Testimony of Paul W. Wozniak
Managing Director
UBS Financial Services Inc.

U.S. House of Representatives
Subcommittee on 21^st Century Competitiveness
Committee on Education and the Workforce

"Consolidation Loans"

July 21, 2003

Good Morning. I am Paul Wozniak, a Managing Director and Group Manager of UBS Financial Services Inc.’s Education Loan Group. The Group is the largest of its kind on Wall Street, and we are mandated to coordinate all education loan related finance activities in the Asset-Backed Finance, Taxable Fixed Income and Municipal Securities Departments. Last year my group managed $12.5 billion of education loan financing activities. I am currently in my 22^nd year of financing postsecondary education loans.

I was asked to describe for the Subcommittee the manner in which education loans, and specifically consolidation loans, are financed and to address market issues that may arise as a result of permitting such loans to be reconsolidated.

Education loans are held by a variety of entities including for-profit and not-for-profit corporations and state agencies. During the past 18 months, some $58 billion of long-term securities were issued by these entities to finance postsecondary education loans, primarily FFELP loans. Additional capital was provided to a lesser extent to this sector by lenders through other internal sources of funds.

The securities issued took many forms, but generally reflected common themes; (i) they were asset-backed (meaning secured by the loans themselves) securitizations or debt financings, (ii) they were structured vehicles of various complexity, (iii) they were structured to meet strict rating agency stress cases to achieve investment grade ratings and (iv) they were designed to meet investors’ preferences. Further, it is essential to the rating agencies rating opinion that asset securitizations are issued via a bankruptcy remote trust or entity.

The securities were distributed globally to investors and included such securities types as floating rate notes, auction rate notes, reset notes and fixed rate bonds. Virtually all these securities have very long dated maturities. To achieve the most efficient structures, many programs incorporated derivative products into the trust. The purpose of these instruments is generally twofold: First, to provide asset-liability management or match funding for the assets, and second, to allow an issuer to access one market that may be preferred by investors, and synthetically converting the risk of the obligation to something more useful to the issuer.

For example, while the US dollar floating rate note market ("FRN") is an excellent funding vehicle for FFELP loans, investor demand is thin for longer maturities, especially maturities that would help securitize the longer cash flows of consolidation loans. However, there is longer term investor interest in Euro denominated floating rate notes. Hence, a derivative product can be employed to convert Euro currency and rate risk to US dollar rates in a less expensive manner than could otherwise be done directly with US dollar investors around the world.

With this as background, there is one thing that lenders and investors value most and that is predictability. The greater the predictability, the more efficient the pricing of the debt will be. The more efficient the pricing of the debt, the better able the lender will be to offer borrowers the most beneficial terms, and ostensibly, those lenders offering the best terms and service to students will achieve a growing share of the market. Investors that have invested in student loan backed securities, have been drawn to the sector by the relative predictability of cash flow repayment despite the many unique features inherent in the FFEL program. FRN investors, in particular, carefully analyze the speed at which they expect a portfolio of loans to repay. Significant variances from expectation cause investors to reassess the risk or value of an investment. Identifiable market developments may cause an investor to reevaluate its model. Systematic risk, such as legislative risk, may be viewed with more caution, as it is less predictable or market driven.

A loan refinancing option that gives some borrowers a second bite at the apple is something that most investors could have not contemplated in assessing the average life of their investment. The consolidation option was generally viewed as a mechanism that permitted those with multiple loans to combine them into a single loan thereby resulting in a single borrower repayment, or by those borrowers with large balances to achieve a more manageable monthly payment through extended repayment. Reconsolidation, on the other hand, will target only certain loans (as currently proposed, most attractive to borrowers that may have consolidated several years ago) having the greatest value in outstanding trusts. It is safe to say that as a result, investors in all types of student loan backed securities will be unambiguously less secure than they would be absent a reconsolidation option. The magnitude of this decreased security may only be assessed on a trust-by-trust review, and for FRN and fixed rate investors who have already agreed to accept a certain yield spread or interest rate on their securities for the life of the offering, it is a risk they will bear as the market adjusts.

Increased prepayment speeds and the potential loss of favorably performing collateral (potentially creating a negative selection bias for a portfolio) will invariably be factored into future investor evaluations of the sector. Presumably, investors may also increase the weight they place on an evaluation of legislative risk to the extent that it could be measured. As there is a large foreign investor base, especially in FRNs, their ability to assess or manage this potential risk is somewhat diminished. Therefore, it is difficult to assess a magnitude to any investor response.

Reconsolidation will also have an impact on the Direct Loan portfolio. As the government continues to look at certain options to manage its portfolio, a reconsolidation option will diminish the value the government will be able to realize on any loan sales or securitizations of its own.

The implications of the reconsolidation of consolidation loans are subtle to be sure. It is important to weigh the goals and benefits of any new options against the goals and benefits of the entire FFEL program. The ability of lenders to continue to raise capital on the most efficient basis possible should be one of the criteria included in this evaluation, because this has been one of the driving factors in providing borrowers the benefits and services they have so come to expect.

I thank you for your time.