After announcing a round of layoffs last week, Alabama-based bank Regions Financial Corp. will report its first-quarter earnings on April 15, which will most likely commence a year that will be dominated by decisions connected to the nationwide credit crunch.
Housing-related loans will be Regions’ (and the entire banking industry) weak spot. According to a Morningstar analyst, Regions’ loans to homebuilders in Florida and Atlanta are the source of its biggest woes.
In January, Regions started targeting $850 million of loans of its homebuilder portfolio it hoped to find a way out of. Instability in their homebuilder portfolio is expected the rest of this year and Regions recently reported to the SEC that its nonperforming asset and charge-off levels will continue to go up in 2008. The bank will also realize costs associated with its 2006 merger with AmSouth Bank through the second quarter of this year.
As the bank gets ready to move into managing the uncertain credit cycle, litigation will also plague its decisions.
For example, in West Tennessee, there are six pending federal lawsuits (there are no class actions as of yet) that specifically relate to activities of Regions' investment banking arm, Memphis-based Morgan Keegan. Morgan Keegan executives are departing the company amidst emerging complaints that allege the company misrepresented or failed to disclose facts concerning portfolio composition, fair valuation, liquidity, and risk in fund registration statements and other documents.
And last week, the New York-based Catholic Medical Mission Board filed a federal suit against Regions in Birmingham claiming that bank executives swindled shareholders and sold their shares of Regions stock because they allegedly knew the share price would fall.
Monday, March 31, 2008
Legg Looking at Solutions to Auction-Rate Problem
Asset manager Legg Mason Inc. announced it is seeking solutions for investors of auction-rate preferred securities issued by seven closed-end funds and expects preferred auctions to continue to fail. However, the company will not promise a resolution will be reached or disclose which solutions are being considered, although they say “any potential solution would be subject to factors beyond Legg Mason’s control,” including market, credit and economic developments.
When the auction-rate market began collapsing earlier this year, investors in auction-rate securities discovered that these so-called “cash alternatives” were actually illiquid, leaving them with more than $300 billion worth of these securities and a higher penalty interest rate.
Affiliates of Legg’s seven closed-end funds have issued approximately $672 million in auction-rate preferred securities, preferred stock or debt instruments. Overall, closed-end funds have issued more than $60 billion in such securities.
Legg Mason blames the failure of auction-rate securities on the current economy and credit crunch but is also careful to add that the failure is not a credit issue related to the actual funds or portfolios. A possible solution for Legg is to restructure the securities so that money-market funds could invest in them. But there are regulatory issues before that option can be considered a possible alternative.
Meanwhile, investors of failed auction-rate securities are already taking action to protect themselves by filing arbitration claims with the Financial Industry Regulatory Authority.
When the auction-rate market began collapsing earlier this year, investors in auction-rate securities discovered that these so-called “cash alternatives” were actually illiquid, leaving them with more than $300 billion worth of these securities and a higher penalty interest rate.
Affiliates of Legg’s seven closed-end funds have issued approximately $672 million in auction-rate preferred securities, preferred stock or debt instruments. Overall, closed-end funds have issued more than $60 billion in such securities.
Legg Mason blames the failure of auction-rate securities on the current economy and credit crunch but is also careful to add that the failure is not a credit issue related to the actual funds or portfolios. A possible solution for Legg is to restructure the securities so that money-market funds could invest in them. But there are regulatory issues before that option can be considered a possible alternative.
Meanwhile, investors of failed auction-rate securities are already taking action to protect themselves by filing arbitration claims with the Financial Industry Regulatory Authority.
Small Investors Wonder Where Their Bailout Is
As the Federal Reserve tackles $29 billion worth of foul assets for Bear Stearns, Gretchen Morgenson from The New York Times points out that thousands of small individual investors with cash frozen in the dismal auction-rate securities market are also wondering who will help them out.
Big business get bailouts but long-suffering small investors are finding few satisfactory options. They can hope that the issuer of the auction-rate security will buy it back. Or they can sue the brokers who sold the securities but many investors cannot afford these lawsuits. Consequently, investors sit and wait with their frozen assets.
Created in the 1980s, auction-rate securities are debt obligations of an issuer like a municipality or a closed-end fund and interest rates reset at auctions that occur every week to a month.
These were supposed to be safe and liquid cash alternatives for investors. The auction-rate market worked fine until the beginning of this year when buyers disappeared from the auctions, leaving investors with frozen cash.
A majority of the $330 billion auction-rate securities market consists of debt obligations issued by municipalities and nonprofit institutions and some $65 billion is in preferred shares issued by closed-end funds. But the system of the preferred shares is causing a mess with investors.
Closed-end funds issue auction-rate preferred shares at a certain interest rate and earns a higher percentage on that money through smart stock picking so that increases the yield they pay to their common shareholders. Of course, shareholders of closed-end funds love the higher yield that auction-rate preferred shares provide and the closed-end fund companies have a fiduciary duty to those shareholders.
However, investors of preferred shares, which have no maturity dates, don’t want long-term investments and wants the close-end fund companies to buy back their preferred shares. Here lies the quandary then. If the companies were to get rid of preferred shares, their common shareholders would lose out on the higher yield.
Investors also have another reason to be mad because the penalty interest rates they receive on their holdings when the auctions fail are far lower than the penalty rates (sometimes in double digits) on many municipal auction-rate notes. Many investors of preferred shares are relatively small investors who got into the stocks when the minimum investment fell to $100,000 to $25,000 a few years ago.
Some companies are taking action. Two weeks ago, Nuveen Investments, which has 120 closed-end funds and $15.4 billion of auction-rate preferred shares outstanding, said it was hoping to refinance those shares and allow shareholders to cash out. Eaton Vance also arranged a plan to redeem preferred shares issued by three of its funds.
But other fund companies have done little to ease the plight of their preferred shareholders. The impression given to investors is that the companies are concerned first with their shareholders and are not assuming any responsibility to investors.
Steven J. Klindworth, a small investor in Austin, TX, is taking action into his own hands. Klindworth recently filed an arbitration claim against Deutsche Bank Alex. Brown, the firm that sold him the preferred securities, after the firm refused to buy the securities back. The suit says that by putting Klindworth’s assets into the risky securities, his broker had acted contrary to his instructions. According to a transcript of a phone conversation between Klindworth and his broker, his broker said “Had I known those risks, I wouldn’t have put you into it.”
Investors in these preferred securities relied on their brokers’ assurances that the stocks were safe because prospectuses spelling out the risks did not accompany these sales. Since there was no prospectus, the broker had full duty to ensure the investment and risk was suitable to the investor. Brokerage firms made more on these securities than they would have made in selling money market funds.
Regulators are also responding. On March 29th, Massachusetts subpoenaed to UBS, Merrill Lynch and Bank of America seeking documents related to their sales of auction-rate securities to determine whether investors were properly informed of the risks. But on that same day, UBS confirmed that it was lowering the value of its clients’ auction-rate preferred shares by about 3 percent and some may be more than 20 percent.
More lawsuits are expected in the near future if the auctions continue to fail and fund companies refuse to bail out investors from these so-called “cash equivalents.”
Big business get bailouts but long-suffering small investors are finding few satisfactory options. They can hope that the issuer of the auction-rate security will buy it back. Or they can sue the brokers who sold the securities but many investors cannot afford these lawsuits. Consequently, investors sit and wait with their frozen assets.
Created in the 1980s, auction-rate securities are debt obligations of an issuer like a municipality or a closed-end fund and interest rates reset at auctions that occur every week to a month.
These were supposed to be safe and liquid cash alternatives for investors. The auction-rate market worked fine until the beginning of this year when buyers disappeared from the auctions, leaving investors with frozen cash.
A majority of the $330 billion auction-rate securities market consists of debt obligations issued by municipalities and nonprofit institutions and some $65 billion is in preferred shares issued by closed-end funds. But the system of the preferred shares is causing a mess with investors.
Closed-end funds issue auction-rate preferred shares at a certain interest rate and earns a higher percentage on that money through smart stock picking so that increases the yield they pay to their common shareholders. Of course, shareholders of closed-end funds love the higher yield that auction-rate preferred shares provide and the closed-end fund companies have a fiduciary duty to those shareholders.
However, investors of preferred shares, which have no maturity dates, don’t want long-term investments and wants the close-end fund companies to buy back their preferred shares. Here lies the quandary then. If the companies were to get rid of preferred shares, their common shareholders would lose out on the higher yield.
Investors also have another reason to be mad because the penalty interest rates they receive on their holdings when the auctions fail are far lower than the penalty rates (sometimes in double digits) on many municipal auction-rate notes. Many investors of preferred shares are relatively small investors who got into the stocks when the minimum investment fell to $100,000 to $25,000 a few years ago.
Some companies are taking action. Two weeks ago, Nuveen Investments, which has 120 closed-end funds and $15.4 billion of auction-rate preferred shares outstanding, said it was hoping to refinance those shares and allow shareholders to cash out. Eaton Vance also arranged a plan to redeem preferred shares issued by three of its funds.
But other fund companies have done little to ease the plight of their preferred shareholders. The impression given to investors is that the companies are concerned first with their shareholders and are not assuming any responsibility to investors.
Steven J. Klindworth, a small investor in Austin, TX, is taking action into his own hands. Klindworth recently filed an arbitration claim against Deutsche Bank Alex. Brown, the firm that sold him the preferred securities, after the firm refused to buy the securities back. The suit says that by putting Klindworth’s assets into the risky securities, his broker had acted contrary to his instructions. According to a transcript of a phone conversation between Klindworth and his broker, his broker said “Had I known those risks, I wouldn’t have put you into it.”
Investors in these preferred securities relied on their brokers’ assurances that the stocks were safe because prospectuses spelling out the risks did not accompany these sales. Since there was no prospectus, the broker had full duty to ensure the investment and risk was suitable to the investor. Brokerage firms made more on these securities than they would have made in selling money market funds.
Regulators are also responding. On March 29th, Massachusetts subpoenaed to UBS, Merrill Lynch and Bank of America seeking documents related to their sales of auction-rate securities to determine whether investors were properly informed of the risks. But on that same day, UBS confirmed that it was lowering the value of its clients’ auction-rate preferred shares by about 3 percent and some may be more than 20 percent.
More lawsuits are expected in the near future if the auctions continue to fail and fund companies refuse to bail out investors from these so-called “cash equivalents.”
Saturday, March 29, 2008
UBS Lowers Price of Auction-Rate Securities &
On March 29th, UBS began to lower the values of auction-rate securities held by its clients, a move that will be an unpleasant surprise to investors who had been told they were investing in a safe cash alternative.
