The Coronado Student Loan Trust was the largest single collateralized loan obligation trust to fail. It had an unacceptably high concentration of risky loans, and its continued existence was imperiled by the risk posed by this overexposure to subprime borrowers. To understand what went wrong with this trust, it is best to first understand what a student loan trust is and how they work. A trust is essentially an entity that owns assets, such as loans or mortgages. In other words, a trust is not a third-party company, but simply a legal arrangement for holding assets and property. The Coronado Student Loan Trust was established in 2005 as a way for investors to get exposure to student loans without having to directly own them. Think of it like an investment club that owns shares in specific companies instead of owning the companies themselves. Each share represents an undivided interest in the assets of the trust. The Coronado Student Loan Trust ended up being too heavily exposed to subprime borrowers, which led to its failure when those loans defaulted at a high rate.
What is a Collateralized Loan Obligation Trust?
A collateralized loan obligation trust, or CLO, is a type of investment vehicle that is structured as a trust. The trust is an arrangement for holding the assets that make up the fund — typically loans. A CLO is a large pool of loans that are put together, often by a bank or investment bank, then sold to investors. In this case, the loans are all student loans. The loans can either be originated by the CLo or purchased from other lenders. CLOs are often used as collateralized securities, meaning that they are backed by some type of collateral. Student loans are often used as collateral because they are generally considered to be secure debt.
How Does a Student Loan Trust Work?
A student loan trust is a type of collateralized loan obligation trust. The trust is an arrangement for holding the assets that make up the fund — often student loans. A student loan trust is a large pool of loans that are put together, often by a bank or investment bank, then sold to investors. In this case, the loans are all student loans. The loans can either be originated by the CLO or purchased from other lenders. The trust holds the loans until the maturity date, at which point the investors receive their money back plus interest. Most student loan trusts act as pass-through vehicles, which means that investors do not receive payments from the loans. Rather, investors receive the proceeds from the sale of the loans once they are repaid by students. This is because the loans are collateralized. Student loan trusts work best when the interest rates on the loans are low. This is because low rates mean that the loans will be paid off quickly, allowing the trust to be liquidated. When the interest rates are high, it takes longer for the loans to be repaid, making the liquidity of the trust less certain.
Risk of Default for Student Loan Borrowers
The default risk associated with student loans is a significant consideration when evaluating the riskiness of student loan trusts. After all, an investor’s ability to make money from a student loan trust comes primarily from the repayment of the loans. The repayment of student loans is dependent on the borrower repaying their loan. If the borrower is unable to make the payment, the investor does not get repaid. The likelihood of defaulting on student loans is based on the creditworthiness of the borrower. The three main creditworthiness metrics that are commonly used to assess default risk are credit score, loan-to-value ratio (LTV), and debt-to-income ratio (DTI). The higher the credit score, the lower the likelihood of default. This is the case for both mortgages and student loans. The lower the LTV, the lower the likelihood of default. This is the case for mortgages but not for student loans. The lower the DTI, the lower the likelihood of default. This is true for both mortgages and student loans.
Why Did the Coronado Student Loan Trust Fail?
The high concentration of subprime borrowers in the Coronado Student Loan Trust was a red flag. This meant that a large number of the loans in the trust were made to borrowers with low credit scores. This is concerning because student loan borrowers with low credit scores are more likely to default on their loans. The borrowers with low credit scores are not just less likely to repay their loans, but they are also less likely to complete their degree, which may otherwise have provided them with better job prospects and higher income. The risk of default and poor repayment is a factor when calculating the expected return from student loan trusts and other CLOs. When investors examine the expected return and the risk of not being repaid, they are determining whether or not the investment is worthwhile. The expected return is based on the current market for student loans, and thus the riskiness of the investment. The Coronado Student Loan Trust was the largest single collateralized loan obligation trust to fail. It had an unacceptably high concentration of risky loans, and its continued existence was imperiled by the risk posed by this overexposure to subprime borrowers.
Can Other Trusts Be At Risk?
Yes. The collapse of the Coronado Student Loan Trust and the failure of other student loan trusts is a sign that student loan trusts are riskier than many investors had thought when they purchased these investments. The riskiness of student loan trusts is clear, but it is not yet clear how this risk will affect the broader market for student loans, as well as the market for other types of CLOs.
The collapse of the Coronado Student Loan Trust and the ensuing ripple effect are a reminder of how complex and interconnected the financial markets really are. When the CLO market collapsed, it hit the market for CLOs hard and caused a ripple effect that hit the broader financial markets. The market for student loan securitizations is particularly ripe for disruption. It is a relatively new market that is heavily reliant on securitization to expand its reach and offer to finance to a growing number of students. With the collapse of the CLO market, investors have fewer places to put their money. This has caused many investors to become more cautious, which in turn has shrunk the market for student loan securitizations. It is also important to keep in mind that the collapse of the Coronado Student Loan Trust does not mean that all student loan trusts are bad investments. It does mean that investors need to be more careful when choosing where to put their money.