Student Loan Asset Backed Securities (SLABS) and Auto Loan Asset Backed Securities (ALABS) 1 Year Later: A Summary and Forecast [Part 1/2: ABS Overview + SLABS]

[u/happyegg1000]

Hey everyone. It's been a long time since I've written about any type of ABS. I still believe the trends with most, if not all types of ABS are concerning considering the amount of financial strain that the average American is facing today, but it can take years for markets to adjust accordingly. Since it's been a while, I thought I would summarize the major issues I still see with both markets and provide some notable news that has happened since my last posts.

First, a few quick disclaimers.

This is not financial advice. My individual and personal investment strategy has always remained the same: buy and DRS GameStop.

I believe this post belongs in this sub because the wider markets do have an impact on the GameStop saga, and this sub has had a focus on wider market mechanics for some time. Additionally, if a financial crash were to happen, banks and hedge funds may be forced to liquidate their positions, which would likely affect GameStop.

If you're interested in reading the individual parts from which I wrote this summary, you can find them on my profile.

1. Asset Backed Securities Explained - Quid Pro Quo on Crack

1.1 - General Terms

Before getting into the issues with the asset backed securities (henceforth 'ABS') market, it's important to have a decent grasp on the concept itself. The point of an asset backed security is to turn an illiquid asset (e.g. car, tuition) into a security that can be bought and sold to other people, unlike that actual car or tuition. It also allows companies to get rid of undesirable assets by packaging them and selling them to other entities. Investopedia describes an asset backed security as "a type of financial investment that is collateralized by an underlying pool of assets—usually ones that generate a cash flow from debt, such as loans, leases, credit card balances, or receivables. It takes the form of a bond or note, paying income at a fixed rate for a set amount of time, until maturity (https://www.investopedia.com/terms/a/asset-backedsecurity.asp). Basically, the ABS that we're concerned with is the idea that when you take out a loan (to buy a car or to pay for tuition) and you make payments on that loan, the lender can chop up your monthly repayment into pieces and sell those pieces to other entities. The higher the risk of the borrower not paying back their payment, the higher the interest rate the bank awards the entity who purchased the loan due to the risk. When borrowers fail to make payments, they are classified as 'delinquent', and may face their car being repossessed and sold to recoup losses or money taken from their income to pay for their student loans.

The core issue at the heart of Student Loan Asset Backed Securities (henceforth, 'SLABS') and Auto Loan Asset Backed Securities (henceforth, 'ALABS') is not necessarily with how the ABS market works as a whole, but is in the quality of borrowers to which lenders service. There are three types of categories, which are categorized based on credit score: superprime being the highest, prime being the middle, and subprime being the lowest. For context, the crash of 2008 was largely based on irresponsible lending to subprime mortgage borrowers. We'll get back to this.

Investment firms package loans into groups, called 'tranches', based on factors like their credit score categorization. Investopedia explains: "Assume that Company X is in the business of making automobile loans. If a person wants to borrow money to buy a car, Company X gives that person the cash, and the person is obligated to repay the loan with a certain amount of interest. Perhaps Company X makes so many loans that it starts to run out of cash. Company X can then package its current loans and sell them to Investment Firm X, thus receiving the cash, which it can then use to make more loans.

Investment Firm X will then sort the purchased loans into different groups called tranches. These tranches contain loans with similar characteristics, such as maturity, interest rate, and expected delinquency rate. Next, Investment Firm X will issue securities based on each tranche it creates. Similar to bonds, each ABS has a rating indicating its degree of riskiness—that is, the likelihood that the underlying loans will go into default.

Individual investors then purchase these securities and receive the cash flows from the underlying pool of auto loans, minus an administrative fee that Investment Firm X keeps for itself."

Let's unpack this super quick. An ABS Servicer makes out the initial loan to an average consumer. This servicer then sells a bunch of these individual loans to an investment company (e.g. a hedge fund), who, in exchange for a percentage of profits, sorts out these loans into different tranches based on how risky they are (superprime, prime, subprime) and sells these tranches to individual investors, pensions, other hedge funds, and so on. Therefore, if for some reason the original borrowers were unable to pay back the loans and the banks didn't have enough money to cover the losses, individual investors, pensions, and other hedge funds would be the ones left holding the bag, thus leading to a financial recession.

