MONTANA STATE UNIVERSITY Auction Rate Bond Market Overview Montana Board of Regents March 5, 2008

What Is The Current Problem With The Bond Market? Why are basically sound bond offerings “failing,” like what just happened with MHESAC? Auction Rate Securities (ARS) are “failing” to be resold at their weekly auctions, meaning that current investors cannot sell and must continue to hold their bonds; principal and interest on the bonds is still being paid when due. Auctions are failing because large bond insurers with years of triple-A ratings have been placed on credit watch or downgraded. Their ratings are in jeopardy because they have insured risky mortgage pools, including sub-prime loans.

What Is The Effect Of A Failed Auction? After a failed auction, investors must hold their bonds, even if they had planned on cashing them in. Investors receive a higher rate (penalty rate), which is specified in the bond indenture. MSU’s penalty rate cannot exceed 12%, and is currently calculated at 6.15%. MSU’s penalty rate is calculated based on certain market indices, and is affected by our and our insurers’ Moody’s and S&P ratings.

What MSU Bonds Are Potentially Affected By This Market? Series G 2003 Series G 2003 was issued to refund Bozeman 1993 and Northern 1994 bonds, which financed new family housing and renovation of residence halls. $18.7 million of variable rate bonds were issued in the “auction rate” mode. The average interest rate of Series G 2003 has been 2.33% over the past five years, whereas a traditional fixed rate issue would have been approximately 3.25%. The remaining $17.8 million Series G bonds will mature over the next 8 years (2016).

What MSU Bonds Are Potentially Affected By This Market? (cont’d) Series J 2005 Series J 2005 renovated the health and fitness center and the student union building in Bozeman. $25.75 million of variable rate bonds were issued in the “auction rate” mode with an interest rate swap. The average interest rate of Series J has been 4%, whereas a traditional fixed rate issue would have been approximately 4.75%. The remaining $25.5 million Series J bonds will mature over the next 27 years (2035).

Why Did MSU Choose To Issue Variable Rate Debt? The Series G bonds were issued at a variable rate to save interest costs as compared with refunding at a fixed rate. Approximately $2 million has been saved over the first 5 years of the Series G bonds. The Series J bonds were issued at a variable rate to save interest costs as compared with a traditional fixed rate. Approximately $450,000 has been saved over the first 2.5 years of the Series J Bonds.

Could MSU Auction Rate Bonds Fail To Be Resold? What Is The Impact? Yes, MSU bonds can fail to be resold. That does not mean that MSU must pay off the debt before originally scheduled. Instead, the auction investor must accept the present penalty rate formula and cannot convert their investment to cash.

What Can MSU Do To Avoid Higher Interest Costs? There are steps MSU can take to mitigate the impact of the current market conditions. Bonds can be remarketed at a fixed rate. Bonds can be remarketed as variable with a letter of credit (LOC) from a major bank. An LOC will allow the G & J Bonds to be remarketed without experiencing higher rates resulting from downgraded insurers. Other solutions may also be effective.

Are There Many Universities In This Situation? Yes. Numerous universities, hospitals, student loan authorities, airports and other revenue bond issuers have used auction rate bonds. For 10 years prior to 2008, auction bond issuance grew substantially: 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

Are There Many Universities In This Situation? (cont’d) The auction rate bond market has approximately $350 billion outstanding; $80 to $90 billion in student loan bonds alone The benefit of auction rate bonds was cost savings: Savings of .35% to .75% over variable rate demand bonds (VRDBs). Savings of over 1% over traditional fixed-rate issues, which on a $25 million bond had projected savings of $3.7 million.

What Are Universities Doing To Resolve These Problems? A variety of approaches are being considered: Remarketing bonds on a traditional fixed rate Remarketing as variable rate bonds with LOC support Amendments to existing interest rate swaps are being considered to help offset the higher auction rate costs. All are watching to see if and how the bond insurers’ problems may be resolved by the market or by government intervention.

Is Anyone Trying To Resolve The Problem With The Insurers? Some insurers have raised capital. Warren Buffet has offered to reinsure the municipal portion of the insurers’ business. Insurers are considering splitting into two parts: muni and mortgage entities. The New York Insurance Commission and Gov. Spitzer are involved in negotiations with insurers. The market for auction bonds may be attracting investors with its higher rates.

How Long Might It Take For These National Issues To Get Resolved? Impossible to say. Billions of dollars are at stake and many bright minds are working on these problems daily. The FED rate cuts have provided a good environment within which to remarket variable bonds.