The Wall Street Journal-20080212-Student-Loan Issues Under Stress
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Student-Loan Issues Under Stress
Full Text (841 words)Securities tied to student loans, another seemingly safe corner of the credit markets, are succumbing to the credit crunch.
Wall Street's financial-engineering machine bundles together long- term student loans and uses them as collateral for short-term investments owned by money-market investors. Since Thursday, auctions of these securities conducted by Goldman Sachs Group Inc., J.P. Morgan Chase & Co. and Citigroup Inc. have failed to generate investors' interest, leaving roughly $3 billion of such securities in a sort of limbo.
Under normal conditions, the banks would step in when investor demand is weak -- just as a specialist on the New York Stock Exchange intervenes to keep trading liquid in a stock. Because big banks are already bloated with other kinds of loans and bonds they are trying to get rid of, they have been allowing the auctions to fail.
That, in turn, is pushing up interest rates for the securities and leaving them in the hands of investors who might have intended to get rid of them.
"Investors are seeking safety right now," says Joe Lynagh, portfolio manager at T. Rowe Price who runs tax-exempt money-market and other short-term investments.
These auction failures are a sign of the extreme stress in markets for an array of investments with complex structures or unusual designs. Wall Street created a boom in these kinds of investments in the past decade, bundling together everything from subprime mortgages to municipal bonds and corporate debt, and creating complex instruments out of them. Investors, especially fund managers, are now shunning the products for fear they could decline in value.
In this case, the student loans are typically backed by the federal government as part of the Federal Family Education Loan Program. The securities they go into are called auction-rate securities.
Issuers like SLM Corp. (known commonly as Sallie Mae), Educational Funding of the South (EdSouth), Brazos Higher Education Service Corp. and College Loan Corp., among others, have had auctions fail, say investors who participate in that market.
These issuers finance their lending programs in part by pooling together loans and using them as collateral for these securities, which they sell to investors as an alternative to cash. While the loans are long-term loans that run for decades, the securities they issue have interest rates that reset in auctions every few weeks, a bit like adjustable-rate mortgages.
Wall Street creates similar auction-rate markets for municipal bonds, corporate debt and other instruments.
Moody's estimates the auction-rate market for federally backed student loans, called Slars, or student-loan-backed auction-rate securities, is $80 billion to $90 billion out of a total $325 billion- to-$360 billion market for overall auction-rate securities.
A failed auction essentially means that when the debt comes due for investors to bid on again, dealers like Citi, J.P. Morgan or Goldman can't find anyone interested.
The banks aren't required to step in and buy the debt themselves. Instead, when the auction fails, the banks can stay on the sidelines. When they do, the securities are left in the hands of investors who already hold them and might be trying to auction them off. The interest rate, rather than being a market-based rate, then gets reset based on a formula written when the securities were originally sold.
"We're not a liquidity provider," said one banker involved in the market.
Rates in this market have been moving higher because demand is drying up, pushing up borrowing costs for student-loans firms, and ultimately student borrowers. Rates in the auction-rate markets broadly have risen from 3% to about 5%, according to Municipal Market Advisors.
A spokeswoman for Citigroup said, "We have seen widening spreads, reduced demand for certain auction-rate securities and failed auctions." In some of those auctions, she said, "Citi acted as broker dealer." A spokesman from Goldman Sachs declined to comment. A spokesman from J.P Morgan didn't comment.
Treasurys Rise on Worry
About Subprime Crisis
Treasurys rose as negative news from American International Group Inc. and Standard Chartered PLC sparked concern that the subprime- mortgage crisis is spreading.
Jitters dragged the two-year note's yield, which moves inversely to price, to 1.918%, as its price rose 1/32 point to 100 13/32.
The benchmark 10-year note was up 10/32 point, or $3.1250 per $1,000 face value, at 99 1/32. Its yield fell to 3.618% from 3.656% Friday, as yields move inversely to prices. The 30-year bond was up 19/32 point at 99 16/32 to yield 4.405%, down from 4.440%.
AUCTION RESULTS
Here are the results of the Treasury auction of 13-week and 26-week bills.
All bids are awarded at a single price at the market-clearing yield. Rates
are determined by the difference between that price and the face value.
13-Week 26-Week
Applications ..................... $70,450,930,000 $66,172,892,000
Accepted bids .................... $24,000,133,000 $22,000,261,000
Accepted noncomp ................. $1,773,570,000 $1,427,892,000
Accepted frgn non ................ $200,000,000 $350,000,000
Auction price (rate) ............. 99.431250(2.250%) 98.948444 (2.080%)
Coupon equivalent ................ 2.301% 2.137%
Bids at market yield ............. 99.97% 34.54%
Cusip number ..................... 912795E49 912795F97
Both issues are dated Feb. 14. The 13-week bills mature May 15, and the
26-week bills mature Aug. 14.