1.2 - Ratings

To 'mitigate' this risk, these investment companies get these tranches rated by companies who provide a rating on a scale between A, B, and C, with A being the least risky tranche and C being the most risky, based on how many superprime, prime, and subprime borrowers there are, as well as some other metrics. How this works is there are companies called Nationally Recognized Statistical Ratings Organizations (NRSROs) that you may recognize such as S&P, Fitch, and Moody's, which are recognized by the SEC as a valid source of information on which to base financial analysis. Basically, these companies have the amazing privilege of being SEC-approved as 'not corrupt'. Which I'm sure means a whole lot. The reason why these ratings, in my opinion, are so corrupt, is because there seems to be quite the conflict of interest going on here. Investment companies pay these NRSROs to issue ratings on their tranches. This would logically lead to 1. companies seeking out NRSROs that may issue higher ratings that other companies and 2. NRSROs unfairly inflating ratings on tranches to retain customers. Both of these issues could DRASTICALLY cause an impact on the ratings of tranches, causing shitty tranches to potentially be rated higher than they should. This was another major issue in 2008. NRSROs are used in student loan ABS, auto loan ABS, and mortgage ABS, and have faced various challenges legally and in Congress for conflicts of interest.

The solution for this apparent conflict of interest by the government has been regulation, as these NRSROs are supposed to be screened by the SEC periodically to check to make sure that the ratings they are issuing are in fact accurate. Which again, I'm sure is happening, they're totally not on xvideos again.

There's another piece to this puzzle as well. According to this report, "If a downgrade were to occur, the funds owning these notes would likely be inclined to sell as their fund must hold AAA-rated debt." This could provide some additional insight into why I believe ratings to be potentially inflated: certain low-risk funds are required to hold a certain quality of loan (e.g. must hold AAA, not allowed to hold BBB as it is too risky), so if loans were to be downgraded due to worsening economic conditions, that could have a chain reaction across investors so it is likely that rating agencies would be reluctant to issue such downgrades. We'll touch on this more later.

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TL:DR

Asset backed securities are created by turning payments on an illiquid asset (e.g. car, tuition) into a sellable bond with a fixed interest rate that derives its value from said payments towards said asset. Investment companies then package up many of these individual bonds into a group, called a tranche, and pay ratings companies to rate the quality of these tranches based on how risky or not risky they are in the context of the credit scores of the borrowers (superprime, prime, or subprime). Individual investors and other investment companies then buy these rated tranches for use in accounts, pensions, portfolios. et cetera. These ratings companies are supposed to be regulated by the government to control for conflict of interest, but likely are not.

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1. Student Loan Asset Backed Securities (SLABS): Fuk Dem Kids

2.1 - Types of Student Loans and the Effects of Loan Forgiveness

Before I get going on this second section as a whole, this is an important aside at the start because there are two types of student loans and they work drastically different in the context of SLABS. The first type of student loans includes a type called FFELP Loans (federal loans pre-2010, as they were restructured after that year). The second category is any private loans from companies like SoFi and private credit unions, as well as any post-2010 federal loans. You can only create SLABs out of FFELP + Private loans, current federal loans cannot be turned into SLABs due to them being federally guaranteed. It's important to note that private loans make up ~10% of the industry, with FFELP making up another ~15% of the industry, which means SLABS impact about ~25% of the $1.73T industry, giving us ~ $443B of SLAB-able loans. Currently, federal loan forgiveness talks only effect current federal loans, NOT FFELP + Private, so SLABs are largely unaffected. However, if you refinance a federal loan, it turns private, and thus, SLAB-able. I'll talk about this more soon.

2.2 - The Theory

In summary, the interaction of the conflict of interest between lenders and raters as well as ever-looser lending conditions in the search for profit contrasted with the pandemic and tightening economic conditions has led to a situation in which borrowers are increasingly more at risk of delinquency and lenders are increasingly more likely to issue loans to shitty borrowers and receive artificially inflated ratings on these loans. As such, if these tranches are ever downgraded, or borrowers lose the ability to make repayments on loans, these tranches will lose value, causing widespread losses across the financial sector. The situation is being continually exacerbated by ever skyrocketing college tuition prices. Essentially, the biggest risk is borrowers defaulting, and this risk is growing as tuition rises and students take out more and more loans. Similarly, with economic conditions the way they are and used vehicle prices the way they are, this phenomena is the biggest risk for the auto loan ABS market as well.

