Archive for the “Student Loan Bonds” Category

Fears continue to escalate about the future of mortgage giants Fannie Mae and Freddie Mac. On July 11, both the New York Times and the Wall Street Journal reported that federal officials were weighing a government takeover of one or both of the companies, placing them in a conservatorship if problems worsen.

Fannie Mae and Freddie Mac guarantee about half of all mortgages in the United States. If regulators were to place the companies in a conservatorship, their common shares would be worth little or nothing, and essentially double the size of public debt by adding about $5 trillion in potential obligations to the nation’s balance sheet, according to the New York Times.

As of Friday, shares of Fannie Mae and Freddie Mac stock had fallen nearly 50 percent, following concerns by investors that both companies were looking at additional losses and possible default on debt.

Both Fannie Mae and Freddie Mac are privately owned government-sponsored enterprises (GSEs), and play a critical role in the country’s mortgage market. As explained by the Wall Street Journal, Fannie Mae and Freddie Mac are shareholder-owned companies that buy mortgages, package them into securities and then sell them to investors. The companies do not actually make home loans but instead provide stability and liquidity to the mortgage market by guaranteeing that investors who buy mortgage securities will receive timely payments of principal and interest.

Should a conservatorship for Fannie Mae and Freddie Mac actually come to fruition, it would be the second time in less than five months that such a rescue plan was engineered to avoid a crisis in the nation’s financial markets. In March, in order to prevent the bankruptcy of Bear Stearns, the Federal Reserve stepped in to facilitate the sale of the 85-year-old investment banking giant to JPMorgan Chase for $236 million. In January 2007, Bear Stearns was worth $20 billion.

Our affiliation of lawyers is actively involved in advising individual and institutional investors in evaluating their legal options when confronted with subprime and other mortgage-related investment losses.

Â

Investors in auction-rate securities have quickly discovered that all things are not created equal. While the dark clouds surrounding auction rate securities are slowing lifting for investors in auction-rate securities sold by municipalities or closed-end mutual funds, investors who own any of the $85 billion of auction debt backed by student loans continue to face a perpetually stormy forecast.As reported in the May 28 issue of Business Week, student-loan-backed auction-rate bonds have ended up as one of the worst-performing areas of the auction bond market. Trading for as little as 75 cents on the dollar in limited secondary market trading, investors in these securities have taken huge losses on what they thought were low-risk, cash-equivalent investments.

The main problem facing investors who hold student-loan-backed debt is that the government-run and private student loan lenders responsible for issuing the securities do not have the ability to generate additional financing to redeem their bonds at par. Moreover, the penalty rates on many of the student-loan-backed auction bonds have temporarily fallen to 0% and by law, the trusts that issue student-loan-backed bonds cannot pay out more than they receive as interest payments from borrowers.

How It Began

Auction-rate securities - which are long-term bonds sold by issuers such as municipalities, student loan companies, hospitals and closed-end funds - have interest rates that reset every seven, 14, 28 or 35 days. For decades, the auction-rate market operated relatively smoothly, with only 13 auction failures reported between 1984 through 2006.

In February 2008, however, everything changed. The credit ratings for the bond agencies responsible for backing the auction bonds were unexpectedly downgraded. In turn, new investors were no longer willing to bid in the auctions, leaving existing investors holding securities for which there were no buyers. The Wall Street investment banks, which once prevented the auctions from failing by stepping in with their own capital to buy the bonds, pulled back their support entirely.

Following the collapse of the auction-rate market, a number of “rescue plans” were put in motion. Some municipalities began redeeming or announcing plans to redeem more than $60 billion of the $165 billion of auction-rate bonds they issued. Closed-end fund issuers also began making some headway, redeeming about 23 percent of the auction-rate preferred stock shares they have backed.

As for student loan issuers - and the investors holding the student-loan-backed debt - the picture remains grim. Thus far, only the Missouri Higher Education Loan Authority (MHELA) has announced a rescue plan, according to the Business Week article. Reportedly, MHELA has plans to buy back approximately $30 million of its $3.5 billion of outstanding debt at a discount.

Meanwhile, investors who hold student-loan-backed debt can only sit and wait. To date, almost all of the auctions in the student-loan auction rate market continue to fail and only $1 billion of the $85 billion outstanding has been refinanced. For now anyway, it appears these investors are permanently sucked into the auction-rate vortex - and have little chance of getting out.

Our affiliation of lawyers is actively involved in advising individual and institutional investors in evaluating their legal options when confronted with subprime and other mortgage-related investment losses.Â

The auction-rate securities freeze may bring on yet another headache for investors in the student loan-backed sector of the market.

