With almost all of its $2.1 billion of outstanding debt tied to the auction-rate securities market, Vermont's student loan corporation is seeking financing options to help avoid disruptions in its lending program.

Since Feb. 8, more than 90% of auctions for Vermont Student Assistance Corp. have failed.

VSAC said it currently has about $2 billion of auction-rate debt outstanding. The issuer is exploring options to raise the funding for its lending program, which has about 90,000 borrowers and last year originated about $380 million of student loans, said VSAC vice president of policy, research, and planning Scott Giles. VSAC hopes to originate about the same amount of loans this year.

"We're working very aggressively first and foremost to secure the capital that we need in order to originate loans in the fall," said Giles.

In late December, as an experiment to try to prevent auction failures, VSAC's board chose to temporarily raise its fail rate through the end of March on about $350 million of its taxable debt to 18% from between 4% and 5%, said Giles. Of the $350 million, about $172 million has hit the cap of 18%, and about $65 million has cleared at 12%, Giles said. The remainder has not yet gone to auction.

"What we didn't anticipate was that the investment banks would abruptly stop supporting liquidity to the auction-rate market," Giles said.

Giles noted that because the rolling average for the auction rates for the past 11 months can't yield a result that is higher than the Treasury bill plus 120 basis points, the new rates after March for the taxable debt will have to be low enough to bring a 12-month average that includes some 18% rates back below the Treasury bill-based cap. This will likely yield several auctions where the rate is capped at 0%. Most investors will after a couple of months have an average rate that is at or close to the Treasury bill-based cap.

Prior to auction-rate woes, VSAC's taxable bonds traded at about 3.2%. Tax-exempt debt, with a failed auction rate of about 3.5%, was trading at about 2.5%, according to Giles.

"The problem for VSAC is their cost of borrowing goes up and there's less spread to stay in business," said Vermont Treasurer Jeb Spaulding, who is on VSAC's board. "Right now we're keeping a close eye on it and trying to work with banks and trying to find the best way to move forward."

A possible solution that VSAC is looking into is refinancing its auction-rate debt using variable-rate demand obligations, Spaulding said.

"VSAC doesn't need capital until this coming summer, so we have a few months to work on that," said chairman J. Chester Johnson of Government Finance Associates, Inc., VSAC's financial adviser.

"It's going to take time to convert the outstanding portfolio into other forms of variable-rate indebtedness," Johnson said. "But VSAC has sufficient reserves to cover a fairly lengthy process of that conversion, and we're having discussions with underwriters and liquidity providers to provide various support mechanisms."

"Since we don't believe that this is a long-term situation, we're prepared to drop on our reserves in order to make loans this fall," said Giles. Still, "We are taking a look at working on several opportunities to refinance some of our auction-rate securities in order to reduce the costs of financing," he said.

VSAC has been issuing ARS for about 15 years now, and up until now, "it's been a win-win for all of the parties," said Giles. "Auction-rate has been the most efficient and cost-effective means of issuing long-term bonds to finance student loans. Every basis point we save in efficiency and in cost is a basis point that is available for borrower benefits."

"During its heyday, purchasers had access to their capital when they invested and could pull out at any particular time, so that was attractive to them," said Johnson. "And it accommodated the needs of student loans."

But now VSAC sees the era of auction-rate debt coming to an end.

"We do know that over time there will have to be a conversion to other kinds of structures," Johnson said. "In the new market, it would be unwise for any governmental entity to rely on the auction market for any amount of its capital."

While VSAC is looking for opportunities to convert its auction-rate debt, it also believes that the federal government may need to step in to aid student loan entities across the U.S. that are experiencing auction-rate failures.

Rep. Paul E. Kanjorski, D-Pa., agrees that the federal government should take a role in aiding student loan agencies. He sent a letter last week to Committee on Education and Labor Chairman George Miller urging him to work to protect the viability of the Federal Family Education Loan Program and maintain access to higher education opportunities for students and their families.

With all the auction-rate failures occurring nationwide, Giles noted, "We are a small fish swimming in a very, very large tsunami," said Giles.

On a short-term basis, VSAC would like to see the federal government and U.S. Treasury inject liquidity into the auction-rate market to help address auction failures that many student loan organizations are experiencing, Giles said. So far, any attempted liquidity from the federal government and U.S. Treasury - in the form of interest rate cuts and lowering the federal funds target rate - has been more focused on the recovery of larger financial institutions from the subprime mortgage crisis, Giles said.

"So in a sense, that money is not flowing downstream," Giles said.

Giles believes that if the federal government and the U.S. Treasury could inject liquidity into the bond market through purchasing bonds, it could be helpful to VSAC and other student loan organizations that are experiencing auction failures.

Additionally, if VSAC moves into variable-rate demand option, it needs a line of credit so that investors are guaranteed, Giles said. Banks have been the traditional sources for lines of credit, "and that credit is in short supply and in very high demand."

"We need to have some kind of a liquidity facility," Spaulding said.

Giles said that while some bondholders have expressed concerns to VSAC, it is primarily about liquidity matters.

"They want the confidence that they can actually get their money when they want it," said Giles. "They have no concerns about the quality of the asset."

"These student loans are 97% guaranteed by the federal government," Spaulding said. "It's not a question of security; it's a question of liquidity."

VSAC plans to go to market in June or July this year, and will issue about $190 million of debt. About $120 million will be tax-exempt debt, while about $70 million will be taxable. As of now, none of the debt will be auction-rate.

It is still too early to tell whether student loan corporations will be able to drum up enough capital to provide loans to all individuals who need them come fall. Whether it will affect university ratings if student loan corporations cannot provide enough loans for the incoming students also remains to be seen.

"Loans are still an important part of the packaging for financial aid for students," said Standard & Poor's credit analyst for higher education Mary Peloquin-Dodd. "The disruption in the student loan market could be a problem if it affects origination of loans."

However, "At this point, we're more concerned about the schools being able to covert their own bonds to more reasonable interest rates than the other way around," said Standard & Poor's director Marc Savaria said.

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