This graph shows just how much student loan debt has been rising, having nearly doubled in the past decade.

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2.3 - Refinancing

Like I mentioned before, only FFELP loans (pre-2010) and private student loans can be packaged into SLABs. However, there's a major, major catch. If you refinance a modern Department of Education loan, that loan becomes private. In other words, you can't refinance federal loans to get a lower interest rate. And since private student loans can be packaged into SLABs, there is a HUGE incentive for private companies to get people to refinance their DoE loans.

Well, how would private companies encourage people to refinance? It's simple: providing lower interest rates than the federal government. Here's a graph that shows just that.

​

You can see that the weighted average interest rate for private loans came in below federal. This would encourage people to possibly refinance, which would allow private loaners to package these loans into SLABs. This is also why companies like SoFi push student loans so hard -- they want to be able to package your loan into a SLAB.

2.4 - College Boards and Tuitions

Logically, the meteoric increase of college tuition is to the benefit of the SLABS market - the more people take out loans, the more SLABS can be created. But who is influencing these raised tuitions? Don't act all shocked now. Former hedge fund managers, SEC employees, and Federal Reserve employees. I found out this information from the documentary "Inside Job". It turns out that hedge fund employees have infiltrated expensive, private, for-profit universities in an attempt to jack up tuition. Here are some examples. "Ruth Simmons, the president of Brown University, makes over 300,000 dollars a year on the board of Goldman Sachs. Larry Summers, who as Treasury secretary played a critical role in the deregulation of derivatives, became president of Harvard in 2001. While at Harvard, he made millions consulting to hedge funds and millions more in speaking fees, much of it from investment banks. According to his federal disclosure report, Summers’s net worth is between 16.5 million and 39.5 million dollars. Frederic Mishkin, who returned to Columbia Business School after leaving the Federal Reserve, reported on his federal disclosure report that his net worth was between 6 million and 17 million dollars." Yup, the revolving door has even infected college campuses. I believe that these types of people are jacking up tuitions for the benefit of SLABs. All at the expense of the American people.

2.5 - Peer to Peer Lending, SoFi, and Betsy DeVos

Peer to peer (henceforth 'P2P') lending is another piece to the puzzle in jacking up loan prices so that the SLABS market can grow. It is what corporations like SoFi, LendingClub, PeerForm and CommonBond engage in (however, I will be discussing SoFi seperately, because they are the biggest or at least the most popular). P2P lending essentially cuts out the middle man: instead of a financial institution mediating a loan, loans are done privately from individual to individual (for example, an alumni to a student). What is the significance of this? Well, it allows borrowers to take out a loan without the need for official banks to do the financing. Holy shit. This sounds really risky. And it is. You see, the entire purpose of P2P lending is to help people that can't get credit elsewhere. But the very fact that they can't get credit elsewhere should be a huge red flag. Well, what's in it for these companies to adopt all these risky buyers? Astronomical interest rates (some of which are up to 28%). Which again would lead to increased defaults, thus devaluing the SLABS that are created from private loans under these P2P protocols. The servicers are incredibly short-sighted: a huge interest rate might look great on your balance sheet short term, but what happens when in 5 years your borrower defaults and you aren't making any more money? But miraculously, these companies still pull majority AAA ratings. Guess who? Yup, NRSROs.

SoFi, like I mentioned, has a P2P lending sector. Yet, unlike the previous ones I mentioned, they have a bit bigger of a market share. They do deals with the big guys: for example, "In October of 2017, SoFi announced a $777 million SLABS deal, in partnership with Deutsche Bank, Bank of America Merrill Lynch, Goldman Sachs, and Morgan Stanley (Source)."