Swiss-based UBS is the first major brokerage firm to make this move and they will inform their clients via their online statements. Auction-rate prices will be marked down from a few percentage points to more than 20 percent. Other brokerage firms are expected to follow UBS and several are waiting for the end of the quarter in the coming week to make the decision.
Regulators are also responding. On the same day UBS made its announcement, Massachusetts subpoenaed UBS, Merrill Lynch, and Bank of America for documents related to sales of auction-rate market securities to determine whether individual investors were properly informed of the securities’ illiquid risks.
More than $300 billion of auction-rate securities are held by investors ranging from mutual funds and big institutions to wealthy individual investors. Auction-rate securities are long-term bonds that investors could sell at auctions that took place every week to a month and the interest rates are reset at the time of auction. Investors who wanted a safe and liquid cash alternative were attracted to auction-rate securities since they paid higher yields than traditional savings or money-market accounts. Since the beginning of this year, the auctions have failed to attract buyers and investment banks have refused to step in and finance these securities, leaving investors strapped for cash.
Investors stuck holding these securities are saying they were misled and not warned about the risks in auction-rate securities. Investors are also questioning the accuracy of the models that will be used to price the securities. Wall Street firms often use computer models to price securities that don’t trade often, so how will they price the market when the market does not exist?
Investors will learn the bad news isn’t over yet. Until now, investors were told their auction-rate securities aren’t selling but they would retain their full value. However, UBS confirmed that it will mark down the value of the securities and UBS isn’t offering to buy the securities at the new prices either. Beginning in April, UBS will reclassify the securities from cash alternatives to fixed-income investments instead. Meanwhile, Marten Hoekstra, head of wealth management at UBS for the Americas, says this is in “the best interest of clients to provide them with full transparency in their accounts. Given current market dislocations, this is the next natural step for any committed wealth manager.”
Hoekstra said only 13 percent of the securities would retain their full value and more than two-thirds would see small cuts in value, ranging up to 3 percent. Investors holding auction-rate bonds issued by municipalities, schools and others will have to wait for natural buyers to return to the market before auctions return to normalcy.
UBS would not disclose the total value of auction-rate securities held by its clients, but they say it is concentrated among wealthier clients. The bank’s U.S. wealth management unit oversaw about $743 billion in client assets at the end of 2007.
Other brokerage firms have either declined to comment or said they won’t make a decision on whether to take similar action until March 31st. But last month, Merrill Lynch told their clients that the company will report auction-rate securities at an “estimated” market price and would use outside pricing services to value the securities. However, Merrill did not mark down any securities last month or this month.
The U.S. District Court in Manhattan has sued UBS, Deutsche Bank AG, Merrill Lynch, Morgan Stanley and Citigroup for allegedly deceptive marketing of auction-rate securities. More lawsuits are expected over the coming weeks, and in general, they are alleging that the banks improperly marketed the auction-rate securities as a safe place to invest their money for the short term and failed to inform investors of the risks.
The firms have denied any improper conduct and said they are working with clients on a case-by-case basis to address investors’ frozen assets. UBS and Morgan Stanley have both said they are exploring various alternatives like loans.
Swiss-based UBS is the first major brokerage firm to make this move and they will inform their clients via their online statements. Auction-rate prices will be marked down from a few percentage points to more than 20 percent. Other brokerage firms are expected to follow UBS and several are waiting for the end of the quarter in the coming week to make the decision.
Regulators are also responding. On the same day UBS made its announcement, Massachusetts subpoenaed UBS, Merrill Lynch, and Bank of America for documents related to sales of auction-rate market securities to determine whether individual investors were properly informed of the securities’ illiquid risks.
More than $300 billion of auction-rate securities are held by investors ranging from mutual funds and big institutions to wealthy individual investors. Auction-rate securities are long-term bonds that investors could sell at auctions that took place every week to a month and the interest rates are reset at the time of auction. Investors who wanted a safe and liquid cash alternative were attracted to auction-rate securities since they paid higher yields than traditional savings or money-market accounts. Since the beginning of this year, the auctions have failed to attract buyers and investment banks have refused to step in and finance these securities, leaving investors strapped for cash.
Investors stuck holding these securities are saying they were misled and not warned about the risks in auction-rate securities. Investors are also questioning the accuracy of the models that will be used to price the securities. Wall Street firms often use computer models to price securities that don’t trade often, so how will they price the market when the market does not exist?
Investors will learn the bad news isn’t over yet. Until now, investors were told their auction-rate securities aren’t selling but they would retain their full value. However, UBS confirmed that it will mark down the value of the securities and UBS isn’t offering to buy the securities at the new prices either. Beginning in April, UBS will reclassify the securities from cash alternatives to fixed-income investments instead. Meanwhile, Marten Hoekstra, head of wealth management at UBS for the Americas, says this is in “the best interest of clients to provide them with full transparency in their accounts. Given current market dislocations, this is the next natural step for any committed wealth manager.”
Hoekstra said only 13 percent of the securities would retain their full value and more than two-thirds would see small cuts in value, ranging up to 3 percent. Investors holding auction-rate bonds issued by municipalities, schools and others will have to wait for natural buyers to return to the market before auctions return to normalcy.
UBS would not disclose the total value of auction-rate securities held by its clients, but they say it is concentrated among wealthier clients. The bank’s U.S. wealth management unit oversaw about $743 billion in client assets at the end of 2007.
Other brokerage firms have either declined to comment or said they won’t make a decision on whether to take similar action until March 31st. But last month, Merrill Lynch told their clients that the company will report auction-rate securities at an “estimated” market price and would use outside pricing services to value the securities. However, Merrill did not mark down any securities last month or this month.
The U.S. District Court in Manhattan has sued UBS, Deutsche Bank AG, Merrill Lynch, Morgan Stanley and Citigroup for allegedly deceptive marketing of auction-rate securities. More lawsuits are expected over the coming weeks, and in general, they are alleging that the banks improperly marketed the auction-rate securities as a safe place to invest their money for the short term and failed to inform investors of the risks.
The firms have denied any improper conduct and said they are working with clients on a case-by-case basis to address investors’ frozen assets. UBS and Morgan Stanley have both said they are exploring various alternatives like loans.
Friday, March 28, 2008
Banks Subpoenaed in Massachusetts over Auction-Rate Securities
Massachusetts subpoenaed UBS, Merrill Lynch and Bank of America for documents and testimony to determine whether the state’s investors were informed that auction-rate securities have risks of becoming illiquid.
Auction-rate securities had been assumed to be a safe and liquid alternative to cash until earlier this year when the auction-rate market started to fail as buyers shied away from the auctions. As a result, many investors have since discovered that their cash is frozen in the auction-rate market.
The auction-rate securities in question are primarily preferred shares in closed-end mutual funds and Massachusetts is seeking information from nine asset managers on their experiences with the funds. Many closed-end funds are making an effort to untie their investors from the securities.
In addition, the state is investigating whether these investments were suitable for those investors. Massachusetts is looking at major investment banks, which sold those securities, to understand the role they played in the events that caused the auctions to fail.
Auction-rate securities had been assumed to be a safe and liquid alternative to cash until earlier this year when the auction-rate market started to fail as buyers shied away from the auctions. As a result, many investors have since discovered that their cash is frozen in the auction-rate market.
The auction-rate securities in question are primarily preferred shares in closed-end mutual funds and Massachusetts is seeking information from nine asset managers on their experiences with the funds. Many closed-end funds are making an effort to untie their investors from the securities.
In addition, the state is investigating whether these investments were suitable for those investors. Massachusetts is looking at major investment banks, which sold those securities, to understand the role they played in the events that caused the auctions to fail.
Thursday, March 27, 2008
Citigroup Expected to Experience More Significant Subprime Losses
According to Oppenheimer & Co.’s respected banking analyst Meredith Whitney, by the end of 2008, Whitney predicts that Citigroup will lose 15 cents per share and suffer further writedowns of $13.1 billion on leveraged loans and collateralized debt obligations.
Already, Citigroup decreased dividends and wrotedown almost $18 billion in subprime securities investments. The company cut 4,200 jobs and plans more workforce reductions in order to control costs. Thousands more Citigroup employees may lose their jobs, according to experts.
Uncertainty clouds Citigroup’s financial picture because of the firm’s lack of transparency about its overall loss exposure. At the end of 2007, Citigroup reported that off-the-balance-sheet entities tied to the firm had $356 billion in assets, with maximum potential loss exposure for those assets at $152 billion.
In its annual report, Citigroup stated that its trading arm holds roughly $20 billion in hard-to-value securities related to the commercial real estate market, which recently began to falter. These disclosures complicate investors’ grasp of Citigroup’s true position and the future of their investments.
Already, Citigroup decreased dividends and wrotedown almost $18 billion in subprime securities investments. The company cut 4,200 jobs and plans more workforce reductions in order to control costs. Thousands more Citigroup employees may lose their jobs, according to experts.
Uncertainty clouds Citigroup’s financial picture because of the firm’s lack of transparency about its overall loss exposure. At the end of 2007, Citigroup reported that off-the-balance-sheet entities tied to the firm had $356 billion in assets, with maximum potential loss exposure for those assets at $152 billion.
In its annual report, Citigroup stated that its trading arm holds roughly $20 billion in hard-to-value securities related to the commercial real estate market, which recently began to falter. These disclosures complicate investors’ grasp of Citigroup’s true position and the future of their investments.
Liquidity Crisis Could Lead to High Turnover on Wall Street
Job cuts on Wall Street could be more than 100,000 in a few years, said Jo Bennett, a New York-based executive search firm specialist. According to USA Today, New York City alone could suffer the loss of more than 20,000 financial sector jobs over the next two years leaving thousands of employees at Wall Street firms with no income in the coming months as the subprime crisis and related credit crunch persists.
The job cuts signify the troubles faced by many firms and could affect investments in the long-term. In an effort to control costs, many Wall Street firms already drastically reduced their workforce. More than 34,000 financial sector employees lost their jobs in the last nine months because of the subprime crisis and credit crunch, reports Bloomberg.com. At least 11 firms cut over 1,500 jobs. Citigroup, Lehman Brothers, Bank of America, Morgan Stanley, and Merrill Lynch have been hardest hit by job cuts to date.
For instance, JPMorgan’s recent agreement to buy out Bear Stearns could lead to the elimination of thousands of jobs. Going forward, the likelihood of further consolidation within the securities industry puts more jobs at risk. While the subprime crisis and credit crunch linger, investors should keep a wary eye on the viability and strength of the firms that invest their money.
The job cuts signify the troubles faced by many firms and could affect investments in the long-term. In an effort to control costs, many Wall Street firms already drastically reduced their workforce. More than 34,000 financial sector employees lost their jobs in the last nine months because of the subprime crisis and credit crunch, reports Bloomberg.com. At least 11 firms cut over 1,500 jobs. Citigroup, Lehman Brothers, Bank of America, Morgan Stanley, and Merrill Lynch have been hardest hit by job cuts to date.
