Officials with Montana Higher Education Student Assistance Corp. have taken several steps to protect the provider and servicer of student loans from financial trouble in the wake of problems in the market for its auction rate bonds, but being able to unload those bonds would help more, the president of the Student Assistance Foundation said this week.

"We would like to refund the existing auction bonds because the borrowing costs associated with those bonds is much higher than our borrowing costs with any other financing vehicle we have," Jim Stipcich said.

"Our ability to accomplish those refundings are subject to a number of different factors. There's the market, and very important is liquidity. And liquidity is very scarce in the capital markets today, and that's a major issue."

MHESAC invests in student loans, and finances those investments by issuing a variety of bonds and other debt instruments. Among those for years have been auction-rate bonds, which are essentially long-term obligations with variable interest rates that can change as often as weekly or monthly, depending upon how often the bonds are re-auctioned.

The trouble came earlier this year, when over the course of several weeks more than $1 billion worth of MHESAC's bonds came back up for their regular auctions but there were no buyers. When that happens, the existing owners of the bonds get paid a higher interest rate from MHESAC.

"Our financing costs associated with auction bonds have been about $14 million more than normal," Stipcich said.

As a result, MHESAC has trimmed the amount of benefits it can provide to student borrowers, lowered its operating costs and suspended its loan consolidation activity. SAF, which provides support for participants in the student loan program, has lost around 60 employees to attrition and layoffs over the past several months, a function of decreased workload and decreased volume from its clients.

Stipcich said he anticipates MHESAC will post its first-ever operating loss when the books are closed on the year June 30, but that the organization has positive cash flow, and that SAF is actually servicing a greater volume of loans now than it was a year ago.

MHESAC is hardly alone in the student loan industry in having trouble with auction rate bonds, which for more than a decade were one of the most popular ways to generate money for student loans. According to Bloomberg, of the 10 largest issuers of auction-rate debt from 2000 to 2007, half were student lenders (all much larger than MHESAC).

As a result, agencies are looking elsewhere for funds. The Bond Buyer reported this week that the Arkansas Student Loan Authority got preliminary approval for an $80 million line of credit from the state board of finance -- effectively using the state's own bonding authority. The report said South Carolina is considering a similar move.

Stipcich wouldn't offer much detail on other financing vehicles that might be available to help MHESAC get out from under its auction-rate obligations, saying only that "We're pursuing all opportunities, and that's about all that I can say. It would be in our best interest and our borrowers' best interest to refund the auction bonds, and we are working to do that."

Stipcich said that MHESAC relied more heavily on auction-rate funding until about 2004, when nearly 75 percent of the organization's debt was held in auction-rate bonds. Since then, he said, that figure has been trimmed to about a third.

Many investors viewed auction-rate securities as a place to park money for a short period of time, since the bonds were up for resale frequently and could be unloaded for cash. It was when credit and liquidity became a problem this winter that buyers could not be found, making the bonds a poor choice for short-term investors.

"Many of the investors that are in the auction rate space were using auction rate finance for cash management purposes," Stipcich said. "For many of those people, it was a way to manage the investment of their cash, and really their liquid cash. They can invest it, if they need the cash at the end of 35 days, they sell, away they go. Those players, to be in a situation right now where that investment is illiquid, it's an issue for them."

Stipcich didn't rule out a return to the auction-rate market if there's a recovery, but he doesn't expect that any time soon.

"This disruption in the auction-rate market is pretty serious in that it's impacted a lot of investors," he said. "I believe the recovery of the auction rate market will be very slow. If the auction rate market were to recover, we would look at it and compare it to other financing options at the point in time when that auction market did recover."