College campuses are the setting for a new intellectual debate, whether federally created entities should compete with private firms for the right to enhance educational debt.

And the arguments are about to get very heated. The Student Loan Marketing Association is considering a plan to provide liquidity facilities and direct lending programs to A-rated institutions, according to Capitol Hill sources.

Sallie Mae's proposed venture would result in direct competition with the letter-of-credit market, where domestic and international banks now provide both liquidity facilities and and direct taxable lending programs.

The power to enhance and lend directly to A-rated universities will be officially conferred upon Sallie Mae when this year's reauthorization of The Higher Education Act is signed by President Bush. Congressional conferees already have decided, however, on "expanding the government-sponsored enterprise.

"The bill expands SLMA's targeting to include 'A' rated institutions," Title IV of the act says.

Officials at Sallie Mae declined to discuss the new products. "We feel it's premature to comment before the legislation is enacted," a spokesman for Sallie Mae said.

"They would like to do it. They're considering it," said a source familiar with the reauthorization proceedings. "And why shouldn't they? They got what they wanted from the amendment."

Officials at letter-of-credit banks see Sallie Mae's entry into the college enhancement market as a daunting prospect.

Direct Lending's the Thing

Lisa Pent, assistant vice president and assistant manager of public finance at Fuji Ban Ltd., said providing liquidity facilities to colleges is a small part of the market, but that direct lending by Sallie Mae could have a big impact.

"They are going after a piece of a pie, but it's not a big pie in the first place," Ms. Pent said. "In direct lending, they can make it very tough to compete, especially if they can compete with us on rate."

Direct lending to colleges is pegged to the London Interbank Offered Rate, or LIBOR, so banks take in whatever they can lend above the going rate, currently 4.5 % for one year.

The major reason enhancing education bonds is a limited market is rooted in the Tax Reform Act of 1986. The tax act capped private universities' tax-exempt borrowing at no more than $150 million outstanding at one time. As a result, the thriving market is in taxable direct lending, bank and enhancement sources said.

The $15 million limit is starkly evident in the new-issue market. Last year, higher education bonds made up less than 5% of the primary municipal bond market, or $7.63 billion of the $172.57 billion sold.

In fact, since many universities have bumped up against their caps, entering the line-of-credit and direct-lending markets could be a forward-looking strategy, according to one liquidity provider executive who asked not to be identified.

"A number of universities are at or approaching that limit," he said, "so far them [Sallie Mae] would be very attractive."

The executive added that an accurate measure of market impact will not be possible until Sallie Mae's pricing intentions are clear. If the federally chartered corporation can lend at low enough rates, the products could "compete with the bond market itself."

Ms. Pent agreed. "It all depends on what they are able to pass on to their customers," she said. "If they can do flat LIBOR, that's real competition."

Sallie Mae's planned entrance into the education enhancement market comes as the College Construction Loan Insurance Association finds its most recent attempt to expand its mandate dead in the water. Connie Lee, 35% owned by Sallie Mae, last month attempted to get authority to insure bonds from A-rated institutions.

Late last week, congressional conferees, reportedly exhausted from steady assaults by lobbyists for General Electric, agreed to an amendment that effectively separated Connie Lee from the private market by requiring that "all monoline insurers" must first decline an A-rated university bond before Connie Lee can insure it.

General Electric Capital Corp. is the parent of Financial Guaranty Insurance Co., the bond insurer which has been most vocal in opposing Connie Lee's expansion.

Nevertheless, the move to create federal corporations for participation in the tax-exempt and other fixed-income markets is "in vogue," according to Capitol Hill consultants.

One Very Happy College

For municipal issuers, the trend bodes well. A federal corporation steps in to insure the bonds, and the interest savings are enormous.

One of the latest borrowings backed by Connie Lee is a case in point. Roger Williams University in Bristol, R.I., late last month completed the largest borrowing in the Ocean State's history, a $43 million deal insured by Connie Lee.

The educators were ecstatic.

"There's no doubt it, the savings that you get from Connie Lee were great," said Thomas Oates, controller of the university.

"It certainly makes the trustees feel more comfortable and proud," said Ralph R. Papitto, chairman of the board of trustees at Roger Williams. "We're selling a piece of paper that's fully insured. It's more prestigious. It give us a better image in the community."

The enthusiasm stems from a fairly hefty reduction in borrowing costs. Mssrs. Oates and Papitto said debt service costs were reduced by 60 to 70 basis points. The proceeds, in addition, will be used to refund about $22 million of outstanding bonds, as well as to fund construction of the university's new law school and other capital projects.

"It creates about $700,000 of additional cash flow," Mr. Papitto said. "It's a no-lose proposition."

Connie Lee's take also was fairly good, given the usually cutthroat level of competition in the bond insurance market. Roger Williams paid about 150 basis points (1.5% of the total principal and interest outstanding), or roughly $1.53 million in an upfront premium.

Yet Roger Williams is a lower-quality credit, justifying 150 basis points, private bond insurance executives said. The university's outstanding bonds are all enhanced, some by Fleet Bank and rated Baa 1 by Moody's Investors Service, others by Bond Investors Guaranty and rated triple-A by Moody's and Standard & Poor's Corp.

Private insurers' premiums generally range in the 25- to 75-basis-point range.

Connie Lee, therefore, stands to make good money, yet not any more in the final analysis than the private market. Standard & Poor's, which rates the firm AAA, holds Connie Lee to a higher analytical standard, due to its inability to diversify its insured portfolio.

Richard Smith, managing director at Standard & Poor's, said the agency assesses an additional 20% capital charge, or surcharge, for Connie Lee's backing of general obligations sold by private colleges. The surchange can range silghtly higher or lower depending on specific circumstances.

After factoring in several assumptions for underlying credit quality, tax treatment, and ignoring operating cost variables, the Roger Williams deal would result in about $230,000 more being set aside by Connie Lee than what is required of private insurers, Mr. Smith estimated.

Connie Lee's "social mission" is amply demonstrated by this deal. And it gives the bond insurer a strong intangible weapon -- the goodwill of college administrators.

This profitable goodwill is being sought by more than Connie Lee and Sallie Mae. In fact, these firms' explorations of the higher-quality realms of the tax-exempt market could turn out to be the advance guard of an ongoing assault.

The Department of Transportation, for example, wants in on the action. Plans are underway to create Dottie Fae, or the Department of Transportation Financing Association, to insure transportation-related municipal bonds.

And other federal agencies are considering financial guarantors. Now circulating is a proposal to create a government-sponsored enterprise that, with the aid of state housing authorities, would directly lend to low-income builders and possibly lessen housing volume.

And outside the tax-exempt market, the Department of Veterans Affairs last week debuted Vinnie Mac, a guarantee program wherein the government insures real estate mortgage investment conduits.

"My hunch is there's a lot more of this stuff coming down the pike," said one Capitol Hill consultant.

Sources in Washington say the concept has caught on as a way to walk a fine line in the ever-tremulous Washington scene: Social concerns are addressed and no one's special interests are stepped on.

No one in Washington, anyway.

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