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Auction-Rate Securities

Agency Seeks ARS Exchange

WASHINGTON — Brazos Student Finance Corp. wants to be the first student loan lender to ask institutional investors to voluntarily tender, at a discount, illiquid auction-rate securities in exchange for new floating-rate notes, about a year after a much larger and more complex offer failed.

The Waco, Tex.-based student loan lender announced late last week that it is working with Morgan Stanley and Merrill Lynch & Co. on an exchange involving about $500 million of senior and subordinate ARS that remain outstanding from 2004.

The two dealer firms both disclosed that they hold more than half, or about $300 million, of the total par volume of exchangeable bonds, and that they plan to tender them as part of the exchange.

The offer, which expires Dec. 11, comes as student loan lenders continue to struggle with massive portfolios of billions of dollars of illiquid ARS because market conditions have made it too expensive for many of them to restructure the ARS into different modes.

But in recent months, at least one issuer, the Connecticut Student Loan Foundation, successfully used its own cash to purchase about $40 million of its ARS at a discount. Meanwhile, as dealers in failed auctions have had to buy back some of the ARS from the customers as part of settlements with state and federal regulators, they are increasingly willing to exchange them with issuers at deep discounts to get them off their books, market participants said.

“This is a positive move and should have been done earlier, but let’s be thankful that it’s being done now,” said Joseph Fichera, senior managing director and chief executive officer of Saber Partners.

A recent academic study found there is more than $70 billion of illiquid student loan ARS outstanding, and argued there would be immense economic benefits if only the federal government could make $25 billion of liquidity available to the market so that nonbank corporations and retail investors could sell their holdings of such debt. 

Under the terms of Brazos’ exchange, institutional investors would have until Dec. 11 to tender their bonds, which have been paying a failure rate equal to the London Interbank Offered Rate plus 150 to 250 basis points since February, 2008, when the ARS market collapsed, according to Ricky Turman, Brazos’ executive vice president and chief financial officer.

In exchange for the existing senior ARS, bondholders would receive par value of new Class A floating-rate notes. And in exchange for existing subordinate debt, bondholders would have to accept a haircut: for every $1,000 of subordinate ARS, they would receive $536 of new floating-rate Class A-S notes  and $291 of new floating-rate Class B notes.

Brazos will also pay cash in an amount equal to the accrued but unpaid interest on the bonds.

Interest rates for the Class A notes will be equal to the three-month London Interbank Offered Rate plus 0.25%, and Libor plus 2.50% on the Class A-S and Class B notes, according to the bond offering documents.

“Morgan Stanley brought us an innovative idea, and we’re glad to work with them and Merrill Lynch to get this to the marketplace,” Turman said.

Market participants noted that the exchange offer comes a year after the student loan lender tried to convince investors to tender a much larger, $6 billion pool of its illiquid ARS in transaction managed by Citi. But they failed to convince the minimum number of investors to go along with the transaction.

That proposed transaction was a lot larger and earlier in the ARS crisis, and was further complicated by problems in the floating-rate note market, said Mark Weadick of Student Loan Capital Strategies LLC.

Weadick said he believes the new offer will likely be successful because the notes Brazos plans to issue are unlikely to include an optional call feature, which made its existing ARS difficult to trade and price.

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