond issued by monoline insurance company or Fannie/Freddie which guarantees timely payment of interest and ultimate repayment of principal
Mortgage Insurance (Lender Paid)Use of deep mortgage insurance to cover losses up to a specified LTV
Loans typically amortize principal over their term-to-maturity. Some loans require balloon payments.
Loans may prepay in advance of the scheduled maturityVoluntary prepayment— Refinancing or sale of homeInvoluntary prepayment— Repossession or loss of homeWhen a prepayment occurs, principal is paid through to the security holders, thus retiring that portion of principal that is attributable to the loan that has prepaidPrepayment measured by Constant prepayment model (CPR)
Home Equity loans exhibit much less negative convexity as compared to Conforming and Jumbo MBS.
Typical HEL ABS Deal CharacteristicsPricing Benchmarks Swaps, EDSF, LIBORCoupon Type Fixed or FloatingTypical New Issue Size $750 million - $2 billionTranched by credit rating and maturity
Prepayment rates are expressed in terms of Constant Prepayment Rate (CPR), which measures monthly prepayments as a percentage of the previous month’s outstanding principal balance.
Variation in prepayments from those expected at pricing can lengthen or shorten the bond’s life
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Structure:Factors affecting prepayments
Interest rates
Incentive is a function of interest rates, shape of the curve, and loan rate. Higher quality borrowers tend to be more sensitive than lower quality borrowers due to the increased quantity of refinancing options.
Home Price Appreciation
Housing Market: Price appreciation may allow borrowers to take additional equity out or trade up their houses.
Credit quality
An improvement in credit history provides incentive for lower quality borrowers to refinance as their improved status makes possible substantial savings.
Prepayment penalties
Dramatically reduce the incentive to refinance while penalty is in effect.
Typical prepayment penalty is 6 months interest on 80% of the loan.
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Class WAL (Yrs) Rating Collateral Type Fx/Fl
Class
WAL (Yrs)
Rating Collateral Type Fx/Fl
AF-1 1 AAA FRM group Sequential FX 1AV-1 2.5 AAA ARM conforming Pass-through FL
AF-2 2 AAA FRM group Sequential FX 2AV-1 1 AAA ARM non-conf Sequential FL
AF-3 3 AAA FRM group Sequential FX 2AV-2 3 AAA ARM non-conf Sequential FL
AF-4 5 AAA FRM group Sequential FX 2AV-3 7 AAA ARM non-conf Sequential FL
AF-5 7 AAA FRM group Sequential FX
AF-6 6 AAA FRM group NAS FX
M-1 6 AA All groups Subordinate FL
M-2 6 A All groups Subordinate FL
B-1 6 BBB All groups Subordinate FL
B-2 6 BB All groups Subordinate FL
Class WAL (Yrs) Rating Collateral Type
FX/FL
Class
WAL (Yrs)
Rating Collateral Type FX/FL
AF-1 1 AAA FRM group Sequential FX 1AV-1 2.5 AAA ARM conforming Pass-through FL
AF-2 2 AAA FRM group Sequential FX 2AV-1 1 AAA ARM non-conf Sequential FL
AF-3 3 AAA FRM group Sequential FX 2AV-2 3 AAA ARM non-conf Sequential FL
AF-4 5 AAA FRM group Sequential FX 2AV-3 7 AAA ARM non-conf Sequential FL
AF-5 7 AAA FRM group Sequential FX MV-1 6 AA ARM groups Sequential Sub FL
AF-6 6 AAA FRM group NAS FX MV-2 6 A ARM groups Sequential Sub FL
MF-1 6 AA FRM group Sequential Sub FX BV 6 BBB ARM groups Sequential Sub FL
MF-2 6 A FRM group Sequential Sub FX
BF 6 BBB FRM group Sequential Sub FX
“Y” structure“Y” structure
“H” structure“H” structure
Structure:Sample capital structures
“H” structure: two groups each with its own senior/subordinated structure
“Y” structure: two separate groups backing separate senior tranches; both groups backing subordinated tranches
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Structure: Stepdown
Sample target credit support percentagesSample target credit support percentages
Subordinated bonds locked out (i.e., do not receive principal) prior to the stepdown date
Stepdown date typically set at the earlier of
1) AAAs paid off or
2) the latter of — i) 36 months from deal closing and — ii) when senior credit enhancement reaches target
On or after the stepdown, subordinated bonds receive principal only is the triggers are passing
Initial Credit support After Stepdown Date Target
Credit Support
Senior Certificates (AAA) 17.90% 35.80%
M-1 (AA+) 14.80% 29.60%
M-2 (AA) 12.85% 25.70%
M-3 (AA-) 11.05% 22.10%
M-4 (A+) 9.40% 18.80%
M-5 (A) 7.85% 15.70%
M-6 (A-) 6.45% 12.90%
M-7 (BBB+) 5.20% 10.40%
M-8 (BBB) 4.20% 8.40%
M-9 (BBB-) 3.15% 6.30%
M-10 (BB+) 2.00% 4.00%
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Structure:Triggers
Performance triggers are embedded in the transaction typically to increase credit enhancement in the face of weaker than expected credit performance
If performance triggers fail, principal that would have otherwise have gone to pay down the overcollateralization, mezzanine and subordinate bonds are redirected to pay senior bonds. Bonds revert to sequential pay.Trigger typically will shorten senior bonds and extend subordinate bonds
Usually compares credit enhancement with delinquencies or based on life-to-date cumulative losses (can be “static” or “dynamic”).