For instance, JPMorgan’s recent agreement to buy out Bear Stearns could lead to the elimination of thousands of jobs. Going forward, the likelihood of further consolidation within the securities industry puts more jobs at risk. While the subprime crisis and credit crunch linger, investors should keep a wary eye on the viability and strength of the firms that invest their money.
Wednesday, March 26, 2008
Protestors at Bear Stearns Demand Aid for Homeowners
About 60 protesters chanting “Help Main Street, not Wall Street” entered the lobby of Bear Stearns in Manhattan today to demonstrate your opposition to the Federal Reserve’s help in bailing Bear Stearns out of bankruptcy by arranging its takeover by J.P. Morgan on March 16.
After being escorted by police out of Bear Stearns, the protestors moved to J.P. Morgan.
Organized by the Neighborhood Assistance Corporation of America, the demonstrators are demanding aid for struggling homeowners and blaming Bear Stearns and J.P. Morgan employees for helping fuel the mortgage crisis.
Lenders were encouraged to drop standards to create new loans to fulfill demand for mortgage debt from investment banks like Bear Stearns. The banks then repackaged and resold the debt to investors. As a result, some lenders resorted to scams and fraud to initiate loans.
As part of the Bear Stearns and J.P. Morgan deal, the Feds agreed to guarantee up to $29 billion of Bear Stearns assets. This agreement has alarmed some who are worried that the U.S. government will rescue a failing Wall Street bank while ignoring the millions of home owners facing the possibility of foreclosure.
After being escorted by police out of Bear Stearns, the protestors moved to J.P. Morgan.
Organized by the Neighborhood Assistance Corporation of America, the demonstrators are demanding aid for struggling homeowners and blaming Bear Stearns and J.P. Morgan employees for helping fuel the mortgage crisis.
Lenders were encouraged to drop standards to create new loans to fulfill demand for mortgage debt from investment banks like Bear Stearns. The banks then repackaged and resold the debt to investors. As a result, some lenders resorted to scams and fraud to initiate loans.
As part of the Bear Stearns and J.P. Morgan deal, the Feds agreed to guarantee up to $29 billion of Bear Stearns assets. This agreement has alarmed some who are worried that the U.S. government will rescue a failing Wall Street bank while ignoring the millions of home owners facing the possibility of foreclosure.
Monday, March 24, 2008
Citigroup Adds Funds to Mat and ASTA
The investing public and Wall Street has surely made note of the recent bailout of megabank, Citigroup’s, Asta and Mat hedge funds due to uncertainty in the once-safe municipal bond market. The latest news brings one more warning to be wary of hedge funds whether you invest in them or manage them.
According to Financial Times online in a March 11 article by Francesco Guerrera, Citigroup initiated a $1 billion bailout of six internal hedge funds, with $600 million in additional capital and another $400 million targeted to boost the shaky funds.
With growing losses on mortgage-related products, could bond insurers forfeit their coveted triple-A ratings? That question has triggered extensive turmoil in the municipal bond market. For brokerage clients and affluent bank customers who bought Citigroup’s Asta and Mat funds, the plummeting municipal bond prices resulted in potential margin calls by prime brokers.
The bailout by Citigroup showcases the risks taken by many Wall Street firms when they created or bought hedge funds in order to boost trading profits and collect high fees from investors. Of course, those risks also affect the investors in hedge funds. Because of the lack of transparency in the funds, hedge fund investors are at a disadvantage.
According to Financial Times online in a March 11 article by Francesco Guerrera, Citigroup initiated a $1 billion bailout of six internal hedge funds, with $600 million in additional capital and another $400 million targeted to boost the shaky funds.
With growing losses on mortgage-related products, could bond insurers forfeit their coveted triple-A ratings? That question has triggered extensive turmoil in the municipal bond market. For brokerage clients and affluent bank customers who bought Citigroup’s Asta and Mat funds, the plummeting municipal bond prices resulted in potential margin calls by prime brokers.
The bailout by Citigroup showcases the risks taken by many Wall Street firms when they created or bought hedge funds in order to boost trading profits and collect high fees from investors. Of course, those risks also affect the investors in hedge funds. Because of the lack of transparency in the funds, hedge fund investors are at a disadvantage.
Wall Street Struggles to Stabilize Operations and Generate Cash
Many Wall Street brokerage firms and investment banks are frantically working to generate the hefty sums of cash required to stabilize their operations all I the wake of the subprime meltdown and the resulting credit crunch, many Wall Street brokerage firms and
Numerous banks have sold loans especially leveraged buyout (LBO) loans at big discounts in order to produce cash and strike these loan liabilities from their balance sheets. Since the beginning of the year, bank holdings of LBO loans plummeted from $163 to $129 billion. Banks are even stepping out from their lending groups to sell their pieces of the LBO loans for a portion of their face value. For instance, Goldman Sachs offers its part of Chrysler’s $7 billion in loans for as low as 72 cents on the dollar.
The selling isn’t just limited to loans; some banks are trimming parts of their business. Citigroup’s Australian retail brokerage unit is reported to be on the market. In addition, Citi will reportedly shut down branches in Taiwan and combine others in Singapore and Hong Kong. UBS, AG, the large Swiss bank, may sell business units to generate cash. So far, UBS denies reports of selling its U.S. PaineWebber brokerage unit.
Throughout Wall Street, job cuts continue. Because of weakening credit conditions, Wall Street firms eliminated around 10,000 jobs last year. Citigroup is expected to lay off at least 5% of its securities unit employees. In January 2008, the firm said it plans to trim 4,200 employees. According to a report this week, Citi will fire 2,000 investment bankers and traders by the end of this month. (It’s uncertain whether these cuts were included in the plans previously announced.) Richard Bove, a Punk Ziegel & Co. analyst, says Citigroup will drop a total of 30,000 jobs.
At Goldman Sachs, as many as 1,500 people, or 5% of the firm’s employees, may lose their jobs but, according to the firm, not because of layoffs. Goldman Sachs maintains that these cuts only affect underperformers. UBS recently announced that it may eliminate up to 8,000 jobs across various business units, totaling 5% to 10% of its workforce. Then, of course, there are the many Bear Stearns employees who will lose their jobs after the merger with JP Morgan Chase.
For the public, watch your investments in the coming months to see how these troubles may affect you. For those who work on Wall Street or run a Wall Street firm, shaky times lay ahead, to say the very least.
Numerous banks have sold loans especially leveraged buyout (LBO) loans at big discounts in order to produce cash and strike these loan liabilities from their balance sheets. Since the beginning of the year, bank holdings of LBO loans plummeted from $163 to $129 billion. Banks are even stepping out from their lending groups to sell their pieces of the LBO loans for a portion of their face value. For instance, Goldman Sachs offers its part of Chrysler’s $7 billion in loans for as low as 72 cents on the dollar.
The selling isn’t just limited to loans; some banks are trimming parts of their business. Citigroup’s Australian retail brokerage unit is reported to be on the market. In addition, Citi will reportedly shut down branches in Taiwan and combine others in Singapore and Hong Kong. UBS, AG, the large Swiss bank, may sell business units to generate cash. So far, UBS denies reports of selling its U.S. PaineWebber brokerage unit.
Throughout Wall Street, job cuts continue. Because of weakening credit conditions, Wall Street firms eliminated around 10,000 jobs last year. Citigroup is expected to lay off at least 5% of its securities unit employees. In January 2008, the firm said it plans to trim 4,200 employees. According to a report this week, Citi will fire 2,000 investment bankers and traders by the end of this month. (It’s uncertain whether these cuts were included in the plans previously announced.) Richard Bove, a Punk Ziegel & Co. analyst, says Citigroup will drop a total of 30,000 jobs.
At Goldman Sachs, as many as 1,500 people, or 5% of the firm’s employees, may lose their jobs but, according to the firm, not because of layoffs. Goldman Sachs maintains that these cuts only affect underperformers. UBS recently announced that it may eliminate up to 8,000 jobs across various business units, totaling 5% to 10% of its workforce. Then, of course, there are the many Bear Stearns employees who will lose their jobs after the merger with JP Morgan Chase.
For the public, watch your investments in the coming months to see how these troubles may affect you. For those who work on Wall Street or run a Wall Street firm, shaky times lay ahead, to say the very least.
Sunday, March 23, 2008
Fed Intervention Cause Woes to Speculators
Wall St. and investors have been abuzz over the shotgun marriage between Bear Stearns and J.P. Morgan Chase. Regulators claim that the move was to prevent a Bear Stearns bankruptcy that would ignite a tumbling of financial dominoes on Wall St.
Gretchen Morgenson of the New York Times thinks there is more to the story though. Morgenson explains that the J.P. Morgan - Bear Stearns arrangement, and the
Bank of America - Countrywide match before it, are tactics by the Federal Reserve to deflate the credit insurance market and humble some of the speculators who have caused it to inflate so enormously.
The Feds haven’t voiced concerns over the credit default swaps, aka credit insurance contracts, and the banks haven’t commented either, but the Feds intervention has caused at least billions of dollars in credit insurance on the debt of Countrywide and Bear Stearns to become worthless. Their marriages with Bank of America and J.P. Morgan respectively will wipe out all outstanding credit default swaps because the two stronger banks will assume the debt of the target. For J.P. Morgan, taking in Bear Stearns debt for a mere $250 million allows J.P. Morgan to eliminate a huge risk at bargain price.
Credit default swaps are typically 5-year insurance contracts that bondholders could buy to hedge their exposure to the securities. The swaps are supposed to cover losses to banks and bondholders when companies fail to pay their debts. In recent times though, the credit insurance market have been swamped by speculators who use derivatives to bet on troubled companies, making the swaps the fastest growing contracts. The value of the insurance outstanding rose from $10.2 trillion to $43 trillion in two years.
However, the rule of the game requires the company to default on its bonds before an insurance contract will pay out to the buyer.
Entities that wrote the insurance no longer have to pay since these companies will not default. Investors who bought credit insurance to hedge their Bear Stearns and Countrywide bonds will receive new debt obligations from the acquiring banks so they’ll be safe too. However, the biggest losers are the speculators who bought insurance and betted on the failure of the two troubled companies. They lost their entire bet as their insurance value collapsed after the takeover caused the bonds to rise.
The speculators are mostly participants who do their transactions privately and the derivatives market is huge and unregulated so it is unknown who those speculators are right now. Speculators aren’t likely to voluntarily reveal their losses until they’re forced to. But hedge fund and proprietary trading desks on Wall Street are most likely among them.
Bear Stearns and Countrywide’s deals may be a template for future rescues even though there aren’t many big banks left that are financially sound enough undertake such a rescue.
