Student lenders nationwide relied on the auction-rate securities market to raise money so they could make or buy student loans. Auction-rate securities backed by student loans made up about a quarter of the $330 billion auction-rate market, but since the market’s collapse early this year, debt sales by U.S. public student-loan agencies have grounded to a halt. For the first time in 40 years, no municipal bonds backed by student loans were sold in the first quarter.
Lacking the ability to finance, public lenders in Michigan, Missouri, New Hampshire, Texas, Pennsylvania and Iowa have suspended or limited their loan originations. The two biggest borrowers, Brazos Higher Education Authority of Waco, Texas, and the Pennsylvania Higher Education Assistance Agency, stopped making new loans in the last two months although the Illinois loan agency will continue the business. 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. Cit Group Inc., based in New York, and NorthStar Education Finance Inc., a nonprofit organization in Minnesota, said this week that they will stop making new loans to U.S. students after lending costs soared.
On April 2, 114 of the 115 tranches of student-loan bonds that came up for auction failed. That same day, there were 353 failed auctions out of a total of 563 municipal auction bonds. Almost all auction-rate securities issued by closed-end mutual funds also failed.
When auctions fail, investors are unable to get their money and the rate resets to a high level or one based upon a previously agreed upon formula and often secured to money-market benchmarks such as the London interbank offered rate. The latter is typical of student-loan debt, giving investors less of an incentive to buy, because benchmarks have declined.
According to UBS, lender profitability has 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.
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