Wall Street sells asset-backed bonds that are supported by payments on everything from credit-card balances to boat loans. But it may have met its match in truck-driving-school student loans,
according to Dow Jones news wires.
Some transactions valued at more than $500 million -- backed by more than 90,000 truck-school student loans that were bundled, insured and sold to investors -- have steered off course, setting in motion a pileup of recriminations and sending a convoy of lawyers down to Texas.
Student Finance Corp. in Radnor, Pa., securitized the loans. About 70% of the loans are in default as a result of the subprime nature of the borrowers and a weakening economy.
Loan insurer Royal Indemnity Corp., which wrote policies insuring students' interest and principal payments, is suing SFC, its former officers and a number of truck-driving schools, charging fraud. Royal is the U.S. subsidiary of Royal & Sun Alliance, which announced a radical restructuring plan last week, aimed at shoring up its capital position and improving profits.
"Royal did not intend to insure abnormal credit risks of this type and magnitude," Royal Indemnity said in a complaint filed in June in state district court in Jefferson County, Texas.
Among other things, Royal Indemnity alleges that SFC used the proceeds of new loans to cover up defaults on loans outstanding. Royal Indemnity also points at some of the trucking schools, alleging that the loans were so lucrative for the schools that they were granted "without regard to the likelihood of repayment."
Attorneys representing the former officers of SFC, said their clients "deny all allegations of fraud or misconduct" claimed by Royal Indemnity.
Sharon Asch, senior analyst at Moody's Investors Service Inc., said vocational-school student loans that are not backed by a government guarantee carry high risk. "We've seen default rates as high as the 50% to 60% range," Asch said.
Complicating the matter, SFC filed for bankruptcy-court protection Nov. 4.
Despite the fracas and SFC filing, the SFC bonds remain rated triple-A, the highest possible credit rating. The bonds were issued through a bankruptcy remote trust, meaning they won't be affected by SFC's bankruptcy-court filing. Like most asset-backed securities with top ratings, the bonds carry a guarantee of payment for the holders.
New York-based bond insurer MBIA Inc. stands by its guarantee on principal and interest payments to holders of the SFC bonds, MBIA spokesman Mike Ballinger said. MBIA has filed a lawsuit with Wells Fargo Corp.'s Wells Fargo Bank, trustee on some of the transactions, against Royal Indemnity to force it to make good on its policies covering the loans, Ballinger said.