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Tastylunch (99.64)

Advice Sought: Auction Rate failure

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February 22, 2008 – Comments (9) | RELATED TICKERS: JPS

It's fairly old news on CAPS by now

The Preferred Auction market is in an unprecedented freefall 

http://www.nytimes.com/2008/02/15/opinion/15krugman.html?scp=30&sq=auction&st=nyt

Unfortunately for me  I happen to have one of those myself (ticker symbol JPS) and wasn't aware of the industry's problem until it ran in the NY times last week and by then well everbody knew and thus tried to sell theirs. Nice, a 1930's style classic panic. There is talk of the brokerages opening a emergency secondary market in the coming weeks but there will be probably a relatively hefty discount on all sales there (perhaps 20% or more). 

So I'm stuck with a failed auction for the time being and wondering what my next move should be. I think the fund I have is a pretty decent one but I'm not sure that really matters when the whole market for them is virtually non-existant. I'm inclined to try to ride out the crisis (selling on a emergency secondary market seems like it could be a panic move to me), but at the same time I have to admit I'm not entirely certain that the fund won't default.

Any advice or input would be greatly appreciated. 

9 Comments – Post Your Own

#1) On February 22, 2008 at 3:53 AM, AnomaLee (30.09) wrote:

I just read through that article, and I'm sorry you weren't aware of the current conditions. Personally, I don't think this is a safe place to be right now.  These auctions aren't the only ones being effected. Paper issues everywhere are falling.

I heard a figure on CNBC's Fast Money this week that the amount of capital raised by corporate bonds used to be in the range close to $2 Trillion and now it's less than $800 Billion. One of the commentators,Guy Adami,  made a quick remark about that and said "....how are these companies going to raise money.... I think there is huge problems in the market right now..."  I don't know the specifics behind the numbers they quoted, but that just doesn't sound good.

If you read the depressing doom & gloom blogs by some of the top-rated CAPs players you'll find solid posts about how securities across the world are facing serious contraction and spread problems. I have dwot to thanks for most of those insightful posts...

Hope the CAPs community helps you in your decision. 

 

 

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#2) On February 22, 2008 at 8:27 AM, camistocks (80.01) wrote:

Since the USA is in a recession, the news in the media is extremely bearish. Apparently these auction rates  market problems have to do with the monoliners (ABK, MBI), which are the companies who are insuring bonds from default. Their traditional business was to ensure municipal bonds which is regarded as a safe business. However in recent years they also went into the CDO and subprime bonds...

Warren Buffett has created a bond insurance company himself and has proposed to insure something like $800 billion worth of municipal bonds held by these companies, or in short, the riskless business. Elliot Spitzer has set a deadline for the monoliners to find a solution for their capital needs and if they won't he will act somehow. It should take a couple of weeks but probably the monoliners will be forced to sell the muni part of their business to Buffett and keep the risky CDOs (and maybe go bankrupt...)

Warren Buffett doesn't take risks. Confidence will then return and the auction rate market for munis will stabilize.

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#3) On February 22, 2008 at 8:56 AM, dwot (99.98) wrote:

What's the maturity time frame for your holdings?

If the time frame is long, you are hooped.  That's the stuff that no one wants to hold.  It has been playing musical chairs and the music just stopped.  I was reading a post that some of this stuff is written over 40-50 years and if rates reset to say 5%, getting out of it would only give you about 50c on the dollar, 6% about 42c on the dollar.

If the time frame is short it will most likely be fine.  The loss of face value is pretty much because of the time value of money and the uncertainty.  Shorter term stuff may suffer losses, but they will be minimal.

When you say fund, to me that means you don't have control over these things, someone else is doing the buying and selling.  That would be a good reason to me to exit.  And if this thing has a range of stuff, well, the fund could likely be frozen because of others getting out first. 

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#4) On February 22, 2008 at 9:04 AM, dwot (99.98) wrote:

I just saw Camistocks' post. 

Municipalities will probably have an increased default rate because of the declining real estate market.  They do not have their revenue based on a sustainable tax base, but have gone to hitting the developers instead of an equal distribution of costs spread throughout the tax base. 

