Florida Schools, California Convert Auction-Rate Debt

By Jeremy R. Cooke

Feb. 22 (Bloomberg) — California, Florida schools and the operator of John F. Kennedy International Airport joined a growing list of municipal borrowers exiting the U.S. auction- rate bond market as record failures push taxpayer costs higher.

Thousands of auctions run by banks to set rates on the debt failed this month as investors shunned the securities and bankers refused to submit bids, sending interest costs as high as 10 percent on some bonds. Auctions covering as much as $26 billion of bonds a day failed to attract enough buyers since Feb. 13, according to Bank of America Corp.

Florida’s Palm Beach County Schools converted $116 million of the securities into fixed-rate debt this week, while the Seattle area’s Valley Medical Center refinanced $170 million. The Port Authority of New York and New Jersey said it would redeem $200 million next month after its weekly interest rate rose as high as 20 percent.

“We expect to be out of the auction-rate market business in six to eight weeks,” said Steve Coleman, a spokesman for the Port Authority, which operates JFK and New York City’s other major airports and owns the World Trade Center site.

Rates in the $133 billion market are determined through a bidding process every seven, 28 or 35 days. Auctions fail when there aren’t enough buyers, leaving bondholders who wanted to sell stuck with the securities and taxpayers with higher interest costs.

Rising Failures

Yesterday’s 641 auctions of publicly offered bonds resulted in 395 failures, or 62 percent, according to data compiled by Bloomberg from four auction agents including Deutsche Bank AG. Just 44 failures were recorded between 1984, when the market was created, and the end of last year, Moody’s Investors Service said in a Feb. 19 report.

The rates when auctions fail are spelled out in documents governing the bonds, and are set as high as 20 percent or based upon money-market benchmarks.

Borrowers — including local governments, hospitals, museums, student-loan agencies and closed-end funds — must pay the penalty rates until buyers support future auctions, or they can modify the bonds to another kind of variable-rate debt or apply a fixed rate.

The average rate for seven-day municipal auction bonds rose to a record 6.59 percent on Feb. 13 from 4.03 percent the previous week, according to indexes compiled by the Securities Industry and Financial Markets Association.

`Unacceptable Level’

Palm Beach school officials started working on a conversion plan in December when rates topped 4 percent. They reached 9.75 percent this week, short of the 15 percent penalty rate. The district’s interest payment for this week’s auction was about $220,000, up from $107,000 during a week in December.

“As a public entity, that’s an unacceptable level of risk for us,” said Leanne Evans, treasurer of the 170,000-student district, one of the five largest school systems in Florida. After converting the debt, the district pays a 4 percent yield.

California, the biggest municipal borrower, plans to replace $1.25 billion of auction-rate bonds, said debt manager Paul Rosenstiel. New York City’s Municipal Water Finance Authority yesterday said it will pay off auction debt by selling $684 million of variable-rate demand notes on March 18.

Until this year, banks that collect annual fees of about 0.25 percent to run auctions would step in to stop failures when bidding faltered. Goldman Sachs Group Inc., Citigroup Inc., UBS AG and Merrill Lynch & Co. stopped committing capital after banks sustained at least $146 billion in credit losses and writedowns from the subprime mortgage collapse. That’s left corporate treasurers and wealthy individuals, some of whom bought the debt as cash equivalents, unable to access their money.

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When Bankers Fear to Act

NY Times Report

By FLOYD NORRIS

Published: February 22, 2008

Where is J. P. Morgan when we need him?

In times of market crisis, the safest course for any one market participant may be the riskiest course for the entire market. If everyone wants to sell, prices can go in only one direction.

In past financial crises, it has fallen to someone — regulators, investment banks or even a single banker — to organize collective action and avert disaster.

Such moves involved persuading people to take steps that seemed to go against their own private interests. Buy stocks when everyone wants to sell? Lend money to a bank in danger of failing, when your own bank might need the money tomorrow? Join with others to buy securities from a desperate seller, rather than try to maximize your own profits from his precarious position? It goes against the basic principle of markets, that your job is to look out for yourself.

But all those things have happened in the past. Unfortunately, nothing like them is happening in the current crisis.

In 1907, Morgan demanded that presidents of New York trust companies — then a type of second-class bank — act together to save one of their own, the Trust Company of America, from a bank run.

The presidents, wrote Robert F. Bruner and Sean D. Carr in their book, “The Panic of 1907,” were “convinced that it was their primary responsibility to conserve their assets in order to survive the financial storm that was swirling around them.” Morgan said that would simply assure that all would fail, one by one.

Morgan, then the dominant figure in American finance, called the presidents to a Saturday meeting in his library — and locked the door. Not until dawn Sunday did he let them out, after they had committed the needed cash.

