Saturday, March 1, 2008

Auction Rate Market is Trapped

--Assets in money-market mutual funds typically build up in the first three months of the year but have outflows in late March and mid-April as investors pull out money to pay the tax man, according to research firm iMoneyNet. --But this year, investors who had parked their savings in another type of cash alternative, known as auction-rate securities, may be in a pinch. In recent weeks, the market for these securities has collapsed, leaving investors locked into investments they can't get out of. --Firms such as UBS AG, Citigroup Inc., Morgan Stanley and Wachovia Corp.'s Wachovia Securities, are setting up margin loans or lines of credit. Merrill Lynch & Co., for example, is allowing investors to set up margin loans of up to $10 million against certain investment-grade auction-rate securities. Investors with securities issued by closed-end funds can get loans of up to $10 million through Merrill's banking unit. --Investors, however, will have to still pay interest on those loans. Merrill says standard pricing and terms apply on these new loans. UBS is charging lower rates for clients who can't get their money out of auction-rate securities -- generally as low as the 30-day London interbank offered rate plus a quarter point, or currently about 3.4% -- than it would otherwise charge on its standard margin loans and lines of credit. --Some firms, such as Morgan Stanley, also are doing so-called swaps for select clients with multimillion-dollar positions. Basically, clients who don't need immediate liquidity are swapping their low-yielding cash-like holdings for higher-yielding auction-rate securities. That allows the original holders of the auction-rate securities to exit their positions without taking a loss. It is occurring on a case-by-case basis for the very wealthy and isn't regarded as a mass solution. --In addition, Wall Street brokerage firms are also actively looking at creating a secondary market, which will allow investors to sell their auction-rate securities to other investors. The catch: Investors participating most likely would have to sell securities at a discount. --For investors who don't need the money right away, there is an upside -- higher yields. Many auction-rate securities are required to pay higher interest rates if an auction fails. Rates typically reset higher with every failed auction. --However, investors who bought auction-rate preferred securities issued by closed-end funds are among the worst off because they are only getting 0.20 to 0.30 of a point higher interest than what they would normally get without auction failures. That provides little incentive for the funds to cash out investors.

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