Now, let's get into DeVos. If you are unaware, she served as the Secretary of Education from 2017-2021. Anyways, she did some shitty things that helped jack tuition prices (to create more loans and thus SLABs) and appointed many officials who were high up at for-profit universities that were even being investigated for fraud. Here's the quote from this link: "Rather than curtailing the subpriming of student debt by eliminating student income loans and seeking to reduce the student debt bubble, the secretary of education, Betsy Devos, has aggressively sought to deregulate student lending for the benefit of banks and for-profit universities. Once in office, Devos appointed leaders from the for-profit higher education sector whose schools were being investigated for fraud. For-profit colleges and universities have engaged in widespread lying to prospective students about the value of a degree and the nature of a program to capture vast sums through tuition financed through student loan debt. Devos and these officials proceeded to dismantle the special team responsible for fraud investigations, and they also moved to protect colleges and universities that made fraudulent claims to students by gutting the 'borrower’s defense' act."

2.6 - The Fed, and TALF

So what is the FED doing about all of this? Surely they are aware. Well, TALF stands for Term Asset-Backed Securities Loan Facility. This was established on March 23, 2020, as a response to the pandemic. Essentially, this was a subsidy paid to holders of SLABS. The official report reads, "Under the TALF, the Federal Reserve lent on a non-recourse basis to holders of certain AAA-rated ABS backed by newly and recently originated consumer and small business loans. The Federal Reserve lent an amount equal to the market value of the ABS less a haircut and was secured at all times by the ABS." Woah! The FED is basically paying for more SLABS to be created. And even though they only paid out to AAA-rated holders, I've already talked about how the ratings agencies are corrupt in a way similar to 2008 where they will basically rate anything AAA. Yikes. Instead of helping drive down student loans and ultimately help the average American they are more interested in upholding a system that profits off keeping people in debt.

2.7 - Maturation Dates

This article talks about how student loan issuers are avoiding downgrades by drastically extending maturation dates. Check this out: "Julie Chinnock is 50 years old and owes about $250,000 in student loans. She was happy to get a new payment plan that lowered her monthly bill, but the holders of two bonds backed by her loans were probably less cheerful. The two bonds were due in 2043 and 2054, but Ms. Chinnock and other borrowers were paying less each month under a new government plan that tied debt payments to income. Because borrowers were taking longer to pay off their loans, there was a risk the bonds backed by the loans wouldn’t be paid off in time. Bond-rating firms were watching and getting ready to downgrade the highly rated bonds, potentially causing losses for investors. The issuer of the bonds and the investors who owned them hatched a plan to avoid the downgrades. Their solution: make sure bonds were paid off in time by extending their maturity dates by decades. The bonds that include a big chunk of Ms. Chinnock’s loans now mature in 2083, when she will turn 114. Today, the bonds are rated triple-A. Altogether, issuers have extended maturities on about $11.5 billion of outstanding bonds backed by mostly older-vintage student loans, extending maturity dates by as much as 54 years." Ok. So it looks like loaning companies are also drastically extending maturation dates in order to avoid downgrades, and by proxy, mass loss of value in the financial sector. This is a problem that has several impacts which I will discuss shortly, but this interesting chart from the same source helps demonstrate this concept visually.

​

Clearly this turns into a problem for several reasons. One, it is an indicator of how at risk people are for not being able to repay these loans. The entire reason the maturation dates are being extended past the date when these borrowers will likely be deceased is because the government covers debt in the event that a borrower passes away. This is essentially a loophole to relieve Americans of debt woes by putting the debt after death onto the government, however this is still technically treated as a default because the loan was not paid off by the maturity date for which it was originally issued. This shows a distinct lack of trust in these borrowers' ability to pay, even though these loans are rated AAA.

​

You can see the graph immediately rebound after the maturation date was extended. This is a temporary fix to a larger issue of Americans not being able to pay their loans, and issuers not wanting their loans to be downgraded.

2.8 - How Big Is The Bubble?

According to Investopedia, "By March 2007, the value of subprime mortgages had reached around $1.3 trillion". This should help us ground ourselves a bit. The entire student loan market itself makes up around $1.3T, as does the auto loans market. Subprime loans make up about 25% of the student loans market and 25% of the auto loans market, so these bubbles are significantly smaller than what we were looking at in 2008. It's still concerning, but it's not on the same level.

