Fitch: Pending Legislation Spells Uncertainty for U.S. Student Loan ABS.

NEW YORK -- On July 11, 2007, the U.S. House of Representatives passed the College Cost Reduction Act of 2007 (H.R. 2669) by a vote of 273 to 149. Nine days later, the U.S. Senate passed its version, the Higher Education Access Act of 2007 (S. 1762) by a vote of 78-18. Both bills now move to conference where they will be reconciled and submitted to the President for signature. Fitch believes that certain items in the bills could have an impact on future U.S. student loan asset-backed securities (ABS) transactions and are likely to lead to a change in the landscape of student lending industry. Given that both versions focus on Federal Family Education Loan Program (FFELP) issuance on a forward looking basis, Fitch does not anticipate the current legislation will result in any rating actions on existing ABS transactions backed by FFELP student loans. However, Fitch believes that as proposed, the legislation would:

--result in higher initial credit enhancement for new FFELP transactions due to lower excess spread from reduced Special Allowance Payments (SAP);

--result in higher initial credit enhancement for new FFELP transactions due to a lower reimbursement guarantee;

--result in a material change in the economics for, and hence viability, of certain lenders.

Background:

The proposed legislation amends the Higher Education Act of 1965 by instituting a number of changes to the federal financial assistance programs related to postsecondary education. Affected programs include the FFELP, the Federal Direct Student Loan Program, the Federal Perkins Loan Program, the Pell Grant Program and a number of new and expanded grant programs. The House version also incorporates an effort to contain annual tuition increases at levels below the national average increase through a grant program.

The FFELP is a focal point of the proposed legislation. The House proposal calls for lowering interest rates on subsidized Stafford loans from the current fixed rate of 6.8% to 3.4% over the next five years, while increasing loan limits by $2,000 annually for third and fourth year students, resulting in aggregate borrowing levels increased by $7,500. Additional affordability measures include an income-based repayment program and a loan forgiveness program for qualified borrowers. Provisions affecting lenders and guarantors include a reduction in SAP, Lender Insurance Percentages and Guaranty Agency Collection Retention Amount as well as an increase in the loan origination fees paid by lenders and a repeal of the Exceptional Performer (EP) status. While the Senate bill contains similar components, it is most notably silent on both the reduction in interest rates and the increased loan limits.

Impact on Student Loan ABS:

Current SAP rates for FFELP loans are 90-day commercial paper (CP) plus 1.74% for Stafford loans in school, grace, and periods of deferment, and 90-day CP plus 2.34% for Stafford loans in repayment. PLUS and federal consolidation loans carry a 90-day CP plus 2.64% rate. Under both versions of the legislation, these rates will be reduced for loans disbursed on or after Oct. 1, 2007. Under the House plan, SAP rates will be reduced by 0.55% for Stafford and consolidation with PLUS loans reduced 0.85%. The Senate recommends reductions of 0.50% and 0.80%, respectively, adding a not-for-profit clause limiting reductions to 0.35% and 0.65%, respectively. In all cases, the 30 bp. differential in SAP margin reductions between PLUS and Stafford loans would cause PLUS loans to have the same SAP rate as Stafford loans in repayment. Fitch expects these decreases to affect credit enhancement levels for future transactions that finance increasingly higher percentages of loans disbursed after the cut-off date. Excess spread, the primary source of credit enhancement in student loan ABS, would decline. This may cause premium proceeds structures to take a longer period of time to reach an asset to liability, or parity, ratio of 100%.

Also effective Oct. 1, 2007 is the potential reduction of the reimbursement guarantee provided by FFELP guarantors to lenders. While the Senate proposes keeping the guarantee level at 97%, the House bill suggests a reduction from 97% to 95%. Should the House version carry, Fitch would expect to see an increase in loan loss severity; however, this increase is expected to be small in dollar terms. For example, assuming a 40% default rate on a $1 billion transaction with a one-to-one parity ratio, the amount of principal loss resulting from a 2% reduction in guaranty reimbursement is $8 million representing an increase in net principal losses of 0.80%. Fitch believes excess spread levels on future transactions financing these loans will be sufficient to cover the increased loss amounts depending on the final adjustment to the SAP rates.

Both bills modify the current maximum three-year period for which a borrower can receive an economic deferment extending it to six years in the case of the Senate and eliminating the maximum in the House version. A new income-based repayment plan is also introduced, similar to the current income-contingent repayment (ICR) plan in the direct student loan program. Under the proposed plans, a borrower will be considered to have a Partial Financial Hardship should their total federal student loan payments exceed 15% of their calculated income. Calculated income is defined as adjusted gross income less an amount which is 150% of poverty line applicable to the borrower's family size. As a result of this hardship, a borrower can elect to have their payments limited to 15% of their calculated income.

The House proposes that any interest shortfall resulting from these lower payment levels be capitalized during the hardship period. Fitch believes that this may place a liquidity constraint on future transactions financing larger balance loans or loans to borrowers with incomes not substantially higher then 150% of the poverty level. Alternatively, the Senate requires the U.S. Department of Education (DOE) to pay the interest shortfall during the hardship period, mitigating the liquidity constraint to an extent depending on when lenders receive payments. In addition, both bills provide for loan forgiveness in the form of a government payment of 100% of any remaining principal and interest should the reduced payment plan cause the loan to remain outstanding beyond the maximum allowable repayment period. This repayment period is set at 20 years and 25 years in the House and Senate legislation, respectively.

Fitch also believes that the combination of potential FFELP loan limit increases under the House bill as well as the introduction of new grants and enhancements to existing grant programs under both bills will have an affect on origination volume for both FFELP and private student loan lenders. While most of the grant programs focus on segments of the student population not traditionally served by private student loan lenders, a program available in the House version could impact private programs.

As part of an effort to restrain tuition increases, the House proposes that students attending institutions who maintain annual tuition increases below the national average be eligible for additional grant dollars. Assuming that those dollars are allocated to students unable to borrow under private programs, the overall cost of education at these institutions would grow at a slower pace, directly affecting all eligible private loan borrowers at that institution. This could result in lower private student loan origination volume.

The following two provisions will not have an impact on future or existing student loan ABS but do impact the economics of the student lending business:

--The repeal of the EP status under both bills will eliminate the reimbursement guarantee rate of 99% for previously eligible servicers. Historically, Fitch has not given credit to this additional coverage above the standard reimbursement rates since the EP designation is applicable in one-year increments providing no assurance that future designations would apply.

--Both bills also call for change to the lender origination fee paid by lenders to the DOE, increasing the amount from 0.50% to 1.0% with the House version providing an exception to small lenders, governmental and non-profit entities. Additionally, the amount the collection retention amount allowed Guaranty Agencies is reduced from 23% to 16% in both versions.

The remaining provisions of each bill as currently drafted do not appear to have a material affect on the economics of existing or future student loan ABS transactions and, therefore, Fitch does not anticipate that these provisions will have an impact on outstanding ratings.

Fitch's rating definitions and the terms of use of such ratings are available on the agency's public site, 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.