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Peeling Back the Onion: Uncovering the True Risks of Student Loan Backed Auction Rate Securities

2 min read

Moody’s Review for Downgrade and Fitch Rating Watch Negative:

AMS-3, 2003, LP, Class A-1 auction rate note (Aaa/AAA)
AMS-3, 2003, LP, Class A-2 auction rate note (Aaa/AAA)
AMS-3, 2003, LP, Class A-3 auction rate note (Aaa/AAA)
AMS-3, 2003, LP, Class A-4 auction rate note (Aaa/AAA)
AMS-3, 2003, LP, Class B auction rate note (A3/A)

Opinion Summary

In light of the current credit events and ratings actions surrounding auction rate securities (ARS) issued by Academic Management Services Corp (AMS), investors need to reassess the unique risk characteristics of this obscure security class. It is our opinion that current holders should strongly consider redeeming existing holdings issued by the same entity.
It is easy to dismiss the discrepancies discovered at AMS as isolated events unique to this servicer; however, we hold the view that scant disclosure, limited external oversight, as well as unfamiliarity of the investing public with this relatively new asset class, will likely contribute to more credit surprises in the industry.
Limited by the length of this commentary, we attempt to focus on just one of the risks associated with ARS investments, the structural risk. We seek to articulate why such a pristine triple-A credit rating on an ARS may not be as indicative of the true risk as one on corporate debt.
For a highlight of the other common risks associated with ARS investments, please refer to our publication “Seven Facts and Fiction About Auction Rate Securities”.

Background

Swansea, Massachusetts-based AMS is a unit of Texas issuer UICI that markets, originates, funds and services guaranteed student loans. It held $1.3 billion of student loans at year-end 2002, according to UICI’s SEC filings.
On July 21, 2003, AMS discovered a shortfall in the type and amount of collateral supporting two of the “securitized student loan financing facilities” by three of its “special financing subsidiaries.” In addition, all seven of its financing subsidiaries may have failed to comply with their reporting obligations. The former president of AMS was placed on leave and was relieved of all responsibilities.
Special financing subsidiaries are special trusts that allow a student loan originator to hold the assets legally separate from the parent organization for securitization purposes.
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Lance Pan joined Capital Advisors Group in 2003. As Director of Investment Research and Strategy, Lance assesses the risk and relative value of asset classes and credits, creates advanced credit approval and surveillance procedures, issues credit opinions, and provides investment strategy recommendations. Lance oversees Capital Advisors Group’s Credit Committee.

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