In 1987, on Tuesday, Oct. 20, it appeared that the crash of the previous day was going to get worse. Market makers had little capital and less appetite to risk it, and one by one trading in the shares of major companies was halted because there were no buyers. In Chicago, the futures market was talking about halting trading in stock index futures because there were not enough stocks trading to know what the futures were worth.

That changed when two major brokerage firms — Goldman Sachs and Salomon Brothers — sent word to the New York Stock Exchange floor that they would buy any stock in the Standard & Poor’s 500 if their orders were needed to keep the shares trading. Just after that word was sent, the market turned around.

In 1998, when a possible hedge fund failure seemed to threaten the financial system, it was the Federal Reserve Bank of New York that called in all the major financial institutions and organized a bailout.

But efforts to organize concerted action this time have been limited. Treasury Secretary Henry M. Paulson Jr. has sought to get agreements in two areas — renegotiating mortgages and putting together a fund to deal with one of the early manifestations of the problem, the threatened collapse of odd financial instruments called structured investment vehicles — but there has been no visible effort to deal with the underlying problem.

In part, that may reflect the slow realization of what is at stake. For many months, we called it the subprime mortgage crisis, because that was where the problem first became apparent. But that label is far too narrow, and serves to obscure what is at stake.

“Rather ominously, borrowing costs for even the most creditworthy of firms have started to rise,” said Paul Ashworth, an economist with Capital Economics in London. Homeowners who can still get mortgages have seen rates rise in recent weeks, and banks say they are tightening their standards for both credit cards and commercial real estate loans.

“The principal cause for concern today is the paralysis of the credit markets,” Martin Feldstein, a Harvard economist and an adviser to President Ronald Reagan, wrote in The Wall Street Journal this week. “The collapse of confidence in credit markets is now preventing that necessary extension of credit. The decline of credit creation includes not only the banks but also the bond markets, hedge funds, insurance companies and mutual funds. Securitization, leveraged buyouts and credit insurance have also atrophied.”

The latest area of crisis is one that Morgan would have recognized in 1907. The major Wall Street houses — from Morgan Stanley and Goldman Sachs to Citigroup and Merrill Lynch — have refused to commit capital to the auction-rate market, a market that was supposed to allow investors to sell each week, via an auction that set interest rates.

Now many auctions are failing. That has left customers unable to sell securities that were supposed to have virtually guaranteed liquidity, and it has left the issuers — who paid fees to the banks to conduct the auctions — paying ridiculously high interest rates. Its not easy to get both borrowers and lenders feeling angry and abandoned, but Wall Street has managed the feat.

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Regulators Probe Funds After Failed Auctions Draw Ire

By Christopher Condon and Michael McDonald
(Source: Bloomberg)

State regulators are scrutinizing sales of auction-rate securities by closed-end mutual funds as investors complain they can’t get out of the investments, which were billed as the equivalent of cash.Massachusetts Secretary of State William Galvin asked nine fund companies for information about failed auctions that left investors unable to sell their holdings, his office said in a statement yesterday. Ohio Attorney General Marc Dann may file lawsuits after state funds bought the securities, spokeswoman Jennifer Brindisi said yesterday in an e-mail.

“I wanted something as good as cash, and now I’ve got a lot of money in there that I needed to get at quickly,” Aaron E. Some, an investor in Delray Beach, Florida, said in an interview yesterday. The investor said he has $4.5 million tied up in auction-rate securities issued by closed-end funds.

The heightened regulatory interest comes as money managers look for ways to let investors cash out after recent auctions, mostly by municipal bond funds, didn’t attract enough buyers. The failures have raised concerns that closed-end funds may be forced to sell assets to pay off auction-rate investors, cutting into returns for fund shareholders and flooding the municipal bond market.

Closed-end funds issue a fixed number of common shares that trade on an exchange like stocks, unlike open-end mutual funds, which continually issue and redeem shares from investors. Some closed-end funds also sell auction-rate securities, in the form of preferred shares, to finance additional investments, a strategy aimed at boosting returns.

$60 Billion Outstanding

Interest rates on the securities are reset through auctions at intervals ranging from 7 to 35 days, allowing buyers and sellers to treat them like short-term investments. When an auction fails because of lack of demand, current investors must hold onto the securities, whose yield is reset to a maximum, or penalty, rate according to a pre-set formula.

More than 450 funds, or 70 percent, use leverage, according to a Feb. 15 research note by Raymond James & Associates Inc. of St. Petersburg, Florida. Of those, 70 percent use the auction- rate market. Closed-end funds have about $60 billion in preferred outstanding, about 20 percent of the auction-rate securities market.

