Frozen market’s big chill
The $330-billion auction-rate securities market will “cease to exist” after it collapsed in February because Wall Street firms stopped using their own capital to buy bonds when demand fell short, a Citigroup Inc. analyst said.
If the frozen market doesn’t thaw soon, a large number of angry investors could abandon the brokerages that sold them the now-illiquid securities, Citigroup analyst Prashant Bhatia wrote in a report.
Auction-rate bonds allowed issuers such as local governments, hospitals and closed-end mutual funds to issue long-term debt at short-term rates that were reset in auctions of the debt every 7, 28 or 35 days.
Investors began abandoning the auction-rate market this year because of concerns that companies insuring municipal bonds wouldn’t meet their obligations in case of default. The firms that underwrote the auction-rate debt and managed the auctions, facing their own capital concerns, stopped acting as buyers of last resort. As a result, investors weren’t able to turn the securities into cash, and some issuers were left paying penalty interest rates as high as 20%.
“The liquidity providers were unwilling to provide liquidity,” the Citigroup report said.
Citigroup was the top underwriter of municipal auction-rate securities in 2006, managing $8.4 billion of sales, according to Thomson Financial.
The auction-rate market has shrunk by at least 15%, or $51 billion, as U.S. municipal borrowers paying penalty rates have refinanced and as closed-end funds, which issued about $40 billion of the securities, have begun to bail out investors, according to data compiled by Bloomberg. The average interest rate on auction-rate municipal debt that resets weekly fell to a nine-week low of 5.14% last week, still well above the 2007 average of 3.65%.
The New York Giants football team said Tuesday that it would redeem $100 million of the $650 million in auction-rate bonds it sold to help finance a stadium in East Rutherford, N.J. The team has been paying as much as 22% on the debt.
The collapse of the auction-rate market will raise the cost of leverage for closed-end mutual funds, Citigroup said.
About 70% of closed-end funds have borrowed money in an effort to boost returns, mostly by selling auction-rate preferred shares.
