Thursday, January 28, 2016

Restudying Student Loan ABS

What ever happened to Student Loan ABS deals (aka SLABS)?

Back in 2005 they were "[displaying] exceptionally strong credit quality."  But those same deals -- not just 2005-2006 vintage subprime crisis era concoctions -- have taken a turn for the worse. The storm of circumstances surrounding SLABS that is now coming to light and causing losses and downgrades is not dissimilar to that which surrounded crisis-era RMBS deals.

We visited 18 trusts from the National Collegiate Student Loan Trust (NCSLT) shelf, comprising a total of 140 tranches.

Not all tranches performed poorly.  Several of those tranches had paid down in full.  But all 18 trusts have tranches outstanding (89 in total) and all of these outstanding tranches, including those initially rated AAA, are currently rated in junk territory or deep junk territory by both Fitch and S&P.   (However, Moody’s has held some in the investment-grade region, and for full disclosure, some downgraded securities are on S&P's watchlist for possible upgrade.)

Anatomy of a SLABS

Let’s take a closer look at one tranche of one deal in particular, The National Collegiate Student Loan Trust 2003-1 A-7, an originally-rated AAA tranche of a 2003 vintage deal ... a deal that started accumulating losses in 2004.

The following table shows the initial and current ratings of the four outstanding NCSLT 2003-1 tranches:

This trust is not atypical, and thus worthwhile to examine as a representative deal. Tranche A-7 consists of floating rate notes with a notional of $250 million and a maturity of 8/25/30.  At the time of issuance, the principal and interest of these private student loans were 100% guaranteed by The Education Resources Institute, Inc. (TERI), which was at the time of closing rated Baa3 by Moody’s. TERI subsequently folded into bankruptcy, but that's only part of the story, and not a central concern, at least for the A-7s.

In addition to TERI's support, at initiation, tranche A-7’s credit support additionally consisted of subordinate tranches B-1 and B-2 ($41.25 million each) plus a reserve fund of some $88 mm.

The AAA ratings started to disappear in 2008 -- Moody's began downgrading in 2008, with Fitch and S&P following suit in 2010 --  and the ratings deterioration has continued since then.

By June 2013, Moody's reported that their projected lifetime default % of the original pool NCSLT 2003-1 was at the time at 40%, higher than the break-even lifetime default rate of 34%. Thus, per Moody's, our beloved A-7 tranche would not fully repay by its maturity date.

A full timeline of activity follows at the bottom of this post.

Meanwhile, in Ohio...

Adam Beverly reportedly took out a $30,000 student loan from Bank One, N.A. in September 2003. His mother, Linda Beverly, acted as cosigner of the loan.

According to one of Bloomberg News’ sources Beverly’s monthly payments were initially around $120 when he entered repayment and subsequently increased to more than $600. The story has it that he was reportedly bounced back and forth between First Marblehead and National Collegiate when he tried to discuss his payments, and he stopped making payments in 2009. The Beverlys reportedly hired a debt negotiation company, Student Loan Relief Organization (“SLRO”) to negotiate payment arrangements for the loan.

On April 16, 2012, the National Collegiate Student Loan Trust 2003-1 Trust filed a lawsuit against Adam Beverly and his mother Linda demanding repayment of the loans. Upon receipt of the summons, Linda Beverly called their SLRO contact, who said he would “take care of it.” After several weeks passed, her contact stated that SLRO would be unable to accomplish anything on the loan.

Linda and Adam Beverly purportedly attempted to contact the attorney representing NCSLT 2003-1 and Ms. Beverly also spoke directly to individuals at the National Collegiate Student Loan Trust who could not find any record of the loans.

The trial court granted default judgment against Adam and Linda Beverly on June 25, 2012. The default judgment awarded the 2003 Trust damages of $43,713.22, accrued interest of $5,017.42 through April 4, 2012, and interest at a variable interest rate from April 5, 2012.

Adam and Linda Beverly appealed, and a panel of Ohio Supreme Court judges vacated the default judgment on September 30, 2014. They found that NCSLT filed a complaint in its own name, on notes payable to someone else, without alleging or proving assignment of the notes. In other words, NCSLT could not produce any documents showing that it owned the Beverly student loan. 

NCSLT also sued Adam Beverly for a loan taken out in 2005 and packaged in NCSLT 2006-1, with a similar result.