Housing starts are down everywhere and this is a big income hit, as well, record number of requests for property assessments to down grade values to reduce taxes have been happening.  The latter is fixed by simply resetting the mill rate, however, it will be difficult to make up the loss of excessive development fees.

Some municipalities have costs so high due to the empty houses, well, some will not be able to dig out of this mess. 

If your stuff is in the hardest hit real estate markets, that would be an increased reason to consider exiting. 

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#5) On February 22, 2008 at 8:36 PM, Tastylunch (99.64) wrote:

Hey all first off thanks for the responses, it's always helpful to have more insight.

-Anomalee  

Thanks for the sympathy. I have no one to blame but myself in this one. I never really checked on the fund much due to the fact it's listed as Cash equivalent by my brokerage. My dad bought the whole family a bunch of these several years back and I went along with it since he has been investing for a very long time. I just took his word for it about these and never really checked on it much after he bought it. To be honest I'm much more worried about him than me (about 20% of his holdings are in these). I've been so busy at work trying to get ready for the spring season  and doing corporate taxes that I missed the warning signs... Oh well.

-Camistocks

Normally I'd be inclined to agree with you that media has overhyped the problem  and that ARSes would bounce back, but the crisis of confidence has gotten so deep I have to wonder if any brokers would be willing to sell these again. And if the brokers don't sell them  then who in their right mind will buy mine?I know I never want to buy one again and I'm sure I'm not alone in this. Even if the bond monoliners do get bailed out I don't see what will restore faith in the system enough to bring buyers back.

These funds were never supposed to be illiquid ever. That trust has broken, possibly irrevocably. Imagine if money markets went illquid tomorrow, it's basically like a bank run. You should have heard the pure panic that was going on in my broker's office today. They are having conference calls everyday in attempt to resolve the crisis. This is getting very bad, much worse than probably even the media is reporting for once.

-Dwot

What I have is a closed end fund that invests in Auction Rate securities, primarily preferred stock (80%) with very few Munis (at most 20% but usually far less). If you want to see what it is for yourself I have it linked here . Supposedly it only holds AAA securities (who know how much that really means anymore though).  So there is no timeframe per say for me. So you are right, a fund manager does the buying and selling of the securities in the fund. Although the fund itself is not frozen per say at the moment it might as well be since there are no buyers.

When the system was working I had the option of selling my holding once a week on a specified day (in my case it is Thursdays), but the fund itself has no maturity date. Basically when I've tried to sell the fund the last two weeks, there has been no buyers and it has "failed" which in theory was never supposed to happen (until very recently the brokerage houses bought your fund if there were no takers). When your auction fails the fund has to pay the fund holder a higher interest rate as part of its penalty clause in hopes that it will encourage someone else to buy it. Apparently that's helped some who have held some low credit quality certs as their rates have gone up to as much as 15% 

http://online.wsj.com/article/SB120355364158181495.html

I'd prefer to exit it if I can at a decent price , but I have feeling that i'll be very lucky to get 70c on the dollar on the secondary market (if it gets created). I'm inclined to hold it (since I don't need the liquidity currently) in the hopes the primary market gets restored, although that increasingly looks like an unrealistic possibilty.   I suppose that I may have to sell it on the secondary market at some point regardless (which sounds like what you think is best). A 30-50% loss is better than a 100% loss, just a very frustrating outcome for what was purported to a be a cash alternative.

Thanks a lot for responding Dwot, I was hoping you would since you've blogged about it. 

thanks again everyone, I appreciate it very much. I hope your weeks are going much better than mine.

 

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#6) On February 23, 2008 at 9:26 PM, camistocks (80.01) wrote:

You might be interested in this article:  Feb. 21 (Bloomberg) -- State regulators are scrutinizing sales of auction-rate securities by closed-end mutual funds as investors complain they can't get out of the investments, which were billed as the equivalent of cash."

" ``There are discussions at a very high level on how to get the liquidity necessary so that these auctions will succeed,'' Dinsmore said yesterday in a telephone interview. He declined to name the bank or fund companies." 

"

``We know that the market has more or less ceased to exist,'' Galvin, the top securities regulator in Massachusetts, said yesterday in an interview. ``Our concern is about small investors who may have been attracted to closed-end funds because of their reputation for reliability.''