To date, investors who have been unable to sell their securities because of auction failures were paid penalty rates as compensation. Now, however, all that may change, according to an April 10 Dow Jones Newswires column by Stan Rosenberg and Evelyn Juan.

Student loan bonds have been among the hardest hit from the auction-rate crisis. Out of the $330 billion auction market, approximately $86 billion of student loan-backed auction-rate securities were outstanding at the beginning of the year. The problem with student loans is that they are considered “trusts,” which cannot pay out more than they are generating.

In recent months, the unprecedented number of failed auctions has imposed higher interest rates penalties on student loan corporations - rates that have risen well beyond what the trust earned on the loans and above the pre-set maximum penalty rate usually tied to a spread over certain money market rates. Typically, the maximum rates are based on rolling averages of 12-month “lookback” periods.

If the trusts pay out more than they earn, they could reset the penalty rate to zero percent. That means during the time investors wait for a chance to sell their securities, they are paid nothing.

Several issuers already are paying zero percent on some of their taxable student loan revenue auction-rate bonds. Among them: the Iowa Student Loan Liquidity Corp. and the Utah State Board of Regents.

Our affiliation of lawyers is actively involved in advising individual and institutional investors in evaluating their legal options when confronted with subprime and other mortgage-related investment losses.

Troubles stemming from the subprime mortgage crisis have caused 46 student loan lenders to take flight from the Federal Family Education Loan Program (FFELP). And though no students have been unable to secure an education loan as a result of the exodus, it could be only a matter of time if turmoil continues to rock the credit market.

The latest woes affecting the student loan industry are tied to problems on Wall Street, specifically auction-rate securities. Approximately $80 billion of the auction market is made up of bundles of student loans. Because some of these investments are backed by troubled bond insurers, investors have been reluctant to buy the securities, which puts pressure on student lenders that sell them to raise cash.

The 46 lenders - which include Washington Mutual Inc., Sovereign Bancorp Inc., College Loan Corp., CIT Group Inc., NorthStar Education Finance Inc., HSBC Bank USA and Zions Bancorp - account for approximately 12 percent of the federally backed student loan market. In addition to these lenders, state agencies in Iowa, Michigan, Montana and Pennsylvania have suspended their college loan programs indefinitely.

Even before problems hit the auction-rate market, the student loan industry had been going through a rough patch. Last year, Congress cut more than $22 billion from subsidies paid to private lenders in the FFEL program and raised limits on the amount of federal loans students could obtain.

Adding to the industry’s woes is the increase of students who are delinquent or in default on their education loans. Private loans in particular have taken a significant hit, because they are not guaranteed by the federal government and have higher interest rates that are not capped.

Making the Grade

The exodus of student lenders from the FFEL program has some members of Congress worried. In the current academic year, the FFELP is responsible for providing an estimated $50 billion in loans to 6.4 million students.

Recent legislation from Rep. Paul Kanjorski, D-Pa., would temporarily infuse money into the student loan market. Kanjorksi’s bill would allow the 12 regional banks that make up the Federal Home Loan Bank system to invest surplus funds in securities backed by student loans, as well as accept the securities as collateral. The banks also would be able to make money available to the banks and thrifts in their regions for student loans.

Another House bill, this one sponsored by Rep. George Miller, D-Calif., has been proposed that would give the Education Department temporary authority to buy up loans from student lenders to ensure their access to capital.Â
Sen. Edward Kennedy, D-Mass., has proposed similar legislation in the Senate.

Also concerned about the effect of the credit squeeze on the student loan industry is apparently Education Secretary Margaret Spellings. Earlier this month, she announced a contingency plan of sorts that would provide safety net in the event the government’s help is needed to resolve the lending issue.Â

Even the nation’s largest student lender, Sallie Mae, has been rocked by the collapse of the auction-rate bond market. Not only has the lender cut back on making private loans to students, but it also will stop offering consolidation loans for the lower-cost federal loans. In 2007, federal consolidation loans, which combine several federal loans into one loan with lower interest rates and one monthly payment, accounted for nearly 70 percent of Sallie Mae’s government-backed student loans.

Looking ahead, there currently are more than 2,000 lenders participating in the FFEL program. To date, these lenders have been able to quickly step in and pick up where affected lenders who stopped making loans left off.

But, as the credit squeeze gets tighter, more student loan lenders may be forced to bow out of the FFELP. For lenders that stay in the business of making student loans, many will impose stricter credit requirements on students and families, reduce or eliminate borrower benefits and increase interest rates on the loans.

All of which may very well leave students - particularly low-income, first-generation students and minorities - simply priced out of the higher education ballpark.

Our affiliation of lawyers is actively involved in advising individual and institutional investors in evaluating their legal options when confronted with subprime and other mortgage-related investment losses.