Student Lenders Trapped by Auction-Bond Failures as States, Cities Escape
April 4 (Bloomberg) — The collapse of the $330 billion auction-rate securities market has brought debt sales by U.S. public student-loan agencies to a halt.
No municipal bonds backed by student loans were sold in the first quarter, the first time that happened in almost 40 years, according to Thomson Financial. The inability to obtain financing differs from states, cities, schools and hospitals, which sold $82 billion of bonds to fund public works and replace failed auction debt that stuck them with penalty rates as high as 20 percent.
Public lenders from Texas to Pennsylvania to Illinois relied on auction-rate bonds to raise money so they could make or buy student loans. Since mid-February, when Wall Street firms that supported the market for more than 20 years stopped buying securities investors didn’t want, almost all of the debt has failed to find buyers, according to data compiled by Bloomberg.
“The not-for-profit agencies have not raised significant money that I’m aware of in the past few months,” Andrew Davis, executive director of the Illinois Student Assistance Commission, said in an interview from Springfield. “The industry had grown so comfortable with the auction-rate securities.”
Without the ability to finance, public authorities in Michigan, Missouri, New Hampshire, Texas, Pennsylvania and Iowa have suspended or limited their origination of loans, according to an April 1 report from UBS AG.
Fewer Options
The squeeze means students and parents have fewer options to fund college educations. University financial-aid offices are scrambling to update lists of active lenders and help students find less costly private loan alternatives, said Phillip Day, head of National Association of Student Financial Aid Administrators in Washington.
Of the top 10 largest issuers of auction-rate debt among municipal issuers tracked by Thomson from 2000 through 2007, half were student lenders. The two biggest borrowers, Brazos Higher Education Authority of Waco, Texas, and the Pennsylvania Higher Education Assistance Agency, decided in the past two months to stop making new loans. The Illinois loan agency, 10th among issuers, will continue the business, officials said.
“We believe we have liquidity lined up that will take us through most of our needs, but not all of them, for the year,” said John Sinsheimer, chief financial officer of Illinois Student Assistance.
No New Loans
CIT Group Inc., based in New York, and NorthStar Education Finance Inc., a nonprofit organization in St. Paul, Minnesota, said this week that they will stop making new loans to U.S. students after their costs soared.
Auction-rate securities backed by student loans made up about $86 billion of the $330 billion market at the beginning of the year, according to Moody’s Investors Service. The market faltered in February, after dealers stopped acting as buyers of last resort when investor demand flagged.
On April 2, 115 tranches of student-loan bonds came up for auction and 114 failed, based on data compiled by Bloomberg from four major auction agents, including Deutsche Bank AG. The same day, there were 353 failed auctions, or 63 percent, involving a total of 563 municipal issues. Almost all auction-rate securities issued by closed-end mutual funds also failed.
Pegged to Formulas
When auctions fail, investors are unable to get their money and the rate resets to a high level or one based on a formula in the original bond documents and often pegged to money-market benchmarks such as the London interbank offered rate.
The latter situation is typical of student-loan debt, giving investors less of an incentive to buy, because benchmarks like Libor have declined, said Matt Fabian, managing director at research firm Municipal Market Advisors, based in Concord, Massachusetts. The one-month London interbank offered rate fell to 2.74 percent this week from 4.57 on Jan. 2.
“They fail to rates that are pretty low,” Fabian said.
Illinois Student Assistance is paying a taxable rate of 4.20 percent on $70 million of its $885 million in auction debt, compared with a 5.35 percent average during the past year, Bloomberg figures show.
Lender profitability suffered after the U.S. government last year slashed subsidies on guaranteed student loans made through the Federal Family Education Loan Program that back most student-loan auction bonds, according to UBS.
Liquidity `Extremely Expensive’
“The origination of new paper is the problem,” Fabian said. “Liquidity has become extremely expensive, it’s doubled or tripled, and the auction market is broken.”
Missouri’s student loan agency said in February that it would stop making private loans, or those not guaranteed by the federal government, and consolidation loans, which combine different student debts.
“We are non-profit; we operate on a razor-thin margin,” said Will Shaffner, director of business development for the Missouri Higher Education Loan Authority in Chesterfield. “It just doesn’t make sense to issue any debt at these prices and under these conditions.”
To contact the reporter on this story: Jeremy R. Cooke in New York at