Digging out of The Rubble
- Institutional cash investors continue to face uncertainties and difficult choices in ultimately obtaining liquidity despite the latest liquidity announcements. Interests of institutional investors have taken a back seat in these settlements.
- The distinction between retail and institutional investors seems arbitrary and illogical.
- To avoid their own reputational risk, we think that the secondary brokers are better off in following the lead of the primary dealers and working to provide liquidity to their investors.
- It is our assessment that many institutional investors are not likely to receive interim liquidity equivalent to their securities’ par value while they wait (and hope) for their liquidity dates.
- The latest announcements may turn out to be bad news for secondary market participants.
- We expect issuer-led liquidity solutions to kick into a (relatively) higher gear.
- As the focus of the market shifts from “whether”, to “how” and “how soon” one obtains liquidity, dealer engagement and advisory services will likely become more critical in the somewhat flexible and discretionary process.
After six months of deep freeze, the auction rate securities (ARS) market felt the first thaw in August when eight major dealers reached settlements with securities regulators to purchase the bonds at par from their retail investors. The total amount of the dealer-announced liquidity, $58 billion as of August 15, accounts for roughly 28% of the $207 billion auction rate securities market. While the latest news represents the largest liquidity breakthrough to date, we think that institutional cash investors continue to face uncertainties and difficult choices in ultimately obtaining liquidity.
The announcements from Citigroup, Goldman Sachs, UBS, JPMorgan Chase, Merrill Lynch, Morgan Stanley, and Wachovia will put $40 billion of cash in the hands of retail investors as soon as September 2008 and no later than January 2009. Deutsche Bank did not provide details of its settlement as of August 22nd. Additionally, UBS and Wachovia pledged to bring about $13.4 billion of liquidity to institutional investors no later than June 2009. Merrill Lynch promised to purchase from institutional investors with assets less than $100 million by January 2009, although no specific dollar amount was released. The UBS announcement was in addition to the $3.5 billion of closed-end funds it offered to purchase in July. All of the dealers involved agreed to provide zero net-cost loans to retail investors and will reimburse them for any losses on investments sold below par prior to the settlement dates.
No immediate Relief to Institutional Investors
These latest announcements came as the result of increasing legal and reputational risks the dealers have faced in recent months. As of July 30, NERA, an economic consulting firm, had documented 22 ARS related class-action lawsuits against broker-dealers and projected more suits to come. In recent weeks, New York State Attorney General Andrew Cuomo intensified his investigations of 25 broker-dealers involved in the auction market. The North American Securities Administrators Association (NASAA), an alliance of state securities regulators, and the Securities and Exchange Commission (SEC) were conducting their own investigations. In July, Congress also joined in the growing probes.
We do not think it is coincidental that many of the firms mentioned have very large and significant wealth management operations. Even though the parent companies suffered substantial capital depletion as the result of the larger credit market crisis and were shrinking their balance sheets, a refusal to work with investors and regulators would have been more devastating to their businesses in the long-run. The limited wiggle room the dealers had to accommodate retail investors unfortunately means that interests of institutional investors have taken a back seat in these settlements.
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