Eaton Vance to buy back auction-rate stock

Eaton Vance Corp., the second-largest U.S. manager of closed-end funds, borrowed $1.6 billion to buy back auction-rate preferred stock from investors who were stuck with the securities after the market for them froze up in January.

Auction-rate securities are long-term bonds or preferred stock whose interest rates are reset as often as weekly at auctions designed to bring together buyers with investors who want to sell their holdings.

But the market for the securities, which had been issued by municipal borrowers and closed-end mutual funds, came unhinged as investors began to shun paper backed by troubled bond insurers.

As a result, many auctions have attracted no buyers, leaving holders of the securities without a way to sell what they thought were nearly as liquid as cash and forcing issuers of the securities to pay higher “penalty” interest rates.

Because about half of all closed-end funds sold auction-rate preferred stock to finance additional investments, a strategy aimed at boosting returns, their preferred shareholders have been stuck with about $60 billion in securities.

Closed-end funds issue a fixed number of common shares, which trade on an exchange like stocks.

Boston-based Eaton Vance said Monday that three of its funds would redeem preferred shares: Tax-Advantaged Dividend Income, Tax-Advantaged Global Dividend Income and Tax-Advantaged Global Dividend Opportunities, all of which invest in stocks.

“We hope that this is actual proof that we can find solutions to this instead of just sitting here saying we’re doing everything we can,” Jonathan Isaac, Eaton Vance’s head of closed-end funds, said in an interview.

The new debt will cost the funds less than the penalty rates they have been paying, he said. However, the lender that is putting up the money will accept only stock as collateral, not debt, Isaac said.

That means Eaton Vance’s 26 other leveraged closed-end funds, which issued about $3.4 billion in auction-rate preferred shares, can’t yet redeem them because those funds invest in fixed-income assets.

Isaac said he couldn’t promise that the remaining funds would be able to redeem their auction-rate paper.

“We hope so, but until we act, I’d hate to raise people’s hopes beyond what we can reasonably deliver,” he said.

Cecilia Gondor, an analyst at Thomas J. Herzfeld Advisors Inc. in Miami, said raising that money would be difficult “especially as more funds try to do this and create more demand.”

Britain’s Aberdeen Asset Management Inc. last week became the first closed-end fund manager to say it would redeem auction-rate shares.

In the $330-billion market for tax-exempt auction-rate debt, the penalty interest rates tend to be higher than those being paid by closed-end funds. As a result, California and New York City are among the municipal issuers that plan to replace this week some auction-rate debt.

The California Assembly voted 67 to 1 on Monday for a bill to allow local governments to bid on their own auction-rate paper. The bill still must be approved by the state Senate before it can go to Gov. Arnold Schwarzenegger for his signature.

In Washington, lawmakers are scheduled to hold hearings Wednesday on how turmoil in the credit market is raising costs for local governments.