Gretchen Morgenson of the New York Times thinks there is more to the story though. Morgenson explains that the J.P. Morgan - Bear Stearns arrangement, and the
Bank of America - Countrywide match before it, are tactics by the Federal Reserve to deflate the credit insurance market and humble some of the speculators who have caused it to inflate so enormously.
The Feds haven’t voiced concerns over the credit default swaps, aka credit insurance contracts, and the banks haven’t commented either, but the Feds intervention has caused at least billions of dollars in credit insurance on the debt of Countrywide and Bear Stearns to become worthless. Their marriages with Bank of America and J.P. Morgan respectively will wipe out all outstanding credit default swaps because the two stronger banks will assume the debt of the target. For J.P. Morgan, taking in Bear Stearns debt for a mere $250 million allows J.P. Morgan to eliminate a huge risk at bargain price.
Credit default swaps are typically 5-year insurance contracts that bondholders could buy to hedge their exposure to the securities. The swaps are supposed to cover losses to banks and bondholders when companies fail to pay their debts. In recent times though, the credit insurance market have been swamped by speculators who use derivatives to bet on troubled companies, making the swaps the fastest growing contracts. The value of the insurance outstanding rose from $10.2 trillion to $43 trillion in two years.
However, the rule of the game requires the company to default on its bonds before an insurance contract will pay out to the buyer.
Entities that wrote the insurance no longer have to pay since these companies will not default. Investors who bought credit insurance to hedge their Bear Stearns and Countrywide bonds will receive new debt obligations from the acquiring banks so they’ll be safe too. However, the biggest losers are the speculators who bought insurance and betted on the failure of the two troubled companies. They lost their entire bet as their insurance value collapsed after the takeover caused the bonds to rise.
The speculators are mostly participants who do their transactions privately and the derivatives market is huge and unregulated so it is unknown who those speculators are right now. Speculators aren’t likely to voluntarily reveal their losses until they’re forced to. But hedge fund and proprietary trading desks on Wall Street are most likely among them.
Bear Stearns and Countrywide’s deals may be a template for future rescues even though there aren’t many big banks left that are financially sound enough undertake such a rescue.
Saturday, March 22, 2008
Investors Seize Control of Bear Stearns Funds
Rebel investors have seized control of two failed Bear Stearns hedge funds which would possibly give them a platform to sue the US bank for compensation. A Cayman Islands court ejected the liquidators appointed by Bear Stearns to run the offshore feeder versions of Bear Stearns High-Grade Structured Credit and Enhanced Leverage funds and replaced them with investor-supported liquidators.
The judge hearing the case said there was a possible conflict as KPMG, which he said was chosen as liquidator by the fund directors at the “instigation” of Bear Stears, was also liquidator of the master fund into which the feeders invested. He said there was no blame attached to KPMG.
The seizure lays the ground for the investors to try to win back some of the $1.6 billion lost in the collapse of its onshore and offshore Bear funds last July, when they became the first high-profile victims of the sub-prime crisis.
This seizure is particularly important because hedge fund investors are usually unwilling to have their names made public through a court hearing for fear of ridicule over losses. By using the feeder funds the case can be made without their names being needed.
The judge hearing the case said there was a possible conflict as KPMG, which he said was chosen as liquidator by the fund directors at the “instigation” of Bear Stears, was also liquidator of the master fund into which the feeders invested. He said there was no blame attached to KPMG.
The seizure lays the ground for the investors to try to win back some of the $1.6 billion lost in the collapse of its onshore and offshore Bear funds last July, when they became the first high-profile victims of the sub-prime crisis.
This seizure is particularly important because hedge fund investors are usually unwilling to have their names made public through a court hearing for fear of ridicule over losses. By using the feeder funds the case can be made without their names being needed.
Friday, March 21, 2008
Auction-Rate Securities Market: Too Good To Last
Local governments across the U.S. are suffering the worst-case scenario of the auction-rate securities market.
Auction-rate securities were supposed to be a cheap alternative to traditional long-term debt by offering financing for 20 years or more at variable rates determined through periodic bidding. The use of auction bonds by states, cities, and municipal borrowers exploded in 2002 but now auction-rate borrowers and taxpayers are suffering as fallout from the collapse of the subprime mortgage market threatens the credit ratings of the world's largest bond insurers, tainting even the safest insured debt. Thousands of auctions have failed from lack of bids, triggering penalty terms that sometimes quadrupled annualized interest rates in one week.
For example, sewer officials for California's Sacramento County sold $250 million of auction-rate securities in November 2004 so they could pay annualized interest as low as 1.35 percent when long- term, fixed-rate bonds were priced to yield an average 4.50 percent. Borrowing for 34 years at a rate that reset every seven days seemed like a good deal until the rate soared to 12 percent last month.
Municipalities that more than tripled auction-rate bond sales between 2001 and 2004 say this year's breakdown in the market showed them why it is not worth being dependant on Wall St. and many are moving towards long-term, fixed-rate debt instead.
For Jefferson County, Alabama, interest on some of the $3.2 billion of auction-rate and other bonds it sold in 2002 and 2003 climbed as high as 10 percent from 2.98 percent in January. They are planning on converting to a fixed-rate debt. If they fail to convert, interest costs may double to more than $250 million annually, which exceeds the $138 million in revenue the sewer system generates yearly.
Even borrowers not facing the excessive interest rates are choosing traditional fixed-rate bonds because locking in costs is safer than having to face the potential soaring rates on auction-rate bonds that typically resets every seven, 28 or 35 days.
Fixed-rate securities made up 83 percent of municipal borrowings in the six weeks beginning Feb. 1, up from 75 percent in all of last year. The auction-rate crisis made it a more attractive option even though yields on 30-year fixed-rate debt reached a three-year high of 5.01 percent March 3.
Examples of others converting to long-term, fixed-rate bonds include:
Rates on $100 million of the auction-rate bonds held by the Port Authority of New York and New Jersey, which owns bridges, tunnels and airports around New York City, soared to 20 percent on Feb. 12. Port Authority sold $700 million of fixed-rate bonds on March 12 to refinance auction securities. One half of the new debt sold at an average interest cost of 5.76 percent, the other half sold at 5.85 percent.
The Port of Portland, which owns the Portland International Airport in Oregon and four marine terminals, is going to refinance $138 million of auction-rate bonds next month after interest rates on some its bonds rose from 3.5 percent to 7.87 percent on Feb. 27. That has added as much as $1 million in additional costs. The port isn't able to directly convert its auction debt into long-term, fixed-rate bonds because the securities are tied to interest-rate swaps. Instead, the district will convert them into another type of variable-rate debt.
Last month, the rates on some of the $430 million in auction-rate bonds the San Francisco Airport Commission sold in 2004 and 2005 were as high as 10.9 percent, up from 4.25 percent in January. The commission is converting $230 million of that debt into fixed- rate bonds because last month alone interest costs increased $2.1 million.
Auction-rate securities were supposed to be a cheap alternative to traditional long-term debt by offering financing for 20 years or more at variable rates determined through periodic bidding. The use of auction bonds by states, cities, and municipal borrowers exploded in 2002 but now auction-rate borrowers and taxpayers are suffering as fallout from the collapse of the subprime mortgage market threatens the credit ratings of the world's largest bond insurers, tainting even the safest insured debt. Thousands of auctions have failed from lack of bids, triggering penalty terms that sometimes quadrupled annualized interest rates in one week.
For example, sewer officials for California's Sacramento County sold $250 million of auction-rate securities in November 2004 so they could pay annualized interest as low as 1.35 percent when long- term, fixed-rate bonds were priced to yield an average 4.50 percent. Borrowing for 34 years at a rate that reset every seven days seemed like a good deal until the rate soared to 12 percent last month.
Municipalities that more than tripled auction-rate bond sales between 2001 and 2004 say this year's breakdown in the market showed them why it is not worth being dependant on Wall St. and many are moving towards long-term, fixed-rate debt instead.
For Jefferson County, Alabama, interest on some of the $3.2 billion of auction-rate and other bonds it sold in 2002 and 2003 climbed as high as 10 percent from 2.98 percent in January. They are planning on converting to a fixed-rate debt. If they fail to convert, interest costs may double to more than $250 million annually, which exceeds the $138 million in revenue the sewer system generates yearly.
Even borrowers not facing the excessive interest rates are choosing traditional fixed-rate bonds because locking in costs is safer than having to face the potential soaring rates on auction-rate bonds that typically resets every seven, 28 or 35 days.
Fixed-rate securities made up 83 percent of municipal borrowings in the six weeks beginning Feb. 1, up from 75 percent in all of last year. The auction-rate crisis made it a more attractive option even though yields on 30-year fixed-rate debt reached a three-year high of 5.01 percent March 3.
Examples of others converting to long-term, fixed-rate bonds include:
Rates on $100 million of the auction-rate bonds held by the Port Authority of New York and New Jersey, which owns bridges, tunnels and airports around New York City, soared to 20 percent on Feb. 12. Port Authority sold $700 million of fixed-rate bonds on March 12 to refinance auction securities. One half of the new debt sold at an average interest cost of 5.76 percent, the other half sold at 5.85 percent.
The Port of Portland, which owns the Portland International Airport in Oregon and four marine terminals, is going to refinance $138 million of auction-rate bonds next month after interest rates on some its bonds rose from 3.5 percent to 7.87 percent on Feb. 27. That has added as much as $1 million in additional costs. The port isn't able to directly convert its auction debt into long-term, fixed-rate bonds because the securities are tied to interest-rate swaps. Instead, the district will convert them into another type of variable-rate debt.
Last month, the rates on some of the $430 million in auction-rate bonds the San Francisco Airport Commission sold in 2004 and 2005 were as high as 10.9 percent, up from 4.25 percent in January. The commission is converting $230 million of that debt into fixed- rate bonds because last month alone interest costs increased $2.1 million.
$21 Billion Bonds Pulled From Auction-Rate Market
According to Bloomberg, municipal borrowers from Wisconsin to California are escaping soaring costs by pulling at least $21 billion worth of bonds out of the auction-rate market by May 1. This amount is significant because it is more than what was sold in any one year before 2002.
Meanwhile, as the auctions fail, borrowers are switching to fixed-rate bonds and other kinds of variable-rate securities. Based on a Securities Industry and Financial Association index, yields on municipal auction debt are almost double what they were on average in January.
The auction-rate securities market attracted borrowers by offering financing for 20 years or more at variable rates determined through periodic bidding without requiring letters of credit. The use of auction bonds by states, cities and other municipal borrowers exploded in 2002 and sales peaked in 2004 before subsiding in 2007. According to Bloomberg, the $21 billion total represents auction bonds to be called, or bought back, on dates from February through the first of May from an original list of $211 billion of the debt.
