08/19/2011

Brazos Mulls Delay for Auction-Rate Swap

Brazos Higher Education may have to delay a bond issue that would replace the last of its auction-rate obligations.

The $550 million deal would finalize a series of tender offers in which the not-for-profit education lender has been retiring auction-rate securitizations by swapping them out for new floating-rate paper backed by the same assets. While the Waco, Texas, operation had hoped to wrap up the effort by yearend, market players now say it looks like the transaction might not take place until 2012.

Why? The financial-market turmoil triggered by S&P’s downgrade of U.S. Treasurys has prompted holders of auction-rate bonds issued by Brazos and others to sit on their holdings, many of whose interest rates soared to high penalty levels during the credit crisis. Those players apparently want to wait for things to settle down so they can get a clearer picture of how they would fare in surrendering the high-yielding positions for floating-rate bonds with lower returns.

Investors also are reluctant to exchange their auction-rate holdings for cash, as it could prove difficult to find suitable replacements amid the market uncertainty.

Another wild card for the broader auction-rate bond market: Tens of billions of dollars of securities could encounter “credit events” if S&P follows on up its government downgrade by lowering its view of loans guaranteed by the U.S. Department of Education under the Federal Family Education Loan Program. That would cause even more deals to pay penalty rates, adding to the temptation for bondholders to hold tight to their positions.

The market for auction-rate bonds imploded in February 2008, when dealers stopped supporting routine remarketing efforts for the once-liquid securities. That left a heap of the obligations stranded with bondholders, typically at increased yields. Issuers have been struggling to retire the obligations ever since.

Brazos, which once had $5 billion of auction-rate paper in the hands of investors, has been lightening that burden at an increasing rate through its tender offers. It started by swapping out $1.4 billion of notes in 2010, capped by a $1.1 billion deal in December. Two more deals followed this year: A $1.5 billion swap on March 10 and a $1.4 billion transaction on June 15.

The three most recent deals were run by Citigroup, which also participated as an investor. The bank had managed many of Brazos’ initial auction-rate issues, and took down a large portion of the paper by placing clearing bids after the market faltered.

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