BRADENTON, Fla. — In its first municipal bond deal in two years, the Kentucky Higher Education Student Loan Corp. today will price $225 million of revenue bonds to take out a portion of its auction-rate securities.
After this transaction, the agency still will have exposure to $715 million of outstanding ARS. It has not yet determined how to refinance the remaining securities because financing costs have gone up since the collapse of the ARS market.
That is the primary reason the student lender hasn’t been in the bond market since June 2008, said James Ackinson, executive vice president of the state-run, nonprofit Kentucky Higher Education Assistance Authority, which oversees the student loan corporation.
Today’s offering, designated as Series 2010-1, will be sold by Bank of America Merrill Lynch as $75 million of Class A1 floating-rate bonds with a final maturity in 2020 and $149.9 million of Class A2 floating-rate bonds with a final maturity in 2034.
Hawkins Delafield & Wood LLP is bond counsel. Kutak Rock LLP is underwriters’ counsel.
The tax-exempt private-activity bonds are not subject to the alternative minimum tax and the interest rate will be based on the three-month London Interbank Offered Rate plus a fixed spread. In addition, the underlying student loans being refinanced were issued under the Federal Family Education Loan Program so they are federally guaranteed as well as over-collateralized by as much as 107%, according to Ackinson.
“This is a seasoned portfolio of loans made and outstanding for some time,” he said.
He said the deal should be attractive to traditional muni investors as well as asset-backed securities investors. However, the bonds are not for investors who are unprepared to hold them until maturity or until early redemption, according to the preliminary official statement.
There currently is no secondary market for the bonds and there is no assurance that a market will develop — or if a market does develop, that it will continue or provide investors with sufficient liquidity, the POS said.
Ackinson said that before the market meltdown his agency could finance at very low cost and additional collateral wasn’t necessary. But the structure of the deal “is what the market is requiring today, and the rating agencies require it,” he said.
Fitch Ratings and Standard & Poor’s have assigned AAA ratings to the bonds.
According to Fitch’s report, nearly 61% of the loans being refinanced are concentrated in Kentucky. Other states with high concentrations of loans in the pool are Alabama, Tennessee, Indiana, and Ohio.
The bonds are payable from a trust estate consisting primarily of student loans originated under the FFELP. Internal credit enhancement for the bonds will include over-collateralization, including financed student loans and cash on deposit in certain funds, according to the POS.
While many of the authority’s previous deals were done on a taxable basis, which helped fund other programs such as loan forgiveness, Ackinson said the structure of today’s offering made sense.
“These tax-exempt Libor-based bonds have a more attractive rate than we would see on a taxable basis,” he said. “In addition to over-collateralization and federal insurance, we expect these loans will generate positive spread for us and therefore additional collateral for the investors.”
The ultimate spread depends on pricing, he said, declining to reveal early estimates of the spreads that could be expected.
“Obviously, we want the lowest cost possible,” Ackinson said. “We have a good idea where these bonds will price but they’ll be higher than we paid on the auction-rate securities when that market was functioning. That business model worked great for years.”
Ackinson said the penalty rates associated with many of the outstanding securities have been manageable because of the historically low interest rates they are tied to, but sooner or later those rates will rise. “The question is how long do you want to go without looking for a refinancing opportunity?”
Other reasons for the delay in refinancing were market conditions and waiting for “the right financing to make that happen,” which led to the structure of today’s offering, he said.
If the economics of today’s deal work, the structure may be considered for refinancing some of the authority’s other failed ARS.
The Kentucky Higher Education Assistance Authority is a public corporation and governmental agency established in 1966 to improve students’ access to higher education through various financing programs. Its financing arm, the Higher Education Student Loan Corp., was established in 1978. It has approximately $2.5 billion of outstanding debt, including a line of credit and commercial paper.
But neither Kentucky nor any other agency will be issuing new debt for student loans originated under the Federal Family Education Loan Program after June 30. Beginning July 1, all loans will be made under the government’s Federal Direct Loan Program, which was a provision of the Health Care and Education Reconciliation Act signed into law by President Obama on March 30.
Agencies like Kentucky’s authority will continue to service outstanding debt and will have opportunities to become servicers of student loans made by the federal government. “The student loan industry has been nationalized,” Ackinson said.