From the market's creation in 1984 through 2007, there were less than 50 recorded failures but just this week alone, about 69 percent of auctions failed to attract enough buyers, resulting in interest rates as high as 14 percent. The auction-rate market has been collapsing since Feb. 13 and since then, 60 percent or more of public auctions have been unsuccessful. At failed auctions, the rates borrowers pay revert to a set level of 10 percent or more, or one based upon money-market benchmarks, which have fallen as the Federal Reserve cut interest rates.
Securities with lower failure reset rates, such as closed-end funds' preferred shares and a $250 million deal by Philadelphia, have been failing in greater proportions as investors seek out the better potential returns on bonds with higher penalty rates. Here are some measures being taken to stem the effects of the auction failures:
Philadelphia plans to get final authorization next week to sell fixed-rate bonds in mid-April to replace auction bonds that have been failing.
Wisconsin this week sold about $800 million of bonds to replace some of the state's taxable auction debt that rose in cost to 14 percent this month. Besides fixed-rate bonds, the state also sold securities paying 1.2 percentage points more than the 3.81 percent based on yesterday's rate.
On March 14, the SEC decided to allow nonprofit hospitals and other borrowers to bid on their own auction-rate bonds as an alternative to stemming failures.
The Reading Hospital and Medical Center in Pennsylvania notified investors of plans to bid on March 19 for $40 million of its debt, after having to pay 11 percent after Feb. 13's auction. The winning rate was 3.75 percent, beating out ones that ranged from 5 percent to 11.3 percent.
Meanwhile, as the auctions fail, borrowers are switching to fixed-rate bonds and other kinds of variable-rate securities. Based on a Securities Industry and Financial Association index, yields on municipal auction debt are almost double what they were on average in January.
The auction-rate securities market attracted borrowers by offering financing for 20 years or more at variable rates determined through periodic bidding without requiring letters of credit. The use of auction bonds by states, cities and other municipal borrowers exploded in 2002 and sales peaked in 2004 before subsiding in 2007. According to Bloomberg, the $21 billion total represents auction bonds to be called, or bought back, on dates from February through the first of May from an original list of $211 billion of the debt.
From the market's creation in 1984 through 2007, there were less than 50 recorded failures but just this week alone, about 69 percent of auctions failed to attract enough buyers, resulting in interest rates as high as 14 percent. The auction-rate market has been collapsing since Feb. 13 and since then, 60 percent or more of public auctions have been unsuccessful. At failed auctions, the rates borrowers pay revert to a set level of 10 percent or more, or one based upon money-market benchmarks, which have fallen as the Federal Reserve cut interest rates.
Securities with lower failure reset rates, such as closed-end funds' preferred shares and a $250 million deal by Philadelphia, have been failing in greater proportions as investors seek out the better potential returns on bonds with higher penalty rates. Here are some measures being taken to stem the effects of the auction failures:
Philadelphia plans to get final authorization next week to sell fixed-rate bonds in mid-April to replace auction bonds that have been failing.
Wisconsin this week sold about $800 million of bonds to replace some of the state's taxable auction debt that rose in cost to 14 percent this month. Besides fixed-rate bonds, the state also sold securities paying 1.2 percentage points more than the 3.81 percent based on yesterday's rate.
On March 14, the SEC decided to allow nonprofit hospitals and other borrowers to bid on their own auction-rate bonds as an alternative to stemming failures.
The Reading Hospital and Medical Center in Pennsylvania notified investors of plans to bid on March 19 for $40 million of its debt, after having to pay 11 percent after Feb. 13's auction. The winning rate was 3.75 percent, beating out ones that ranged from 5 percent to 11.3 percent.
Thursday, March 20, 2008
SEC Might Expand Bear Stearns Inquiry
The SEC, which is usually quiet about their investigations, has issued a statement indicating it has expanded an inquiry into Bear Sterns Cos. to include what was or wasn’t said in the two months leading up to the brokerage firm’s collapse.
The SEC’s enforcement division also wrote to J.P. Morgan Chase & Co., as it was negotiating to take over Bear Sterns, about their “investigations and potential future inquiries into conduct and statements by Bear Stearns before the public announcement of the transaction with J.P. Morgan.”
The SEC’s letter did not give J.P. Morgan any assurances that it won't bring a case against them. However, it is unlikely that the SEC would bring a case against J.P. Morgan because the firm didn't have access to Bear Stearns’ books and public statements to determine the adequacy of any statements but the SEC could still file civil charges against individuals.
Bear Sterns is already the focus of several civil and criminal investigations. The SEC and Justice Department are investigating Bear Sterns for the factors that led the collapse of its hedge fund last spring. The New York attorney general is also looking into Bear Sterns’ packaging and selling of mortgage-backed securities.
Lawyers say comments made by market participants and Bear Sterns executives may have sparked the SEC into looking for improper insider trading. The SEC could be looking at what traders were saying about Bear's liquidity and ability to stay in business. Prior to the Fed’s intervention, widely circulated rumors suggested Bear Sterns sold borrowed shares with the intention of profiting from a price decline before the firm was forced into a desperate rescue by pulling business from its prime brokerage. However, possible focus of the SEC’s expanded probe remains unclear and market-manipulation cases are hard to prove.
The SEC’s enforcement division also wrote to J.P. Morgan Chase & Co., as it was negotiating to take over Bear Sterns, about their “investigations and potential future inquiries into conduct and statements by Bear Stearns before the public announcement of the transaction with J.P. Morgan.”
The SEC’s letter did not give J.P. Morgan any assurances that it won't bring a case against them. However, it is unlikely that the SEC would bring a case against J.P. Morgan because the firm didn't have access to Bear Stearns’ books and public statements to determine the adequacy of any statements but the SEC could still file civil charges against individuals.
Bear Sterns is already the focus of several civil and criminal investigations. The SEC and Justice Department are investigating Bear Sterns for the factors that led the collapse of its hedge fund last spring. The New York attorney general is also looking into Bear Sterns’ packaging and selling of mortgage-backed securities.
Lawyers say comments made by market participants and Bear Sterns executives may have sparked the SEC into looking for improper insider trading. The SEC could be looking at what traders were saying about Bear's liquidity and ability to stay in business. Prior to the Fed’s intervention, widely circulated rumors suggested Bear Sterns sold borrowed shares with the intention of profiting from a price decline before the firm was forced into a desperate rescue by pulling business from its prime brokerage. However, possible focus of the SEC’s expanded probe remains unclear and market-manipulation cases are hard to prove.
Wednesday, March 19, 2008
Auction-Rate Freeze Affects Silicon Valley
Many Silicon Valley start-ups, already suffering from fewer opportunities to go public and an economic downturn, are now stuck holding illiquid auction-rate securities after the $330 billion market for them soured in January. Since that time, frozen auction-rate market has affected big publicly traded companies, the closed-end mutual-fund industry and even some hospitals and schools after investors shied away from the auctions thus making it harder for shareholders to convert the securities to cash.
The private companies will likely be affected more by this freeze and may be forced to dump these securities for big losses. Unlike public companies which often have larger cash reserves, start-ups often have less revenue and need immediate access to their cash and short-term investments to operate their business.
Venture-capital investors in Silicon Valley are also moving fast to ascertain their vulnerability to the auction-rate crisis and determine temporary solutions to the start-ups they have funded. Some possible solutions include taking out special lines of credit from banks or selling auction-rate securities at a discount on an emerging secondary market.
Attracted by the promise of liquidity and a slightly higher rate of return, many start-ups bought auction-rate securities at the urging of investment banks. The affects of the current auction-rate crisis is reverberating throughout Silicon Valley companies that include Internet firms, semiconductor makers and larger medical-related firms poised to go public.
However, not everybody invested in auction-rate securities. Benchmark Capital in Menlo Park, for example, says that “a couple” of portfolio companies hold the debt investments, but they do not represent a significant part of their cash. And start-ups with only a small portion of their cash in the securities may not need the money for months, or even years, so the seized-up market may not hit them as hard.
The private companies will likely be affected more by this freeze and may be forced to dump these securities for big losses. Unlike public companies which often have larger cash reserves, start-ups often have less revenue and need immediate access to their cash and short-term investments to operate their business.
Venture-capital investors in Silicon Valley are also moving fast to ascertain their vulnerability to the auction-rate crisis and determine temporary solutions to the start-ups they have funded. Some possible solutions include taking out special lines of credit from banks or selling auction-rate securities at a discount on an emerging secondary market.
Attracted by the promise of liquidity and a slightly higher rate of return, many start-ups bought auction-rate securities at the urging of investment banks. The affects of the current auction-rate crisis is reverberating throughout Silicon Valley companies that include Internet firms, semiconductor makers and larger medical-related firms poised to go public.
However, not everybody invested in auction-rate securities. Benchmark Capital in Menlo Park, for example, says that “a couple” of portfolio companies hold the debt investments, but they do not represent a significant part of their cash. And start-ups with only a small portion of their cash in the securities may not need the money for months, or even years, so the seized-up market may not hit them as hard.
Monday, March 17, 2008
The Collapse of Carlyle Capital
Carlyle Capital, the highly leveraged hedge fund and publicly traded affiliate of Carlyle Group, collapsed this week and its investors would lose $900 million. Banks, under enormous pressure from regulators to put their balance sheets in order, had been pressing David M. Rubenstein, William E. Conway Jr. and Daniel D’Aniello, the co-founders of Carlyle Group, to put more money into Carlyle Capital.
In early March, Deutsche Bank, J.P. Morgan Chase and others were demanding the company boost its cash reserves, in what is known as a margin call. The bankers kept raising their demands, and some even began seizing and selling Carlyle Capital’s collateral and its chief asset, its AAA-rated, mortgage-backed securities.
According to Rubenstein, they had planned a restructuring arrangement that would invest $400 or $500 million and had asked the banks to freeze seizures for a year so the company’s securities would have a chance to rise in value. Rubenstein said the securities from Fannie Mae, Freddie Mac and Ginny Mae had a historic record as safe investments that were unlikely to decline in value. But with the credit crisis, the banks were hungry for more money and the co-founders knew they could not meet the banks’ demands.
Carlyle Capital’s downfall is a shock to the private-equity giant, which holds a record of returning an average of 26 percent, net of fees, to investors of nearly 60 funds. Carlyle Group manages $81 billion in assets for unions, pensions, endowments, individuals and foreign governments. In the past two years, it returned $18 billion in profits and equity to its clients.
Its stock closed at 35 cents a share yesterday after the fund defaulted on more than $16 billion in assets. The shares have dropped 93 percent since Tuesday.
Rubenstein said the firm planned to explain what happened and do something that would soften the loss for investors in Carlyle Capital but he did not give details. Rubenstein also said he would seek to assure investors that the Carlyle Group remains healthy. It has "enormous profits embedded in its current funds," he said.
