Credit Woes Hit Funding For Loans to Students

By LIZ RAPPAPORT and RANDALL SMITH, Wall Street Journal, Feb. 13, 2008

The credit crunch that has so far caused more than $100 billion of losses for big Wall Street investment firms now extends to students in Michigan, and it could soon hit many other borrowers, ranging from California museums to the prestigious Deerfield Academy prep school in Massachusetts.

Yesterday, the Michigan Higher Education Student Loan Authority, a state agency, said on its Web site that "due to the current and unprecedented capital-markets disruption" it will stop making loans under the state's Michigan Alternative Student Loan, or MI-Loan, program. More than 100 Michigan colleges and universities participate in the program.

In the past few days, problems have mounted for many borrowers as an obscure -- but important -- corner of the credit market called auction-rate securities has gone into a deep freeze.

Borrowers ranging from student-loan authorities to municipalities to big bond funds depend on this market to raise money for making loans and funding projects. They do so by selling securities whose interest rates are reset every week as they change hands in auctions arranged by Wall Street firms like Goldman Sachs Group Inc., Citigroup Inc. and J.P. Morgan Chase & Co.

Moody's Investors Service estimates the size of this market at $325 billion to $360 billion.

In recent days, the money managers and other investors who typically buy auction-rate securities have been balking, out of fear the credit turmoil is spreading. The remaining bidders have commanded higher interest rates from borrowers including Deerfield, San Francisco's de Young Museum, New York's Carnegie Hall and many others. A call to Deerfield's finance department wasn't returned. The de Young Museum
declined to comment.

Meantime, many investors who hold the securities would like to sell them but can't. Of roughly $20 billion in such securities auctioned yesterday, half -- or about $10 billion -- failed to generate enough demand from money managers to sell, according to one trading executive at a top dealer. That pushed up borrowing costs for the issuers to levels ranging from 4.6% to 18%, as their interest rates reset to "penalty" rates that kick in when an auction fails.

'Wave of Panic'

"I think this is a wave of panic, but it could signify a real change in the banks' tolerance for taking debt onto their balance sheets," says Matt Fabian, managing director of Municipal Market Advisors, an independent research firm.

Many of the more than 100 auctions that failed yesterday were held on behalf of closed-end mutual funds, which use auction-rate securities as a way to borrow to enhance the returns in their funds. The managers of these funds include such well-known names as Nuveen Investments Inc., BlackRock Inc. and Allianz SE's Pacific Investment Management Co.

Student-loan authorities in places like Mississippi and Montana were also on the list of failures, as were de Young and Carnegie Hall.

The Michigan student-loan authority wasn't on the list of failed auctions. It previously has issued auction-rate bonds, though it isn't clear whether that market was the cause of its current financial crunch.

Spokesmen for the authority weren't immediately available for comment.

In a memo Monday to the authority, Patricia W. Scott, director of Michigan's student financial services bureau, said, "This is attributable to the capital-markets disruption on our ability to issue new debt," and added that new lending to students would resume, "when conditions warrant and funds become available."

*"If student loan providers are having trouble raising money, then that's a concern for us," says Justin Draeger, spokesman for the National Association of Student Financial Aid Administrators. He says the loans tend to go to low-income students. "If there's a problem with getting the funds, then they may not be able to pay for their education."*

Peter Warren, vice president of government relations for the Education Finance Council, which represents nonprofit lenders and state lending agencies, said that while Michigan may be the only state yet to announce a student-loan halt, others are "seriously evaluating" the viability of their programs.

Problems in the auction-rate securities market have been mounting for days. Last week, about $3 billion in auctions of these securities failed. The tally of failed auctions grew as investor fears intensified.

Wall Street firms generally stayed on the sidelines, taking few of the securities onto their books.One list of failures compiled by Citigroup and circulated by some market participants totaled $6.6 billion in securities in 105 auctions. But one person in the market said the amounts were larger.

The market allows borrowers with long-term financing needs to tap investors who want to hold short-term investments that can be readily turned into cash. Wall Street firms hold auctions of these securities regularly, allowing investors to roll them over with new interest rates or to sell them to somebody else. When auctions fail, which is unusual, investors like funds and corporate treasuries can find themselves
suddenly saddled with long-term securities.

A big problem with some of these instruments is that they are insured by troubled bond insurers like MBIA Inc. and Ambac Financial Group Inc., which have sold guarantees on securities tied to ill-fated subprime mortgages. The insurers run the risk of losing their triple-A credit ratings because of their subprime exposure, and that, in turn, has investors running from other instruments they back. The Michigan Higher Educational Student Loan Authority has issued some auction-rate securities backed by such bond insurance.

New Rounds of Turmoil

Trouble in the credit markets has been cascading for months, with moments of quiet interrupted by new rounds of turmoil. Wall Street firms like Bear Stearns Cos., Merrill Lynch & Co., UBS AG and Citigroup have taken more than $100 billion of write-offs because of their mortgage-linked securities holdings. Along the way, problems rippled into other obscure short-term lending markets, like commercial paper tied to mortgages, and short-term funding entities called structured investment vehicles run by banks.

The new woes in auction-rate securities could be a problem for corporate treasurers who invest their cash holdings in the market.

Bristol-Myers Squibb Co. earlier this month recorded a $275 million charge, attributing it to the global credit crunch and its effects on the company's short-term investment portfolio. The company held some auction-rate securities tied to mortgage and corporate-bond debt.

Caught Off Guard

The charge contributed to a net loss for Bristol-Myers in the fourth quarter and it is now seeking a new treasurer. The company's chief financial officer, Andrew Bonfield, told analysts in late January that the company was unable to unload some of its securities in the auction process.

The problems in the market have caught many investors off guard. In the past, the Wall Street firms that conduct the auctions and underwrite the securities have often acted as a buyer of last resort. But with their own balance sheets already bloated with other assets they don't want to hold, Citigroup, Goldman and others are limiting their support for the market.

As one banker in the market said, they are not obligated to be "liquidity providers."

"It is like a multicar pileup," said one auction-rate securities trader.
The trader says that investors saw last week's failures, and "people are
nervous because they want to have a liquid product."

Spokesmen for J.P. Morgan and Goldman Sachs declined to comment, while a
Citigroup spokeswoman repeated a comment she made Monday, saying the firm "has seen widening spreads, reduced demand for certain auction-rate securities and failed auctions, including some auctions which Citi acted as broker dealer."

The auction-rate securities problems could also affect the many closed-end mutual funds that use this market. The auction failures raise the specter that these funds could sell some of their assets as their financing costs increase.

"It all came to a head today. Investors wanted liquidity -- they're afraid of the next shoe to drop even if they don't know what the next shoe will be," says William Adams, executive vice president at Nuveen.

A spokesman for MFS Investment Management confirmed that its MFS Municipal Income Trust tapped the auction-rate market for funding but didn't have information about what impact the turmoil there might have. Representatives from other mutual-fund firms couldn't be reached for comment or declined to comment.

--Tom Lauricella, Robert Tomsho, Karen Richardson and Romy Varghese contributed to this article.