By: Michael Quint
More than a year after 15 securities firms settled claims of manipulating auction-rate bonds, the $360 billion market remains as opaque as ever.
Investors can’t get basic information about trading in their securities, like the interest rate. Qwest Communications International Inc. and Synaptics Inc. haven’t been able to unload the debt when they wanted to, regulatory filings show. Borrowing costs on the $270 billion of auction bonds sold by state and local governments have climbed an average 13 basis points compared with notes that aren’t subject to periodic sales, according to the brokerage industry’s trade group.
The collapse of debt backed by subprime mortgages that forced banks to report more than $50 billion of losses and writedowns this year is infecting the market for auction securities. Investors are concerned because brokers can advise bidders on what they should pay and the U.S. Securities and Exchange Commission allows dealers to use their inside information to compete with bondholders.
“When you buy auction securities, you are beholden to a broker,” said Adam Dean, president at SVB Asset Management, a San Francisco, California, firm that manages about $6 billion of corporate cash accounts. While Dean doesn’t buy the debt because of the risk that it can’t be readily converted to cash, “our clients are constantly being solicited by brokers,” he said.
Unlike Treasuries or stocks, there is no daily source of information about auction-rate bonds, floating-rate securities whose interest rate is reset though periodic bids, typically every seven, 25 or 28 days.
Investors can’t compare holdings with other auction securities except with weekly indexes maintained by the Securities Industry and Financial Markets Association, the U.S. bond market’s trade group. More timely information is held by brokers who determine rates by figuring out the highest yield that will result in all the bonds being sold.
“Investors and issuers would be well-served if they know the interest rate on these securities,” said Martha Haines, head of the SEC’s Office of Municipal Securities. “They can see where they stand relative to other auction securities.”
Securities firms paid $13 million to settle charges of bid- rigging in auction-rate bonds last year. While the SEC required banks to disclose that they may use insider knowledge to place bids, they don’t have to say how frequently they bid or how much. Dealers also aren’t obligated to disclose rates on auction debt when the securities trade.
“Level Playing Field”
“The auction market as it is now isn’t a level playing field because it denies investors the information they need to assess their liquidity risk,” said Joseph Fichera, chief executive officer of Saber Partners, a New York-based financial adviser.
Auctions for about $6 billion of securities have failed in the corporate market because there weren’t enough bids, according to Lee Epstein, the CEO of Money Market One, a San Francisco brokerage.
Municipal bond insurers, including Ambac Assurance Corp. and MBIA Insurance Corp., accounted for $1.85 billion of failed auctions, according to Fitch Ratings. At least nine collateralized-debt obligations included securities whose auctions have failed, according to court documents.
When auctions fail, the yield is set at a maximum rate specified in sale documents. That can be as high as 12 percent for municipal tax-exempt debt issued by the New York City Municipal Water Finance Authority and as little as 1 percentage point above wholesale bank deposits for corporate securities, bond documents show.
“Investors are nervous that if there aren’t enough buyers at the auctions, they have to rely on bids by dealers,” said Richard Davis, an assistant commissioner at the Utah State Board of Regents.
Utah Rates Rise
Rates for the Salt Lake City-based student-loan agency jumped more than 1 percentage point to 6.40 percent in August. While the rate fell to 5.05 percent this month, it’s still 40 basis points more than the London interbank offered rate, a benchmark for short-term lending. Before August, the debt yielded about 5 basis points less than the benchmark. A basis point is 0.01 percentage point. The difference means $450,000 in extra interest each year on borrowings of $100 million.
There is little chance of failure in auctions of municipal bonds, according to Citigroup Inc. municipal strategist George Friedlander.
“In our opinion, there is no parallel risk on municipals,” though “the short-term muni market has suffered a bit of guilt by association that will take time to recede,” he wrote in an Oct. 5 report. The New York-based bank was the biggest underwriter of auction securities last year, according to Thomson Financial.
Investors such as corporate cash managers buy auction securities as an alternative to money market mutual funds and Treasury bills. One-month taxable auction securities yielded an average 5.27 percent on Nov. 14, according to the trade group index, compared with 3.87 percent for four-week Treasury bills.
A poll of corporate cash managers in May showed that one- third invested in auction-rate securities, according to a report prepared by Citigroup Inc. for the Association for Finance Professionals, whose 16,000 members are mostly corporate treasurers and finance officers.
Holders such as Qwest, the Denver-based local phone carrier in 14 western U.S. states, and Santa Clara, California-based Synaptics, a maker of touch-screen devices for cell phones, have been unable to unload securities because of auction failures, according to SEC filings.
Apex Silver Mines Ltd., a mining company based in Denver, took a loss of more than $20 million in the third quarter to write down the value of $71 million of failed auction securities, according to the company’s quarterly SEC filing.
MetroPCS Communications Inc., a Dallas-based mobile phone company, filed a lawsuit over the failures, alleging in Texas state court that New York-based Merrill Lynch & Co. failed to disclose the risks and ignored the company’s instructions to invest in securities that can be readily sold.
Terez Hanhan, a spokeswoman at Merrill, declined to comment about auction-rate deals run by the brokerage.
The Municipal Securities Rulemaking Board, the self-regulatory group that polices the municipal bond market, is studying disclosure of interest rates on auction securities when they trade, according to Frank Chin, chairman of the rulemaking body. Providing additional information “will be the subject of additional dialog with the SEC,” said Chin, who is also director of public finance at Citigroup, the biggest U.S. bank.
Indexes of auction-rate securities, created by bankers at the time of the SEC settlement, are no substitute for information about specific issues, said Saber’s Fichera. They are based on two days of auction results from the previous week and can be at odds with information available to bankers.
Investors would have more confidence if they had more information, said Lance Pan, director of research at Capital Advisors Group, which oversees $7.5 billion of cash in Newton, Massachusetts.
Bondholders want to know the range of bids on auction securities and whether dealers are stepping in, Pan said. Investors also need to know the ratio of bids to securities available.
“Bankers are pretty hush-hush about auction results,” Pan said. “We just can’t get the information we need to evaluate the risks.”