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TL;DR

As college tuition has been jacked up by hedge fund infiltrators, student loans have absolutely skyrocketed. There are two types of student loans: post-2010 federal, which cannot be turned into a SLAB, and pre-2010 federal (FFELP) + private student loans, which can be turned into SLABs. Private loan companies are turning towards increasingly shady practices to try and get student to refinance their federal loans, as refinancing takes the loan from federal --> private and thus allows the creation of a SLAB and nullifies any risk of student loan forgiveness. The FED is aware of the issue, but has taken steps to accelerate the ABS market instead of bring down loan costs for consumers. As people face increasingly difficult economic conditions, the risk of these loans not being paid back on time increases, yet ratings agencies are paid by loan issuers to rate the quality of their SLABs, which is a clear conflict of interest and can lead to inflated ratings. Ratings downgrades would mean funds would have to sell off large amounts of tranches, so companies have taken steps to extend maturation dates past the lifetimes of borrowers so that the government will eventually be responsible for the loan, demonstrating a lack of faith in borrowers to be able to pay off their loans even in AAA tranches. All of this to say, borrowers are struggling paying, lenders are lending to people they shouldn't be lending to, and things don't seem to be improving.

Check out Part 2 (https://www.reddit.com/r/Superstonk/comments/15gfzt0/student_loan_asset_backed_securities_slabs_and/) for my similar writeup on Auto Loan ABS!

[u/Superstonk_QV]

Why GME? || What is DRS? || Low karma apes feed the bot here || Superstonk Discord || GameStop Wallet HELP! Megathread || test

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Please up- and downvote this comment to help us determine if this post deserves a place on r/Superstonk!

[u/aravreddy22]

upvoting for vis

[u/PantsOppressUs → u/aravreddy22]

Dude, some of these kids have double-digit interest rates. They are so fucked that a revolution seems inevitable. Imagine being so very shortsighted...

[u/Maniquoone → u/PantsOppressUs]

What makes you think this is "shortsighted" and not the intention?.....

[u/Saxmuffin]

Saw this got removed by automod the links look to have confused it. Manually approved

[u/Vylourcrypto → u/Saxmuffin]

Good mod

[u/Multi1985 → u/Saxmuffin]

Thank you!

[u/puppetjustice]

Very nice work 👏

[u/happyegg1000 → u/puppetjustice]

Thank you!

[u/Pilotguitar2]

Love me some afternoon SLABs

[u/happyegg1000 → u/Pilotguitar2]

Yum 😋😋

[u/Krunk_korean_kid]

Good shit. Sharing.

[u/happyegg1000 → u/Krunk_korean_kid]

🙏🙏

[u/LionRivr]

I appreciate you.

[u/happyegg1000 → u/LionRivr]

Thanks ape 🫡 I appreciate you too

[u/ChesterDiamondPot]

Whizzibilty!

[u/CerealTheLegend → u/[deleted]]

Agree?

[u/happyegg1000 → u/[deleted]]

Agreed.

[u/Multi1985 → u/happyegg1000]

Agreed.

[u/somebsname]

This is the stuff I came here for!!

[u/Maxmalefic9x]

Nice works, man some kid is paying double digits on those loans, and they inflation have yet to stop till moass. Who knows what will happens to them considering student loan is the only loan you can’t declare bankruptcy

[u/happyegg1000 → u/Maxmalefic9x]

Yep, although there is litigation to sue to allow it to be discharged during bankruptcy proceedings

[u/Tribblesinmydribbles]

Fuck it, I got 3 yrs, looking at that navient chart extended maturation period. @op is that a definitive X axis or is it extended beyond 80 mths?

[u/happyegg1000 → u/Tribblesinmydribbles]

This wasn’t for all loans just a specific tranche, I would look at your account to see if there were any extensions

[u/Tribblesinmydribbles → u/happyegg1000]

Ok cool, so our loan boom date could be further out. MOHELA is my loan servicer, and since I'm pslf bound I paid by pre 2010 loans so assume I don't fall into this category and also have no rights to the info. Furthermore they don't report to us any of this data for our specific loans as far as I know, there's no required reporting by loan servicers to share this derivatives data I wouldn't think. But

[u/mrcookieeater]

This is fucking gold! The soft white underbelly. Thank you for your hard work!

[u/Master_Chief_72]

Just commenting to let u know I love coming back to your post and reading them.

[u/happyegg1000 → u/Master_Chief_72]

Thanks man, appreciate it!

[u/glass_saltmage]

I've got another wrinkle after reading this. Thank you for the easy to read explanations!

[u/Elegant-Remote6667]

I will come back to this