Education lenders are flocking to traditional student-loan securitizations for funding, following a recent lockup in the market for auction-rate offerings.

Brazos Higher Education of Waco, Texas, and EdSouth of Knoxville, Tenn., are among the companies that are revising their funding strategies in response to the market shift - with both working to issue greater volumes of conventional asset-backed securities with floating interest rates. Others are sure to follow.

Companies like Brazos have long issued a mix of auction-rate bonds and Libor-based floaters to fund their loans, so the change of direction doesn't bring them into completely unfamiliar territory. It does, however, add to an ever-growing list of evasive maneuvers that finance shops have had to make as the broader debt market has been pummeled in recent months.

In the latest turn of events, investors this week rejected tens of billions of dollars of auction-rate securities in the market out of fears that credit problems first seen among subprime mortgages are spreading. That left issuers of the bonds unable to secure new funding at costs they could stomach and caused the rates they pay on outstanding debt to spike.

Auction-rate securities are long-term bonds whose returns mimic those of short-term products. Typically, the securities' interest rates are reset every 28 days to levels determined through investor auctions - a process that also allows current holders to unload them. When those auctions fail, and brokers decline to take down the securities, as happened this week, issuers must pay higher "penalty" rates.

While auction-rate notes can take a variety of forms, both secured and unsecured, those issued as asset-backed bonds are frequently tied to student loans. Unable to sell more of the products, a greater number of education lenders are now viewing the larger market for floating-rate ABS as a more-attractive source of funding.

They're also looking at issuing floating-rate ABS to refinance auction-rate notes whose costs have spiked in recent days.

That reflects a tipping point in education lenders' funding costs. For months, factors related to the global credit crunch have been causing investors to shy away from all types of asset-backed bonds. As spreads on those instruments have swelled, however, the effect among student-loan transactions has been greater on floating-rate instruments than their auction-rate brethren.

Not anymore, as the same credit-related fears are now playing out on the auction-rate side of the market.

To make matters worse, a good deal of auction-rate paper has been guaranteed by bond insurers whose ratings have recently come into question.

Three-year senior student-loan paper with a traditional floating-rate structure is trading at 55-65 bp over Libor right now. While that's a considerable increase from the flat-to-Libor spreads that prevailed a year ago, it looks attractive compared to the current bid of 150-175 bp over Libor for auction-rate products.

The magnitude of the shift toward floating-rate offerings, meanwhile, is difficult to pin down as it involves measuring markets that are already intertwined. The volume of auction-rate student-loan securities in the hands of investors is estimated at $80 billion, but that figure includes both asset-backed securities and revenue bonds - both of which are often issued by state-sponsored enterprises like Brazos.

Still, the migration is likely to be sizable. Nearly $59 billion of student-loan ABS was placed with investors last year, and only a small portion of them were structured as auction-rate offerings. "I think you're going to see a lot more new names in the term market," DBRS analyst David Laterza said.

Only $4 billion of student-loan ABS has priced so far this year, all from Sallie Mae, according to Asset-Backed Alert's ABS Database.

That, in turn, hints at a backlog of loans that lenders have been waiting to fund in hopes that market conditions would improve. When auction-rate transactions were available to them, those companies had the luxury of sitting on the loans. Given this week's shakeup, however, the dilemma now becomes what to do first: Issue floating-rate bonds to refinance costly auction-rate debt, or sell new floaters to clear out warehouse lines containing existing credits. "They're trying to manage which ones take a higher priority," Laterza said.

The decisions will have to come soon. In just a few months, it will be high season for education lenders to be writing new credits for the 2008-2009 school year, so they'll need to make room for those credits in their funding programs.

In most downturns, the need for funding would be less urgent because dealers would buy any auction-rate securities that fail to generate enough interest. But dealers including Citigroup, Goldman Sachs and UBS are declining to take that step now because they're already saddled with holdings of devalued securities tied to subprime mortgages and don't want to run the risk of taking on more troublesome assets.

For the issuers' part, many industry players describe the crisis as a question of liquidity, rather than credit quality. Since most of the loans backing auction-rate student-loan paper carry 97% guarantees from the federal government, investors would likely be made whole even in the event of widespread collateral defaults. That has some calling the exodus from auction-rate notes the result of panic.

In addition to floating-rate transactions, education lenders looking for funding alternatives are considering sales of variable rate demand notes. VRDNs are similar to auction-rate paper in that they are long-term bonds, typically with 15-year lives, whose rates reset after specified timeframes. However, the timeline for that to occur is generally one week. They also carry liquidity support, often from Depfa Bank or Lloyds TSB - or, to a lesser extent, Bank of America.