UBS is sitting on billions in bad student loans

Below is my translation from an excerpt in the Swiss newspaper NZZ:

In 2008, the lucrative business with loans to U.S. students came to an abrupt end. Today, UBS sits on paper that could still be worth $8.4 billion – or less. The collapse of the market for student loans has increased the barrier to a good education for young Americans.

Sebastian Bräuer, New York
Chris Croteau knows UBS only by hearsay. He has no account with the Swiss bank. Nevertheless, there is a fatal connection between the derivatives operations of UBS and the fact that the young man from New Hampshire was on the verge of interrupting his studies.

In the autumn of 2006, the now 20-year old, began to study Business. In order to pay the usual high tuition fees, he took out a loan. A foundation of his state (NHHEAF) awarded favorable loans to students…..

In February 2008 something happened, which UBS later sheepishly described as a “surprising and unexpected result of the U.S. subprime crisis”: Auctions [for student-loan backed securities] were no longer established. There were no more investors. That has not changed: The ABS market is frozen.

For the students in New Hampshire, this had a direct effect: One month later, the NHHEAF stopped awarding new loans. In the previous year the Foundation had funded $67 million in grants that supported 6000 students. “In 2008, demand would have been just great,” said NHHEAF spokeswoman Tara Paine. Thousands of students have had to seek private loans.

The result of the credit crisis has been two-fold:

  1. Students have bee cut off from funds that were previously available. This makes college unffordable for some.
  2. Banks like UBS are sitting on massive losses in student loans as a result of the downturn in this market and in the economy. Whether these writedowns are excessive because of mark-to-market accounting is hotly contested – hence the abuse of reclassification of assets as Level 3 assets.

I mention this story because it gives one a real understanding of what happens when the credit markets seize up. I first highlighted the implosion of thestudent loan market in May and then again in October. It is not just about over-leveraged subprime borrowers. There are other very real consequences. I think it is tragic that many young people might be denied an education because of this situation.

Moreover, this story highlights the degree to which there are many more credit writedowns which still need to be taken. For a troubled institution like UBS, taking these writedowns here and now could be fatal. In my view, this is yet another concrete example of the fragility of European and global banking.

At the end of December UBS had Asset-backed securities with a market value of $12.9 billion, of which $8.4 billion were based on student loans. The sum is only a vague estimate, because there is currently no demand. What the paper is really worth, is controversial. “The asset-backed securities could be worth 20 to 30% more in value,” says Sean Egan of the independent rating agency Egan-Jones. That does not benefit UBS, however, long as they cannot find buyers. Egan believes interest by private investors will likely return in one to two years at the earliest.

Until then, the ABS’s are a ticking time bomb. In the worst case, they must be written down. How much and how fast is a matter of accounting rules. In the last quarter, UBS reported a writedown of $ 1.2 billion – without a refined reclassification of assets, the bank would have had to report a trading loss of $4.2 billion.

Die UBS sitzt auf Milliarden geplatzter Studentenkredite – NZZ

  1. twelve says

    This is not a “credit writedown”. Student loans are 97% to 98% government guaranteed, so there simply is no credit issue with the vast majority of student loan ABS. In fact, unlike just about any other asset class, in many cases literally every single borrower could default and AAA noteholders would get out with full P&I.

    So this isn’t a credit writedown. This is a liquidity writedown.

  2. Edward Harrison says

    I am not making a statement about credit risk. I am making a statement about writedowns of credit, the term used when a company lends money. The holder of a bond is the creditor. Writing down the value of that bond is a credit writedown.

    However, your statement is false. Student loans bundled together in the asset-backed securities market are both publicly-issued and private loans. Private loans do not come with a federal guarantee. So, there is, indeed, credit risk in addition to liquidity risk.

  3. Anonymous says

    Well, problem with NHHEAF being – that UBS can easily claim the CEO misrepresented himself.

    In a 2004 CBS News report, Mr. Rene Drouin, CEO of NHHEAF , was found to have no legitimate or accredited education. Schools Mr. Drouin lists as his “alma mater” have been shut down by state or federal authorities for being unaccredited diploma mills. (Mr. Drouin also claims a law degree from Drexel – the reputable Drexel Univeristy in PA does NOT offer a law degree; however, the Drexel diploma mill in Louisiana that was shut down by Federal Authorities did offer a law degree)

    It is quite possible that Mr. Drouin lacked the basic education and sophistication (assuming he was duped by two separate diploma mills on three occasions) to understand the markets and instruments offered by UBS.

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