This excerpt taken from the ALL 10-Q filed Nov 6, 2008.
Municipal Bonds Included in our municipal bond portfolio at September 30, 2008 are $1.85 billion of auction rate securities (ARS) that have long-term stated maturities, with the interest rate reset based on auctions that historically occurred every 7, 28 or 35 days depending on the specific security. This is compared to a balance of ARS at December 31, 2007 of $2.56 billion, with the decline representing primarily redemptions from calls or refunding proceeds since December 31, 2007. Our holdings primarily have a Moodys equivalent rating of Aaa. We make our investment decisions based on the underlying credit of each security. Approximately $1.80 billion of our holdings are pools of student loans for which at least 85% of the collateral was insured by the U.S. Department of Education at the time we purchased the security. As of September 30, 2008, $1.29 billion of our ARS backed by student loans was 100% insured by the U.S. Department of Education, $267 million was 90% to 99% insured and $246 million was 80% to 89% insured. During the third quarter of 2008, all of our student loan ARS holdings experienced failed auctions and we received the failed auction rate or, for those which contain maximum reset rate formulas, we received the contractual maximum rate. We anticipate that failed auctions may persist and most of our holdings will continue to pay the failed auction rate or, for those that contain maximum rate reset formulas, the maximum rate, as described below. Auctions continue to be conducted as scheduled for each of the securities.
We estimate that approximately one third of our student loan backed ARS include maximum rate reset formulas whereby when the failed auction rate exceeds an annual contractual maximum rate over a preceding stipulated period, the coupon interest rate is temporarily reset to the maximum rate, which can vary between zero and the failed auction rate. This maximum rate formula causes the reset interest rate on these securities to be lower than the failed auction rate in order to reduce the annual interest rate so that it does not exceed the annual contractual maximum rate. Generally, the annual contractual maximum rate is higher than the historical rates paid on these securities. During the third quarter of 2008, $108 million of our ARS reset using the maximum rate reset formula.
During the third quarter of 2008, regulatory authorities announced preliminary settlements in principle with some of the largest broker-dealers of ARS following extensive investigations into the February 2008 ARS market collapse. According to press releases, the settlements require broker-dealers to expeditiously provide liquidity solutions to institutional customers within specified timeframes. While the press release descriptions of the preliminary settlement terms vary in details for institutional investors, at least one description calls for liquidation at par, while other descriptions call for a best efforts approach.
Also included in our municipal bond holdings at September 30, 2008 are $1.11 billion of municipal securities which are not rated by third party credit rating agencies, but are rated by the NAIC and also internally rated by us. These holdings mainly comprise the high yield portion of our overall municipal bond portfolio. The high yield municipal bonds generally provide a higher yield than the municipals rated investment grade by the third party credit rating agencies and provide the opportunity to achieve incremental returns and enhanced diversification of our overall investments portfolio. Our initial investment decisions and ongoing monitoring procedures for these
securities are based on a thorough due diligence process that includes, among other things, an assessment of the credit, structure, and liquidity risks of the issue and issuer. Our internal ratings are generally updated annually; however, they are updated more frequently if developments occur.