Auction-Rate Market Will `Cease to Exist,' Citi Says (Update2)
By Martin Z. Braun
April 15 (Bloomberg) -- The $330 billion auction-rate securities market will ``cease to exist'' after it collapsed in February when Wall Street firms stopped using their own capital to buy unwanted bonds, Citigroup Inc. said.
While the death of the market will only trim brokers' earnings by 1 to 2 percent, investor anger over their inability to liquidate their holdings may be significant if the frozen market doesn't thaw soon, Citigroup analyst Prashant Bhatia wrote in a report. New York-based Citigroup was the top underwriter of municipal auction-rate securities in 2006, managing $8.4 billion of sales, according to Thomson Financial.
``Basically, clients could stop using the services of their brokerage and/or asset management firms as a result of a loss of trust,'' Bhatia wrote.
Auction-rate bonds allowed issuers such as local governments, hospitals, and closed-end mutual funds to issue debt maturing in as long as 40 years at short-term rates that reset every 7, 28 or 35 days through bidding. Investors began abandoning the auction-rate market this year on concerns that companies insuring the bonds wouldn't meet their obligations in case of default.
Thousands of the auctions began failing when dealers, who had stepped in when there weren't enough bidders, pulled back as investment banks and securities firms worldwide took $245 billion in credit losses and writedowns. As a result, investors weren't able to turn the securities into cash, while some issuers were left paying penalty interest rates as high as 20 percent.
No Liquidity
As with structured investment vehicles, ``the liquidity providers were unwilling to provide liquidity,'' the Citigroup report said.
Brokerage clients that hold between $100 billion to $150 billion of auction-rate securities control more than $750 billion in assets, according to the report. Closed-end funds have issued about $40 billion of the securities.
Banks are letting customers borrow against their illiquid auction-rate bonds. UBS AG, which cut the value of the auction- rate securities in its account by about 5 percent, last week said it would allow customers to borrow the full value of their auction debt from the Zurich-based bank starting in May.
Shrinking Market
The auction-rate market has shrunk by at least 15 percent, or $51 billion, as U.S. municipal borrowers refinance to escape higher costs and closed-end funds begin to bail out investors, according to data compiled by Bloomberg. While the average rate for municipal debt with interest set through weekly bidding fell to a nine-week low of 5.14 percent April 9, that's still above the average of 3.65 percent in all of 2007.
The New York Giants announced plans today to redeem $100 million of the $650 million in auction-rate bonds, with interest costs as high as 22 percent, sold to help finance a stadium for the football team under construction in East Rutherford, New Jersey.
Nuveen Investments Inc. and seven other fund managers said they will redeem $7.8 billion in taxable preferred shares that have rates set through periodic dealer-run auctions. About 70 percent of closed-end funds borrow money in an effort to boost returns, most by selling preferred shares on the auction-rate- securities market.
The collapse of the auction-rate market will raise the cost of leverage for closed-end funds, Citigroup said. It will also benefit firms such as Federated Investors Inc.,BlackRock Inc., and Charles Schwab Corp. that have large money-market funds.
``Plain and simple, the money fund turned out to be a superior product and as the ARS crisis is resolved, we expect inflows into money funds,'' Citigroup said.
To contact the reporter on this story: Martin Z. Braun in New York at mbraun6@bloomberg.net;
Last Updated: April 15, 2008 16:17 EDT |
