The U.S. student loan forgiveness that progressives in Congress are calling for may not be a bad thing for investors in bonds backed by that debt, because owners of those securities are getting paid high enough yields to compensate for any early principal payments that may result.

The securities backed by loans originated under a now-defunct program called the Federal Family Education Loan Program, or FFELP, will likely sport higher returns than other floating-rate debt even if loan forgiveness leads to a spike in dreaded prepayments. The sector would become awash with liquidity as the federally-guaranteed loans are paid and the most distressed borrowers avoid default, market participants said.

“If the Biden administration implements some level of debt forgiveness -- $10,000 or $50,000 -- that may lead to prepayment risk, shortening the bonds,” Darrell Wheeler, head of securitized strategy at Cantor Fitzgerald LP, said in an interview. “But even in our shortest prepayment scenario, the bonds still offer an attractive spread pickup,” according to a recent analysis by the bank.

Similar to mortgages in mortgage-backed securities, investors typically dislike when students prepay their loans early because it shortens the bond’s life and prevents them from collecting interest payments for an extended period of time. If the government pays off the student loans, it would essentially act as one big prepayment.

The impact of any forgiveness generally varies and depends somewhat on the price paid for the bond. While the loan forgiveness would prepay bonds and shorten the average life, it’s expected to be only a minor impact on the expected spreads, depending upon the price paid for the bond, according to Cantor’s analysis.

The government guarantee on FFELP student-loan bonds makes these instruments a compelling product to consider as rates rise, especially during an uncertain macro-economic future, Cantor says. Other floating-rate fixed-income products such as collateralized loan obligations, for example, have no such guarantee.

“Loan forgiveness could be a boon to student loan ABS by providing prepayments and liquidity immediately upon forgiveness,” Joseph Cioffi, a partner at Davis & Gilbert LLP, wrote in a Thursday blog post. “Whether the loans are federal or private, the lender would be paid and prepayment rates will go up but at least distressed borrowers will be less likely to default.”

Until July 2010, the FFELP program financed the majority of post-secondary education costs. Private institutions would arrange the loans with non-profit or state entities acting as guarantor, and the Education Department would essentially backstop or re-insure the guarantor. Significant loans were originated before the program ended and more than $250 billion of them remain outstanding today, according to Cantor, and they are still being packaged into new asset-backed securities.

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