Auction-rate securities are also issued as debt by municipalities and institutions such as hospitals and universities. The market has been hurt as investor confidence in the creditworthiness of insurers backing them wanes, and as banks seek to avoid tying up capital after at least $133 billion in credit losses and mortgage writedowns stemming from the subprime-bond collapse. Dealers aren’t supporting the auctions, after routinely stepping in to buy the securities in the past when bidders couldn’t be found.

Seeking a Solution

Two closed-end fund companies are in talks with a “major” bank aimed at thawing the freeze in the auction-rate market, according to Thomas Dinsmore, president of the Closed-End Fund Association, a Kansas City, Missouri-based trade group.

“There are discussions at a very high level on how to get the liquidity necessary so that these auctions will succeed,” Dinsmore said yesterday in a telephone interview. He declined to name the bank or fund companies.

New York-based Morgan Stanley yesterday was the latest fund manager to disclose that some auctions for closed-end preferred shares had failed. Eaton Vance Corp., AllianceBernstein Holding LP, BlackRock Inc. and Nuveen Investments Inc. have also had failed auctions.

Market Disappears

“We know that the market has more or less ceased to exist,” Galvin, the top securities regulator in Massachusetts, said yesterday in an interview. “Our concern is about small investors who may have been attracted to closed-end funds because of their reputation for reliability.”

Some auctions almost failed in mid-2007 before banks brokering them stepped in to boost demand, Payson Swaffield, chief investment officer at Boston-based Eaton Vance, said yesterday in an interview. This month, when buyers dried up again, the banks did not act, angering investors.

“You’ve got $60 billion in which the holders believed until recently they could liquidate on par on demand and suddenly that $60 billion is frozen,” said David Kotok, chief investment officer of Cumberland Advisors Inc. in Vineland, New Jersey, which manages $900 million in assets.

“If you have a pattern for years sustaining a liquidity facility and you suddenly abandon it without notice, do you have a duty to the investor?” he said. “That’s a question that will need to be answered. This is an ugly mess.”

Alternatives

Eaton Vance, the second-largest U.S. manager of closed-end funds after Nuveen, has held “preliminary discussions” with a bank about refinancing alternatives for the securities, according to Swaffield, who declined to name the bank.

Options include replacing the securities with a structured product that money-market mutual funds would be eligible to buy, which would increase demand, he said. Money-market funds are prohibited from participating in the auction-rate market.

Swaffield said the banks that organize the auctions may be able to raise funds directly from the U.S. Federal Reserve.

“The debt had a AAA rating with at least 200 percent collateral, he said. “The Fed should be reasonably comfortable with that.”

The impact of the failed auctions on closed-end funds has so far been small, said Dinsmore, the trade group president. Because of recent interest-rate cuts by the Fed, fund managers said the penalty rates that many closed-end funds now pay are as low, or lower than, rates paid at successful auctions in the fourth quarter of last year.

Discounts Widen

An auction failure “doesn’t disadvantage equity holders,” Dinsmore said. “What it does do is reduce the amount of income from leveraging a portion of the portfolio.”

Common shares of closed-end funds closed Feb. 19 at an average discount of 4.5 percent against net asset value. That was down from an average discount of 3.55 percent at the end of January. Municipal closed-end funds, which all use the auction- rate market for leverage, saw discounts go from 4.23 percent to 5.8 percent.

Original Article 

NY-NJ Port Authority to exit auction-rate market

NEW YORK, Feb 21 (Reuters) – The New York-New Jersey Port Authority on Thursday said it will redeem $200 million of auction-rate paper and exit this market in six to eight weeks after rates briefly spiked as high as 20 percent.

Numerous auctions of this type of debt have failed since late January because investors were spooked by bond insurers’ problems and dealers stopped supporting the auctions.

This has forced many issuers to pay high penalty rates. For example, the rates on $100 million of the Port Authority’s auction-rate paper last week rose to 20 percent from 4.3 percent, agency officials said.

This week, the rates reset at 8 percent — still almost double the previous rates. Hedge funds and wealthy individuals have been big buyers this week, eager to capture such unusually high interest rates.

“We began the process of redeeming about $200 million of versatile structure obligations that we have outstanding,” Anthony Shorris, executive director, told reporters.

“We’ll do that in an orderly process. Our expectation is that we will be out of this instrument in six to eight weeks.”

The authority has about $700 million of auction-rate paper outstanding. The $200 million it will redeem will be replaced with commercial paper, Shorris said.

Its auction-rate paper was insured by Financial Security Assurance (DEXI.BR: Quote, Profile, Research) and MBIA Inc (MBI.N: Quote, Profile, Research). (Reporting by Anastasija Johnson; editing by ; Editing by Tom Hals)

 Original Article on Reuters