Not-for-profit state education finance companies are slowly but surely turning away from the auction rate bond market and migrating to the floating-rate ABS market for financing. Rating analysts attribute the shift to a troubled year in the auction rate market and increasing investor comfort with state issuers that have previously flown below the radar.

Floating-rate student loan ABS made up 72% of the market last year, up from 63% in 2003, and it appears as if that number could be even higher in 2005. The most recent examples of this trend are first-time issuers Montana Higher Education Student Assistance Corporation, which priced a $252 million floating rate deal in May, and the Iowa Student Loan Liquidity Corporation that priced a $700 million floating rate deal earlier this month. Both deals priced about three basis points outside of average student loan spreads at the time.

The shift into the floating rate market "is a combination of [the issuers'] need to diversify funding sources, coupled with increased comfort and breadth of the investor base," said David Hartung, senior director with Fitch Ratings. "Traditional ABS investors have begun to realize that these not-for-profits have been around for years," added Hartung.

State issuers, such as Montana, with no prior history of ABS issuance are able to enter the market also because they are securitizing loans backed by FFELP collateral, and that buys them credibility. "Investors may not be familiar with [the issuer] but they are familiar with the collateral," said Sharon Asch, director with ABN AMRO.

Moody's Investors Service Senior Credit Officer Irina Faynzilberg attributed the increase in floating-rate note issuance to developments in the auction rate market over the past year that caused spreads to widen to unfavorable levels. The first blow to the auction rate market came in June 2004, when the Securities & Exchange Commission began investigating whether certain auction brokers entered into price-fixing agreements with customers.

The second blow came last winter when the big-four accounting firms began advising clients to book auction rate securities as long-term investments. The change in accounting was later endorsed by the Financial Accounting Standards Board, the Public Company Accounting Oversight Board and the SEC and codified as standard in rules FAS No. 95 and FAS No. 115. Since many auction-rate investors had been money-market accounts, precluded from investing in long-term assets, demand for the securities sagged.

In spite of the spread widening, state student loan issuers are not likely to abandon the auction rate market. "[The auction rate market] is still a viable market for them, but they need to be exposed to other kinds of investors," said Faynzilberg.

South Carolina Student Loan Corp. and the Pennsylvania Higher Education Assistance Authority and The North Carolina State Education Assistance Authority are other states to have offered floating-rate student loan deals this year. The Alaska Student Loan Corporation each brought auction rate deals to the market.

(c) 2005 Asset Securitization Report and SourceMedia, Inc. All Rights Reserved.

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