Many investors and analysts think Carlyle Capital is only the first domino to fall as banks move aggressively to seize assets from troubled funds; thus making it more difficult for funds to meet margin calls. Here are some troubled hedge funds to look out for:
· Drake Management’s three hedge funds, with nearly $5 billion under management, recently suspended investor redemptions as it considers liquidating its assets.
· Nuveen Investments faces lower profits and slower growth because of higher borrowing costs brought on by the credit crunch.
· Peloton Partners of London was forced to liquidate its funds recently.
· Thornburg Mortgage, a big U.S. lender, failed to meet margin calls by lenders last week.
· Citigroup is committing $1 billion to shore up its hedge funds.
In early March, Deutsche Bank, J.P. Morgan Chase and others were demanding the company boost its cash reserves, in what is known as a margin call. The bankers kept raising their demands, and some even began seizing and selling Carlyle Capital’s collateral and its chief asset, its AAA-rated, mortgage-backed securities.
According to Rubenstein, they had planned a restructuring arrangement that would invest $400 or $500 million and had asked the banks to freeze seizures for a year so the company’s securities would have a chance to rise in value. Rubenstein said the securities from Fannie Mae, Freddie Mac and Ginny Mae had a historic record as safe investments that were unlikely to decline in value. But with the credit crisis, the banks were hungry for more money and the co-founders knew they could not meet the banks’ demands.
Carlyle Capital’s downfall is a shock to the private-equity giant, which holds a record of returning an average of 26 percent, net of fees, to investors of nearly 60 funds. Carlyle Group manages $81 billion in assets for unions, pensions, endowments, individuals and foreign governments. In the past two years, it returned $18 billion in profits and equity to its clients.
Its stock closed at 35 cents a share yesterday after the fund defaulted on more than $16 billion in assets. The shares have dropped 93 percent since Tuesday.
Rubenstein said the firm planned to explain what happened and do something that would soften the loss for investors in Carlyle Capital but he did not give details. Rubenstein also said he would seek to assure investors that the Carlyle Group remains healthy. It has "enormous profits embedded in its current funds," he said.
Many investors and analysts think Carlyle Capital is only the first domino to fall as banks move aggressively to seize assets from troubled funds; thus making it more difficult for funds to meet margin calls. Here are some troubled hedge funds to look out for:
· Drake Management’s three hedge funds, with nearly $5 billion under management, recently suspended investor redemptions as it considers liquidating its assets.
· Nuveen Investments faces lower profits and slower growth because of higher borrowing costs brought on by the credit crunch.
· Peloton Partners of London was forced to liquidate its funds recently.
· Thornburg Mortgage, a big U.S. lender, failed to meet margin calls by lenders last week.
· Citigroup is committing $1 billion to shore up its hedge funds.
Sunday, March 16, 2008
Citigroup Injecting Hedge Funds with $1 Billion
Citigroup is committing $1 billion to shore up hedge funds pressured by the tightening in the municipal bond market. The money will be spread across six highly leveraged municipal bond funds with $15 billion in assets, which were sold under the names ASTA and MAT, depending on how severely the assets have dropped in value. About $600 million had been provided in the first week of March after lenders issued a margin call in response to falling securities values.
ASTA and MAT funds were first offered in 2002 to Smith Barney clients and private bank customers with more than $5 million in liquid assets. This has been the bank’s fund trading strategy for years.
Trusts run by Citigroup and other financial institutions borrowed money by issuing tax-exempt commercial paper. They then used the cash to buy municipal bonds that have slightly higher yields and pocketed the difference. Using taxable securities, the trusts then hedged against big swings in interest rates by reversing that trade and they piled on leverage to boost returns. The cycle ends with Citigroup fund managers buying the riskiest bonds issued by the trust. The ASTA and MAT funds have total assets worth about $15 billion and about $2 billion in capital.
This trading scheme was failing by the end of last year and it is barely alive now. The market downturn decimated municipal bond yields while the yield on taxable bonds rallied substantially. With the hedges on the trades hemorrhaging money, Citigroup issued margin calls and is now making this $1 billion equity commitment.
Other Citigroup investments have also been hit hard this year.
In Feb., Citigroup suspended redemptions in a large corporate debt fund, CSO Partners, after investors tried to withdraw more than a third of its $500 million assets. In Jan., Citigroup injected $100 million into the fund, which suffered heavy losses last year.
Citigroup rescued seven affiliated investment funds by shifting more than $49 billion in securities onto its already strained balance sheet.
Falcon Strategies, a big fixed income hedge fund, fell more than 30 percent last year after miscalculating that last summer’s market turmoil was over.
Old Lane Partners, the investment fund founded by Citigroup’s chief executive, Vikram S. Pandit, has also posted dismal results.
ASTA and MAT funds were first offered in 2002 to Smith Barney clients and private bank customers with more than $5 million in liquid assets. This has been the bank’s fund trading strategy for years.
Trusts run by Citigroup and other financial institutions borrowed money by issuing tax-exempt commercial paper. They then used the cash to buy municipal bonds that have slightly higher yields and pocketed the difference. Using taxable securities, the trusts then hedged against big swings in interest rates by reversing that trade and they piled on leverage to boost returns. The cycle ends with Citigroup fund managers buying the riskiest bonds issued by the trust. The ASTA and MAT funds have total assets worth about $15 billion and about $2 billion in capital.
This trading scheme was failing by the end of last year and it is barely alive now. The market downturn decimated municipal bond yields while the yield on taxable bonds rallied substantially. With the hedges on the trades hemorrhaging money, Citigroup issued margin calls and is now making this $1 billion equity commitment.
Other Citigroup investments have also been hit hard this year.
In Feb., Citigroup suspended redemptions in a large corporate debt fund, CSO Partners, after investors tried to withdraw more than a third of its $500 million assets. In Jan., Citigroup injected $100 million into the fund, which suffered heavy losses last year.
Citigroup rescued seven affiliated investment funds by shifting more than $49 billion in securities onto its already strained balance sheet.
Falcon Strategies, a big fixed income hedge fund, fell more than 30 percent last year after miscalculating that last summer’s market turmoil was over.
Old Lane Partners, the investment fund founded by Citigroup’s chief executive, Vikram S. Pandit, has also posted dismal results.
Friday, March 14, 2008
Funds Planning to Redeem Auction-Rate Securities
More and more investment funds say they are stepping up plans to return cash to investors who have been stranded in the auction-rate preferred stock market - one of the recent casualties of the credit crisis. However, the process may be slower than some investors might like.
Nuveen Investments Inc., the largest U.S. manager of close-end funds, said it had lined up new debt and was working on refinancing $15.4 billion of auction-rate stock, issued by 100 of its closed-end mutual funds. The firm hopes to begin announcing plans for 13 of the funds, which own stock or invests in government or corporate bonds, to redeem their preferred shares by the end of the month. But Nuveen warns refinancing all 13 funds could take as long as six months, and that success would hinge on “market and economic conditions factors beyond our control.”
ING Clarion Real Estate Securities said two of its funds would partially redeem auction-rate stock. Their rescue plan would retire only a portion of the auction-rate shares of the two funds it was targeting -- 22% in the case of Clarion Global Real Estate Income and 33% for Clarion Real Estate Income.
Eaton Vance Corp. said that three of its funds would buy back auction-rate stock.
Morgan Stanley Investment Management and Van Kampen Funds Inc. plan to hold investor conference calls Friday to discuss the debt situations of their closed-end funds.
For years, auction-rate securities have been used to raise money for closed-end investment funds and municipalities. But as the credit crunch deteriorated this year, investors shied away from the auctions amid concerns over liquidity and bond insurers. As auctions failed, current owners of the securities have been told they were stuck with them - although they were continuing to earn interest. Currently, closed-end funds have more than $60 billion of auction-rate issues outstanding. Municipalities owe about $300 billion via the debt.
Some investors have called for brokerages to buy the securities to help their customers, but no major firm has been willing to provide relief. At best, investors have been told that if they need cash, they could borrow against the securities.
A longer wait may face investors in auction-rate securities of closed-end funds that own tax-free municipal bonds. The challenge for muni-bond funds is replacing current debt with borrowed money that won’t cost more than what the funds earn on their bonds.
Nuveen Investments Inc., the largest U.S. manager of close-end funds, said it had lined up new debt and was working on refinancing $15.4 billion of auction-rate stock, issued by 100 of its closed-end mutual funds. The firm hopes to begin announcing plans for 13 of the funds, which own stock or invests in government or corporate bonds, to redeem their preferred shares by the end of the month. But Nuveen warns refinancing all 13 funds could take as long as six months, and that success would hinge on “market and economic conditions factors beyond our control.”
ING Clarion Real Estate Securities said two of its funds would partially redeem auction-rate stock. Their rescue plan would retire only a portion of the auction-rate shares of the two funds it was targeting -- 22% in the case of Clarion Global Real Estate Income and 33% for Clarion Real Estate Income.
Eaton Vance Corp. said that three of its funds would buy back auction-rate stock.
Morgan Stanley Investment Management and Van Kampen Funds Inc. plan to hold investor conference calls Friday to discuss the debt situations of their closed-end funds.
For years, auction-rate securities have been used to raise money for closed-end investment funds and municipalities. But as the credit crunch deteriorated this year, investors shied away from the auctions amid concerns over liquidity and bond insurers. As auctions failed, current owners of the securities have been told they were stuck with them - although they were continuing to earn interest. Currently, closed-end funds have more than $60 billion of auction-rate issues outstanding. Municipalities owe about $300 billion via the debt.
Some investors have called for brokerages to buy the securities to help their customers, but no major firm has been willing to provide relief. At best, investors have been told that if they need cash, they could borrow against the securities.
A longer wait may face investors in auction-rate securities of closed-end funds that own tax-free municipal bonds. The challenge for muni-bond funds is replacing current debt with borrowed money that won’t cost more than what the funds earn on their bonds.
Thursday, March 13, 2008
Hedge Funds on Brink of Collapse
Last night, several hedge funds with assets of more than $4 billion were on the edge of collapse or had halted withdrawals, despite efforts by the US Federal Reserve this week to ease America’s credit crisis with a $200 billion collateral lending facility.
Seven funds have been frozen this month and the potential closure of six more funds is seen as evidence that the initiative by America’s central bank to allow lenders to swap their risky mortgage-backed bonds for safer Treasury debt will not solve the long-term problem of the deteriorating credit crisis. This fear was reflected on Wall Street as the dollar fell to a new low against the euro and sterling, as the euro hit $1.55 for the first time.
New York-based Drake Management warned investors in its $3 billion Global Opportunities Fund that it is considering closing the fund so they can attempt to maintain and maximize value for investors during this market downturn. The fund, which lost 25 per cent last year, has already blocked investors from withdrawing their cash.
