Student Loan Inverse ETF Funds
Student Loan ABS Background
ABS (Asset Backed Securities) collateralized by student loans (SLABS) is one of four core asset classes financed through asset-backed securitizations. The other three asset backed securities include home equity loans, auto loans and credit card receivables. Federal Family Education Loan Program (FFELP) loans are the most common form of SLABS and are guaranteed by the U.S. Department of Education at rates ranging from 95%-98%. For cases where the student borrower is considered an “exceptional performer,” then the reimbursement rate was up to 100%. As a result, performance has historically been very good and investors rate of return has been excellent.
The College Cost Reduction and Access Act became effective on October 1, 2007 and significantly changed the investment risks for FFELP loans.
The lender special allowance payments were reduced
The exceptional performer designation was revoked
The lender insurance rates were reduced
The lender paid origination fees were doubled.
The other type of student loan, non-FFELP, also known as the Direct Student Loan has grown much faster, since many private student loans are no longer available to students. With an increase to tuition rates and fewer federal aid options available, students are forced to take a federal student loan to pay for their education.
The United States Congress created the Student Loan Marketing Association (Sallie Mae) as a government sponsored enterprise to purchase student loans in the secondary market and to securitize pools of student loans. Since its first issuance in 1995, Sallie Mae is now the major issuer of SLABS and its issues are viewed as the benchmark issues.
Student Loan Bubble
If you believe that there is a student loan bubble that has forced due to continued higher tuition costs, current state of the economy, and other economic factors that would cause students to default on their student loans then you may want to consider betting against these student loan asset backed securities that were outlined above.
There currently is not a student loan inverse ETF available for investors to purchase, but there are other ways to capitalize if you feel this asset class will deflate.
Institutional Investors - Student Loan Credit Default Swaps
Currently, the best way to short the student loan market without focusing on one specific company would be to buy credit default swaps (CDS) on student loan asset-backed securities. This option is only available to many institutional investors, but it’s worth looking into to see if you could invest in this type of investment instrument. Your Bloomberg investment tool will be able to show you the current CDS options available.
What is a CDS - For the uninformed investor
A credit default swap (CDS) is a financial swap agreement that the seller of the CDS will compensate the buyer in the event of a loan default or other credit event. The buyer of the CDS makes a series of payments to the seller and receives a payoff if the loan defaults. If the borrower does default then the buyer of the CDS receives compensation, which is usually the face value of the loan, and the seller of the CDS takes possession of the defaulted loan.
Again, only institutional investors are able to take advantage of a Student Loan CDS if they are betting against borrowers able to repay their student loan.
Student Loan CEBOs - CDS Type of Investments For Retail Investors
The CBOE has announced that the Exchange will begin trading newly-designed Credit Event Binary Options (CEBOs) contracts. In essence these will be like Credit Default Swaps, accessible to everyone, which will have a $1000 payoff per contract in the event of a bankruptcy before contract expiration. A CEBO contract has just two possible outcomes - a payout of a fixed amount if a credit event occurs or nothing if a credit event does not occur. The closer a company is seen as being to bankruptcy, the higher the contract price. If a bankruptcy does take place then the contract settles at $1, its maximum level. The recovery rate is zero, therefore the full payout is awarded ($1 - recovery rate (0)) which translates into a $1000 settlement amount, due to the 1000x multiplier ($1 x 1000). If the entity remains solvent at expiration the contract expires worthless ($0). CEBOs can be conveniently traded out of a securities account, therefore making it an attractive method for equity traders to trade credit. Currently, CEBOs are only available for a handful of privately held companies.
Retail Investors - Shorting Sallie Mae Student Loan Company
Retail investors can short specific student loan companies, since there currently is not a student loan inverse ETF in the market. Retail investors can short Sallie Mae (ticket symbol: SLM) Sallie Mae was launched as a government-sponsored enterprise similar to Freddie Mac and Fannie Mae. It currently services and manages $180.4 billion of government-backed student loan debt. It's also started to issue private student loans, so their student loan debt has substantially increased. With a debt to equity ratio of 36, Sallie Mae is already on the edge of insolvency. A small drop in collections can amount to significantly levered losses to the company. If the student loan default rate increases to 20%, Sallie Mae will most likely not be able to survive. The continuing upward trend of student loan defaults will lead to either insolvency of Sallie Mae or a government takeover, which will both wipe out shareholders.