Investors in the student loan-backed sector of the ailing auction-rate securities market haven’t been able to sell their securities, and now, it looks like some may not even collect the penalty rates that were supposed to be paid to them as compensation.
Out of the entire $330 billion auction-rate market, about $86 billion of student loan-backed auction-rate securities were outstanding at the beginning of 2008. The hitch with student loans is that they are trusts and trusts cannot pay out more than its generating.
After Wall Street firms fled the auction-rate market and the market collapsed earlier this year, student loan bonds were among the worst hit since the trusts had to pay out high penalty interest rates for the failed auctions. Those penalty rates rose beyond what the trust earned on the loans and beyond a pre-set maximum penalty rate usually tied to a spread over certain money market rates. Those maximum rates are usually based on rolling averages of 12-month “lookback” periods. In the event that the trusts paid out more than they earned, the trust could reset the penalty rate to zero percent; thus paying investors nothing while they hope for a chance to sell their securities.
There is one upside to this. Because the maximum rate is a rolling average, each subsequent month could chop off some of that high rate and get closer to equalization.
Iowa Student Loan Liquidity Corp. and the Utah State Board of Regents are among issuers who are currently paying zero on some of their taxable student loan revenue auction-rate bonds.
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