Drake might also be considering whether to close two other hedge funds, the Drake Low Volatility fund and the Drake Absolute Return, both of which lost almost a sixth of their value last year.
GO Capital Asset Management, based in Amsterdam, said that it has frozen its $881 million Global Opportunities hedge fund, preventing investors from withdrawing their capital.
ING, the Dutch bank, froze two investment trusts with assets worth €275 million in New Zealand that were highly exposed to mortgage-backed bonds, blaming the global credit crunch.
Seven funds have been frozen this month and the potential closure of six more funds is seen as evidence that the initiative by America’s central bank to allow lenders to swap their risky mortgage-backed bonds for safer Treasury debt will not solve the long-term problem of the deteriorating credit crisis. This fear was reflected on Wall Street as the dollar fell to a new low against the euro and sterling, as the euro hit $1.55 for the first time.
New York-based Drake Management warned investors in its $3 billion Global Opportunities Fund that it is considering closing the fund so they can attempt to maintain and maximize value for investors during this market downturn. The fund, which lost 25 per cent last year, has already blocked investors from withdrawing their cash.
Drake might also be considering whether to close two other hedge funds, the Drake Low Volatility fund and the Drake Absolute Return, both of which lost almost a sixth of their value last year.
GO Capital Asset Management, based in Amsterdam, said that it has frozen its $881 million Global Opportunities hedge fund, preventing investors from withdrawing their capital.
ING, the Dutch bank, froze two investment trusts with assets worth €275 million in New Zealand that were highly exposed to mortgage-backed bonds, blaming the global credit crunch.
SEC Allows Municipalities to Bid on Own Auction-Rate Debt
At a congressional hearing yesterday, the SEC said it is developing guidance with provisions for appropriate disclosures that would allow local governments to buy their own auction-rate debt without being suspected of market manipulation. SEC is responding to the strain municipalities have been under ever since the auction-rate securities market froze in January. The guidance is expected to be released this week and transparency would be a key component.
One of the SEC conditions for bidding would require an issuer to disclose certain facts related to price and quantity and the SEC would not overrule contracts that prohibit the issuers from buying debt.
There was doubt whether the SEC would allow municipalities to bid on their own auction-rate debt after their enforcement settlement with 15 brokerage firms over market-manipulation in 2006. However, this current move would provide relief to municipalities, student-loan providers, schools and others that have been faced with unusually high borrowing costs in recent weeks as investors fled amid concerns over bond insurers and the lack of liquidity in the auctions. It is estimated that more than $80 billion in securities have failed at auction, resulting in interest rates as high as 20% for some borrowers.
Additional transparency requirements may also be ahead. The Municipal Securities Rulemaking Board, which writes rules governing municipalities, has been considering changes that would increase the transparency of prices.
One of the SEC conditions for bidding would require an issuer to disclose certain facts related to price and quantity and the SEC would not overrule contracts that prohibit the issuers from buying debt.
There was doubt whether the SEC would allow municipalities to bid on their own auction-rate debt after their enforcement settlement with 15 brokerage firms over market-manipulation in 2006. However, this current move would provide relief to municipalities, student-loan providers, schools and others that have been faced with unusually high borrowing costs in recent weeks as investors fled amid concerns over bond insurers and the lack of liquidity in the auctions. It is estimated that more than $80 billion in securities have failed at auction, resulting in interest rates as high as 20% for some borrowers.
Additional transparency requirements may also be ahead. The Municipal Securities Rulemaking Board, which writes rules governing municipalities, has been considering changes that would increase the transparency of prices.
Wednesday, March 12, 2008
The Credit Crunch Hits Jefferson County Alabama
The credit crisis triggered by the subprime mortgage meltdown has claimed its latest victim: Jefferson County, Alabama and investors in the county’s municipal bonds and auction-rate securities.
Jefferson County’s troubles began in 1996 when a federal court action resulted in the county agreeing to update its aging and polluting waste water facilities. The county used swaps to borrow $3.2 billion to pay for its new sewage system. About $2.2 million of the sewer debt consists of auction-rate securities. At this time, the county has experienced failed auctions on $869.45 million of the debt and is underwater in its swap transactions by some $360 million. This makes the viability of Jefferson County questionable and investors in Jefferson County’s debt may sustain significant losses.
In addition, Jefferson County’s bond insurers, Financial Guaranty Insurance Co. and XL Capital Assurance Inc. were hit with credit downgrades recently. These downgrades affected the market for short-term municipal bond debt, including auction-rate securities and variable-rate demand notes. As a result, the county’s interest costs on their debts rose from 3%-4% to as high as 6%-10%. Following this increase, the credit-rating agencies began cutting ratings. On February 27, 2008 Moody’s downgraded the county to B3 from A3.
Auction-rate securities have been popular with issuers like state and local governments, colleges, universities, hospitals, charitable organizations, cultural institutions and other non-profit entities because financing costs are low, no third-party bank support is required and there are usually fewer parties involved in the financing process.
Until recently, auction-bond failures were a relatively rare occurrence. Unfortunately, this is no longer the case. As Martin Braun reported in a February 13, 2008 article on Bloomberg.com, during the past few weeks, investor demand for the securities has declined precipitously as a result of increasing skepticism regarding the credit strength of insurers backing the underlying debt obligations, and the reluctance of banks like UBS, Citigroup and Goldman Sachs to submit bids and risk holding too many bonds. Indeed, nearly half of the $20 billion in securities put up for auction on February 12 failed to generate sufficient interest among bidders and none were sold. Merrill Lynch recently announced that it is reducing purchases of auction-rate securities that fail to attract enough bids from investors, and UBS has decided that it simply will not buy such securities at all. Investors' concerns about the credit ratings of the bond insurers backing the securities essentially caused the failure of these auctions.
For Jefferson County, all these factors have caused its lenders, Bank of America, Bear Stearns Cos., J.P. Morgan Chase and Lehman Brothers, to demand $200 million for additional collateral to support obligations the county owes them. To date, Jefferson County has refused to meet the banks’ demands or to produce additional collateral. The county now faces tough choices on how to raise additional money to cover the debt or face default.
It is not just the county experiencing pain. Investors in auction-rate securities have also been hurt. Many investors — individuals and institutions alike — who purchased the bonds believing that they were safe, low-risk securities equivalent to cash, now find themselves holding an investment for which there is no market. Several investors have already taken legal action against the brokers who sold the securities. Merrill Lynch, for example, is a defendant in a Texas action in which Metro PCS alleges that the firm misrepresented the risks involved and the suitability of the securities under the company's guidelines. Lehman Brothers is the respondent in a FINRA arbitration complaint filed by two wealthy New Jersey brothers, alleging that the firm's investment of $286 million in auction rate securities was inconsistent with the claimants' stated investment objectives. Additional investor suits against other firms are likely to follow.
Jefferson County’s troubles began in 1996 when a federal court action resulted in the county agreeing to update its aging and polluting waste water facilities. The county used swaps to borrow $3.2 billion to pay for its new sewage system. About $2.2 million of the sewer debt consists of auction-rate securities. At this time, the county has experienced failed auctions on $869.45 million of the debt and is underwater in its swap transactions by some $360 million. This makes the viability of Jefferson County questionable and investors in Jefferson County’s debt may sustain significant losses.
In addition, Jefferson County’s bond insurers, Financial Guaranty Insurance Co. and XL Capital Assurance Inc. were hit with credit downgrades recently. These downgrades affected the market for short-term municipal bond debt, including auction-rate securities and variable-rate demand notes. As a result, the county’s interest costs on their debts rose from 3%-4% to as high as 6%-10%. Following this increase, the credit-rating agencies began cutting ratings. On February 27, 2008 Moody’s downgraded the county to B3 from A3.
Auction-rate securities have been popular with issuers like state and local governments, colleges, universities, hospitals, charitable organizations, cultural institutions and other non-profit entities because financing costs are low, no third-party bank support is required and there are usually fewer parties involved in the financing process.
Until recently, auction-bond failures were a relatively rare occurrence. Unfortunately, this is no longer the case. As Martin Braun reported in a February 13, 2008 article on Bloomberg.com, during the past few weeks, investor demand for the securities has declined precipitously as a result of increasing skepticism regarding the credit strength of insurers backing the underlying debt obligations, and the reluctance of banks like UBS, Citigroup and Goldman Sachs to submit bids and risk holding too many bonds. Indeed, nearly half of the $20 billion in securities put up for auction on February 12 failed to generate sufficient interest among bidders and none were sold. Merrill Lynch recently announced that it is reducing purchases of auction-rate securities that fail to attract enough bids from investors, and UBS has decided that it simply will not buy such securities at all. Investors' concerns about the credit ratings of the bond insurers backing the securities essentially caused the failure of these auctions.
For Jefferson County, all these factors have caused its lenders, Bank of America, Bear Stearns Cos., J.P. Morgan Chase and Lehman Brothers, to demand $200 million for additional collateral to support obligations the county owes them. To date, Jefferson County has refused to meet the banks’ demands or to produce additional collateral. The county now faces tough choices on how to raise additional money to cover the debt or face default.
It is not just the county experiencing pain. Investors in auction-rate securities have also been hurt. Many investors — individuals and institutions alike — who purchased the bonds believing that they were safe, low-risk securities equivalent to cash, now find themselves holding an investment for which there is no market. Several investors have already taken legal action against the brokers who sold the securities. Merrill Lynch, for example, is a defendant in a Texas action in which Metro PCS alleges that the firm misrepresented the risks involved and the suitability of the securities under the company's guidelines. Lehman Brothers is the respondent in a FINRA arbitration complaint filed by two wealthy New Jersey brothers, alleging that the firm's investment of $286 million in auction rate securities was inconsistent with the claimants' stated investment objectives. Additional investor suits against other firms are likely to follow.
Nuveen Seeking to Refinance Auction-Rate Debt
Nuveen Investments Inc., the largest U.S. manager of closed-end funds, is seeking new financing for a large portion of the auction-rate securities sold by its taxable funds.
Nuveen plans to begin announcing specific agreements by the end of March but it may take four to six months to complete refinancing for all the taxable funds. Nuveen sponsors 120 closed-end funds, including 100 that have leverage and together have issued $15.4 billion of auction- rate securities. It has 13 taxable leveraged funds that invest in equities and government and corporate debt, and have issued $4.3 billion of the securities. The company has 87 municipal- bond funds with $11.1 billion in auction-rate securities.
Nuveen’s move comes at a time when auctions began to fail amid investor concern over trouble bond insurers that stuck preferred shareholders with about $60 billion in securities they couldn’t sell.