Some auctions almost failed in mid-2007 before banks brokering them stepped in to boost demand, Payson Swaffield, chief investment officer at Boston-based Eaton Vance, said yesterday in an interview. This month, when buyers dried up again, the banks did not act, angering investors.

" 

Since Ambac is going to announce a plan next week, where they will receive fresh capital, they will avoid the downgrade from AAA. I would guess that the ARS markets will be much more liquid this week.

For example, thanks to Paul Krugman the whole world knows by now that the NY port authority had to pay 20% recently. Well, "surprisingly" last week the rate already dropped to 8%, still above normal, but no way as dramatic as before. I would guess this week the rate, and thus the liquidity will be even lower.

Around new year everybody was worried that the banks wouldn't lend to each other anymore. Today the situation has normalized again. (But you wouldn't read about it in the media/bear blogs...)

BTW, there have been many bank runs in history, the last one just recently in the UK, Northern Rock. But still people continue to deposit their monies in banks...

Don't panic and why not talk with your dad first?

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#7) On February 23, 2008 at 11:14 PM, Tastylunch (99.64) wrote:

Hey Camistocks

Thanks for the links/comments/advice. I'm sure you couldn't tell from the tone of mypost but I'm actually not panicking, not at all. I'm prepared to sit on if for years if I have to, I don't currently need the liquidity. I do however want to make sure that that is the best decision before I do anything so I don't miss what my be my best opportunity (if that ends up being what it is) out of a situation if it continues to deteriorate. I don't think this market has the same standard of safeguards in place that say stocks, money markets or investments do, which is where the loss of confidence becomes important.

My Father on the other hand  is panicking a little (probably out of guilt that he got the whole family into these) and my broker really really is. But both of them recommended these to numerous other people. And especially in my broker's case I think a week long of your top clients scareming at you can wear on anybody ( He said I was the only one who has been nice to him all week).

Thanks for the Bloomberg link. I'm very glad to see that my fund company (Nuveen) is one of the two that's involved in the talks of restoring liquidity. I do however think the investment vehicles credibility has been probably destroyed among most individual investors even if liquidity is restored.

You're right the NY port authority's bond will likely calm down here shortly, my holdings however are less attractive in the regard as the penalty has a much lower cap as I don't own the auction securities directly, rather I own a fund that owns ARSes. I  don't think it would ever generate the same interest.

I have no choice other than wait and see at the moment so that's what I plan to do for the time being. I have no interest in helping fuel a panic run or participating in one if I have better alternative. We'll see what happens. I'll be watching the news like a  hawk.

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#8) On March 04, 2008 at 4:56 AM, camistocks (80.01) wrote:

Tasty, if I look at yahoo finance, http://finance.yahoo.com/q/hp?s=JPS , I see that JPS still has a daily turnover of 180'000 units. While this is less than the average, there is still a market going on. Of course, one has to accept a lower sell price, if the bond should be liquidated immediately.

Personally when I want to sell a stock (I only deal in stocks) I always put my sell price below the market price and trust the broker to get me a good price. But that's just me, other's are trying to get a few cents more.

Also, did you check morningstar.com for your bond ratings? Apparently it is only rated A and it invests primarily in A and BBB rated securities.

http://quicktake.morningstar.com/CEFNET/snapshot.aspx?Country=USA&Symbol=jps

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#9) On March 09, 2008 at 12:51 PM, mlapre (< 20) wrote:

My broker sold me $1,000,000 worth of ARP’s in different funds.
I have filed a formal request for a malpratice claim against the brokers E & O insurance. Since most brokerage houses are self insured and must act under the rules of all insurance companies when claims are presented. They open themselves up to bad faith claims for failure to properly respond. Considering the opposing forces at play, doing the right thing as an insuror places them at odds with themselves. My hope is they act improperly and I will have a more valid claim against them for bad faith which will not be tied to the investment issue at all. It becomes a complete seperate issue, and can place tremendous pressure on these firms if everyone pursues this. Being in the insurance industry has made me aware of this angle, should an insuror act in bad faith, the claim for damages can far outweigh the losses in our frozen securities. I encourage everyone to file a written request to open a formal claim. You do not need an attorney to do so.

Comment by Mike L - March 9, 2008 at 12:21 pm Report this comment

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