WASHINGTON -- The new arbitrage rules may provide some issuers who are refunding student loan bonds issued before Jan. 6, 1990, with more favorable arbitrage treatment than was intended, bond lawyers said this week.

The Internal Revenue Service published the rules on June 14, and they generally took effect for bonds issued after June 30.

The new rules contain a refunding exception to the student loan bond restrictions that the IRS adopted in 1990. In what appears to be a glitch, the exception allows issuers who meet certain criteria to earn a 2% spread between the yields of their bonds and the underlying student loans without having to take special allowance payments into account when calculating their arbitrage earnings.

"The net result is that you've got the payments not included but you're entitled to a 2% spread," said one bond lawyer who did not want to be identified.

Special allowance payments are payments the Department of Education makes to issuers to help them cover the costs of administering and servicing student loans. If included in arbitrage calculations, these payments would be treated as an additional form of interest income to the issuer. This could make it tougher for the issuer to keep its investment yield within the permitted spread.

Because of the glitch, the new rules would in some cases provide issuers of refunding bonds originally issued before Jan. 6, 1990, with more favorable arbitrage treatment than under the restrictive student loan bond rules the IRS adopted in 1990.

Those rules contained a refunding exception that exempted issuers who refunded prior bonds and met certain criteria from having to include the payments in arbitrage calculations. But the exception said such issuers could only earn a spread equal to 1.5% plus any additional amount needed to cover administrative expenses.

The idea behind that refunding exception was to allow issuers refunding prior bonds to be exempt from the more restrictive treatment of student loan bonds contained in the 1990 rules. Those rules allowed issuers to earn a spread of 2% plus an additional amount needed to cover necessary expenses, but for the first time, also required them to include the special allowance payments in their arbitrage calculations.

Student loan bond industry officials complained at the time that they might not be able to recover all of their administrative costs if they were required to include the special allowance payments in the arbitrage calculations.

Treasury and IRS officials said this week that they meant to include the refunding exception that was in the 1990 rules in the new rules as well.

But bond lawyers said the federal officials did not quite do that. The refunding exception in the new rules allows issuers refunding bonds issued prior to Jan. 6, 1990, to avoid including special allowance payments in their arbitrage calculations. But it also permits them to earn a 2% rather than a 1.5% spread.

"If that's the case, then it is a technical glitch," said one federal official.

While some lawyers said the glitch would provide unexpected special benefits to many issuers who are refunding such student loan bonds, others disagreed, saying the new rules continue to allow issuers to use previously adopted provisions that may offer a better alternative to the refunding exception.

The new rules, the disagreeing lawyers said, continue to permit issuers who are willing to treat their student loans as "nonprogram investments" to earn a spread between the bond and loan yields that is equal to their reasonable administrative expenses plus 1/8%. This provision was in the 1990 student loan bond rules.

"It could be the 2% rules are more favorable, it could be the 1/8% plus cost rule is more favorable. It just depends on your circumstances," said another bond lawyer who also asked not be identified.

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