US state sues UBS on student loan auction-rate debt

New Hampshire's securities regulator accused Swiss bank UBS AG on Thursday of defrauding the state's leading issuer of student loans, in a scandal that prevents the agency from raising $70 million to fund 6,500 loans.
New Hampshire Higher Education Loan Corp (NHHELCO) had issued auction-rate securities as a low-cost way to fund its operations, but the $330 billion market collapsed in February.
New Hampshire's Bureau of Securities Regulation said UBS Securities LLC had urged the agency to keep issuing the debt even though it knew the market was on the verge of collapse.
New Hampshire wants UBS to pay an undisclosed fine, costs for the investigation and restitution to NHHELCO, Jeff Spill, the state's deputy director of securities regulation said in a telephone interview.
Because of the market freeze, NHHELCO had to shut down two loan programs in March affecting about 6,500 students, NHHELCO President Rene Drouin said.
"We are sitting here with no liquidity for alternative loans and this is a crisis because many parents won't be able to turn to home equity lines to fund their children's education," he said.
NHHELCO will still be able to make loans funded by the federal government. These loans accounted for the bulk of its $250 million program last year that served 80 percent to 85 percent of New Hampshire students.
UBS said it plans to fight the allegations.
"We will vigorously defend ourselves against this complaint as we believe that we worked in the best interests of our investor and issuer clients," UBS said in a statement.
Switzerland's largest bank has worked with NHHELCO since 1997 and has since underwritten $1.5 billion in NHHELCO auction-rate securities.
A number of U.S. states including Massachusetts and New York began investigating auction-rate securities after the $330 billion market seized up in February as the global credit crisis spread.
In separate deals with New York state, UBS and U.S. bank Citigroup Inc have agreed to buy back billions of dollars of the securities from investors.
The Texas securities commissioner said on Wednesday that U.S. and state regulators were close to settling with other banks accused of mishandling sales of auction-rate securities.
This case is different because it focuses on the student loan agency which issued auction-rate securities in order to raise capital that it then loaned to families. The other probes focused on how UBS targeted investors directly to put their money into these securities.
"This is very dramatic and it will have a reverberating effect on students and their parents," Spill, said explaining that NHHELCO has not been able to make private loans this year and thus left many families unable to raise funds private funds to help pay for college.
For years, rates on auction-rate securities were reset at weekly or monthly auctions, which drew investors looking for returns slightly better than money market funds. But on Feb. 13, auction markets all shut down, as trouble in the credit markets spooked investors and Wall Street's giants all decided to stop supporting the trades.