medium · Asset-Backed Securities asset-nuances
A student loan ABS (FFELP) is indexed to 1-month LIBOR + 2.49% for loans in repayment. However, the ABS bonds are indexed to 3-month SOFR + 50 bp. During a period of financial stress, the LIBOR-SOFR basis widens by 100 bp.
What is the primary risk to the transaction?
- Prepayment risk: the basis widening will cause all student borrowers to consolidate their loans immediately.
- Basis risk: the trust's income from the loans may not be sufficient to cover the increased bond interest costs.
- Default risk: the basis widening will cause the Department of Education to cancel the 97% guarantee.
- Liquidity risk: the trustee will be unable to trade the loans because the SAP payments are frozen.
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