The Takeaway

A difficult economy and high unemployment among graduates has led to a high level of defaults in the loans underlying NCSLT 2003-1. If Adam Beverly’s case is at all representative of NCSLT or FMC’s standard practices, the negotiation process (outside of the courts, at least) has not exactly been mastered. Indeed National Collegiate trusts have filed more than 4,000 lawsuits since 2011. Student debtors are fighting back as well, with judges in several states finding that the trusts haven’t proved they own the debt.

We see shades of the RMBS debacle here, with sloppy record-keeping.  Massachusetts AG Maura Healey, who likely has a wider lens, reportedly labels them “abusive loan debt-collection tactics."

These factors are leaving some borrowers without relief, and trusts at times with no legal recourse to collect on their debt. Not to mention some investors in AAA rated debt have been stuck with the resultant junk.

Friday, January 22, 2016

Year of the OIL

Happy new year readers, and welcome to what's increasingly looking to be a year influenced by oil prices (and perhaps considerations of global warming).

Our first post looks at a phenomenon in the world of robotic, efficient markets: a stark inefficiency.

Yesterday Thursday, January 21, shares of exchange-traded note OIL closed down 17%, so we forgive you if you thought that oil had taken another bludgeoning.  Meanwhile, WTI crude oil futures closed up 11% – its best performance of the year so far.  

OIL is the ticker for the iPath® S&P GSCI® Crude Oil Total Return Index ETN.  Page 1 of OIL’s prospectus states, “The return on the ETNs is linked to the performance of the S&P GSCI® Crude Oil Total Return Index,” so OIL could be expected to go up when oil goes up, and vice-versa.

Below is a table of daily returns from the past 7 trading days ... and we see that OIL isn’t doing such a good job of tracking oil’s performance:

Why did OIL tank yesterday, while oil surged?

The answer, in part, is that a market inefficiency (aka a "whoops") was being corrected, or arbitraged away, finally.  But the story gets more interesting...

It’s all about the ETN’s premium to its daily redemption value – think net asset value (NAV).  The daily redemption value is what an investor could redeem his ETN for by turning over his shares to the ETN issuer (in this case, Barclays).  Since the turn of the year, as the price of crude has plumbed new lows, OIL has not fallen nearly has much as it should have.  While the daily redemption value has fallen over 35% YTD, as of Wednesday’s close (1/20) OIL shares were down less than 12% YTD, driving the premium to 49%!  And yesterday was the day the premium was being "corrected."

The top half of the Bloomberg chart below shows the price history since the beginning of 2015 for OIL’s market price and daily redemption value, while the bottom half shows the market premium.

For perspective, the average premium since issuance of the ETN in 2006 is 0.37% (looking at the average premium from issuance through 1H15 we get 0.06%).  Clearly anything over 10% is wildly aberrational – yet that’s been the case since December.

Where were the arbitrageurs, enforcing price efficiency?  Normally, authorized participants (APs) can create and redeem shares of exchange traded products, which keeps prices in line with NAV.  If there is a large enough price-value divergence, an AP would choose to create shares for the cost of the lower NAV (resulting in a long position) while simultaneously selling shares at the higher market price (offsetting the long position that resulted from creating shares), capturing virtually riskless profits.  Conversely, if the NAV were higher, the AP would buy shares at the lower market price while redeeming shares at the higher NAV.  This mechanism keeps prices close to NAV.

However, according to Dave Nadig at Barclays on 9/15/15 slapped a 50 cent per share fee on the creation of new OIL shares.  At a $5.00 NAV, that amounts to a 10% fee!  (Perhaps Barclays is interested in winding down OIL, instead of expanding issuance.)  Regardless of Barclays' motivations (and possible lack of disclosure of this fee if Nadig is correct), the 50 cent creation fee would only explain part of the premium that had built up.  Wednesday’s closing trading price of $5.51 was still 31% higher than the NAV plus 50 cents!

Wednesday at 2:35 PM, Barclays issued an investor guidance press release saying, “Recently, a material premium has developed in the trading price of the ETNs on the exchange in relation to their intraday indicative value.”  It made no mention of any fees that may have thrown sand in the gears of the price/value enforcement mechanism.   Finally, the following day, traders began to trim the premium paid for OIL shares, causing shares to tumble 17% Thursday, with OIL underperforming its NAV by 23% and crude oil futures by 28%.  After Thursday’s price action, OIL only trades at a 16% premium to NAV, with most of that explained by the $0.50 per share creation fee.

Let us know if you have any intelligence to share on this.