Sample Cumulative Loss TriggerSample Cumulative Loss Trigger Sample Delinquency TriggerSample Delinquency Trigger Sample Trigger EffectSample Trigger Effect
Distribution Date %
July 2007 – June 2008 3.00%July 2008 – June 2009 4.75%July 2009 – June 2010 6.00%July 2010 6.75%
60+ Delinquent loans including loans in foreclosure, bankruptcy and REO > 40% * credit enhancement for prior distribution date
OC target will not step down
Deal will pay sequentially
Sub bonds extend, OC release delayed until cured
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Structure:Impact of triggers on cashflow
Home Equity Principal Cashflow – Pass TriggersHome Equity Principal Cashflow – Pass Triggers
Home Equity Principal Cashflow – Fail TriggersHome Equity Principal Cashflow – Fail Triggers
0 20 40 60 80 100 120 140 160 180
AAA pass throughAAA 1yrAAA 3yrAAA 7yr
AAA
BBBBB+
Months
0 20 40 60 80 100 120 140 160 180
AAA pass throughAAA 1yrAAA 3yrAAA 7yr
AAA
BBBBB+
Months
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Structure:Cap risk in Home Equity ABS
Available funds cap
Cap limits the bond coupon to the WA loan rate less servicing fees and other costs
Underlying mortgages subject to initial, periodic and lifetime caps (typically 3%/1%/6%)
Lifetime caps are generally quite high and unlikely to be a limiting factor
On most deals a “shortfall reimbursement” feature covers any interest payment shortfalls by drawing on future excess spread
Transactions may also purchase LIBOR caps or enter into corridors/swaps to mitigate risk
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Structure:Interest rate hedging instruments – caps and swaps
Primary function is to mitigate basis risk (mismatch in asset and liability interest rates)Collateral — Predominantly pays fixed interest for first 2-3 years (due to fixed and hybrid ARM loans)— Floating interest typically references 6-mo LIBORBonds typically pay floating interest referencing 1-mo LIBOR
Interest Rate Caps and SwapsReference 1-mo LIBORAmortizing notional amountsConstant or changing strike rates
Interest Rate CapsRequire an initial cash outlay at deal closingProtect from rise in interest rates above strike
Interest Rate SwapsAlter cashflow characteristics to match those of the assets and liabilities Counterparties agree to swap periodic payments (trust pays fixed, receives floating)
Payments received usually flow through cashflow waterfall
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0%
5%
10%
15%
20%
25%
1 3 5 7 9 11 13 15 17 19 21 23
2000 2001 2002 2003
2004 2005 2006 2007
0%
10%
20%
30%
40%
50%
60%
70%
3 5 7 9 11 13 15 17 19 21 23
2000 2001 2002 2003
2004 2005 2006 2007
Source: JPMorgan, Intex.
HEL ABS ARM prepayments by loan age (CPR)HEL ABS ARM prepayments by loan age (CPR) HEL ABS ARM delinquencies by loan age (60+ delinquencies)HEL ABS ARM delinquencies by loan age (60+ delinquencies)
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