Nuveen plans to begin announcing specific agreements by the end of March but it may take four to six months to complete refinancing for all the taxable funds. Nuveen sponsors 120 closed-end funds, including 100 that have leverage and together have issued $15.4 billion of auction- rate securities. It has 13 taxable leveraged funds that invest in equities and government and corporate debt, and have issued $4.3 billion of the securities. The company has 87 municipal- bond funds with $11.1 billion in auction-rate securities.
Nuveen’s move comes at a time when auctions began to fail amid investor concern over trouble bond insurers that stuck preferred shareholders with about $60 billion in securities they couldn’t sell.
Tuesday, March 11, 2008
Eaton Vance Borrowing to Redeem Auction-Rate Stock
Boston-based 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 collapsed in January. Eaton Vance said 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.
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 froze as investors began to shun paper backed by troubled bond insurers. Consequently, many auctions failed, sticking shareholders with about $60 billion in securities and forcing issuers of the securities to pay higher "penalty" interest rates.
According to analysts at Eaton Vance, the new debt will cost the funds less than the penalty rates they have been paying but the lender that is putting up the money will accept only stock as collateral, not debt. 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. There is no promise that the remaining funds would be able to redeem their auction-rate paper.
Cecilia Gondor of Thomas J. Herzfeld Advisors Inc., which specializes in close-end fund research, said raising that money would be difficult "especially as more funds try to do this and create more demand." Last week, Aberdeen Asset Management Inc. 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 has voted to allow local governments to bid on their own auction-rate securities but the bill still needs approval by the state Senate and Gov. Arnold Schwarzenegger.
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 froze as investors began to shun paper backed by troubled bond insurers. Consequently, many auctions failed, sticking shareholders with about $60 billion in securities and forcing issuers of the securities to pay higher "penalty" interest rates.
According to analysts at Eaton Vance, the new debt will cost the funds less than the penalty rates they have been paying but the lender that is putting up the money will accept only stock as collateral, not debt. 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. There is no promise that the remaining funds would be able to redeem their auction-rate paper.
Cecilia Gondor of Thomas J. Herzfeld Advisors Inc., which specializes in close-end fund research, said raising that money would be difficult "especially as more funds try to do this and create more demand." Last week, Aberdeen Asset Management Inc. 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 has voted to allow local governments to bid on their own auction-rate securities but the bill still needs approval by the state Senate and Gov. Arnold Schwarzenegger.
Sunday, March 9, 2008
FINRA Increases Margin Maintenance
FINRA announced that it is temporarily increasing the maintenance margin requirements for auction-rate securities. Effective immediately, all auction-rate securities that are backed by fixed income products (e.g. municipal bonds, collateralized debt obligations, etc.) will have a 25 percent maintenance requirement.
Recently, the auctions for these securities have been failing because investors concerned over the current credit market environment have not been willing to participate in the auctions. Consequently, holders of these securities have not been able to liquidate their positions. In order to provide liquidity to their customers, several member firms have asked FINRA whether margin can be extended to these securities.
Pursuant to NYSE and NASD rules, fixed income auction-rate securities that carry an investment grade rating are categorized as “investment grade debt securities” and normally would require equity of 10 percent of the current market value. Fixed income auction-rate securities that are below investment grade are categorized as “other marginable non-equity securities and normally require equity of 20 percent of the current market value or 7 percent of the principal amount, whichever is greater.
However, as a result of the reduced liquidity in these securities, member firms will be required to impose a regulatory maintenance requirement of 25 percent of the current market value for all fixed income auction rate securities, regardless of whether or not the security is investment grade.
If fixed income auction rate securities are used as collateral for non-purpose credit to any customer, firms are reminded that they must also consider the 25 percent maintenance requirement when determining any maintenance excess or deficiency. The amount of any deficiency between the equity in the account and the margin required shall be deducted in computing the firm’s Net Capital. Firms should consider the need to institute higher margin requirements if deemed appropriate and remember that auction-rate preferred securities issued by closed-end funds are not marginable.
FINRA is also advising member firms to give careful consideration to the classification of these securities on customer statements as cash or cash equivalents. Firms are also encouraged to review any references and characterization of these securities on the firm’s Web site as short-term securities.
Recently, the auctions for these securities have been failing because investors concerned over the current credit market environment have not been willing to participate in the auctions. Consequently, holders of these securities have not been able to liquidate their positions. In order to provide liquidity to their customers, several member firms have asked FINRA whether margin can be extended to these securities.
Pursuant to NYSE and NASD rules, fixed income auction-rate securities that carry an investment grade rating are categorized as “investment grade debt securities” and normally would require equity of 10 percent of the current market value. Fixed income auction-rate securities that are below investment grade are categorized as “other marginable non-equity securities and normally require equity of 20 percent of the current market value or 7 percent of the principal amount, whichever is greater.
However, as a result of the reduced liquidity in these securities, member firms will be required to impose a regulatory maintenance requirement of 25 percent of the current market value for all fixed income auction rate securities, regardless of whether or not the security is investment grade.
If fixed income auction rate securities are used as collateral for non-purpose credit to any customer, firms are reminded that they must also consider the 25 percent maintenance requirement when determining any maintenance excess or deficiency. The amount of any deficiency between the equity in the account and the margin required shall be deducted in computing the firm’s Net Capital. Firms should consider the need to institute higher margin requirements if deemed appropriate and remember that auction-rate preferred securities issued by closed-end funds are not marginable.
FINRA is also advising member firms to give careful consideration to the classification of these securities on customer statements as cash or cash equivalents. Firms are also encouraged to review any references and characterization of these securities on the firm’s Web site as short-term securities.
Saturday, March 8, 2008
Aberdeen Fund Buying Back Auction-Rate Securities
Aberdeen Global Income Fund Inc. plans to buy back all its auction-rate debt by redeeming $30 million of auction-rate securities known as preferred shares and replacing them with loans from a major financial institution. Aberdeen Global is the first closed-end fund to take the step since the auction-rate market seized up in mid-January.
About half of all closed-end funds used the auction-rate market to finance additional investments in government and corporate bonds. Many brokers marketed the securities as a short-term investment similar to a money-market fund. Auctions began failing earlier this year and preferred shareholders got stuck with about $60 billion in securities as investors fled all but the safest government debt. This news may put pressure on other fund managers to buy back auction-rate debt.
Managers including Chicago-based Nuveen Investments Inc. and Boston-based Eaton Vance Corp., have resisted buying back their preferred shares, explaining that it would hurt their common shareholders. Nuveen and Eaton, the largest closed-end fund managers, have said they are in talks with major banks aimed at bringing new liquidity to the market. Eaton Vance has indicated that it would like to replace its preferred shares with a new form of debt that money-market funds could buy. But that is not an easy thing to do. Money funds are barred from buying securities with maturities longer than 13 months, unless they hold the right to sell back to the issuer at any time.
Cecilia Gondor of Thomas J. Herzfeld Advisors Inc., which specializes in close-end fund research, predicts that not many would follow Aberdeen Global’s example. In addition to being a small fund, Gondor said Aberdeen had a maximum interest rate, which takes effect when an auction fails, considerably higher than most closed-end funds, giving Aberdeen more incentive to refinance. Other fund managers have said their funds have a higher return from their investments than they pay in interest to preferred shareholders.
About half of all closed-end funds used the auction-rate market to finance additional investments in government and corporate bonds. Many brokers marketed the securities as a short-term investment similar to a money-market fund. Auctions began failing earlier this year and preferred shareholders got stuck with about $60 billion in securities as investors fled all but the safest government debt. This news may put pressure on other fund managers to buy back auction-rate debt.
Managers including Chicago-based Nuveen Investments Inc. and Boston-based Eaton Vance Corp., have resisted buying back their preferred shares, explaining that it would hurt their common shareholders. Nuveen and Eaton, the largest closed-end fund managers, have said they are in talks with major banks aimed at bringing new liquidity to the market. Eaton Vance has indicated that it would like to replace its preferred shares with a new form of debt that money-market funds could buy. But that is not an easy thing to do. Money funds are barred from buying securities with maturities longer than 13 months, unless they hold the right to sell back to the issuer at any time.
Cecilia Gondor of Thomas J. Herzfeld Advisors Inc., which specializes in close-end fund research, predicts that not many would follow Aberdeen Global’s example. In addition to being a small fund, Gondor said Aberdeen had a maximum interest rate, which takes effect when an auction fails, considerably higher than most closed-end funds, giving Aberdeen more incentive to refinance. Other fund managers have said their funds have a higher return from their investments than they pay in interest to preferred shareholders.
Friday, March 7, 2008
Another Lawsuit Hits UBS
Already dealing with one investor lawsuit, Swiss bank UBS is facing allegations from Pursuit Partners that it marketed securities as investment grade that the bank knew were destined for junk status. Pursuit Partners, a Connecticut-based hedge fund, claims that it bought collateralized debt obligations (CDOs) from UBS last year when UBS knew that changes in Moody’s rating methodology for CDOs were imminent. Despite that information, UBS continued to market the CDOs to the hedge fund between July and October of last year as if the change would not occur.
CDOs are complex asset-backed securities that comprise various types of loans. They became popular during the U.S. housing boom as banks pooled mortgages into new investment products that were sold to a broad array of hedge funds and other institutional investors seeking robust returns.
The changes at Moody’s involved how the CDOs were valued. Previously, CDOs were priced at current market prices but as the market for securitized subprime mortgages collapsed and ratings agencies faced criticism over how they had rated CDOs, Moody's elected to change to a market-based formula focused on future prices rather than current prices. That change would result in the immediate drop of supposedly safe mortgage-backed securities into the realm of junk.
When Pursuit paid UBS more than $50 million for pieces of the CDO, the transaction was for investment-grade securities. When Moody's announced its new ratings formula on Oct. 10, 2007, the CDOs were immediately reduced to junk status. Although there was no change in the performance of the underlying mortgages, the ratings revision triggered a default clause in underlying derivatives contracts and Pursuit lost its entire investment. Pursuit also claims UBS took both sides of a derivatives contract, allowing it to liquidate the CDOs without sustaining a hit of its own.
Pursuit’s lawsuit also touches on allegations made in the previous lawsuit from German bank HSH Nordbank which accused UBS of pawning off toxic mortgage investments on unsophisticated buyers. In February, HSH Nordbank sued UBS for $275 million, claiming that it bought $500 million in complex mortgage-backed securities that Dillon Read, UBS’s now-closed hedge fund, later stuffed with troubled subprime loans as a way to reduce its own losses.
CDOs are complex asset-backed securities that comprise various types of loans. They became popular during the U.S. housing boom as banks pooled mortgages into new investment products that were sold to a broad array of hedge funds and other institutional investors seeking robust returns.
The changes at Moody’s involved how the CDOs were valued. Previously, CDOs were priced at current market prices but as the market for securitized subprime mortgages collapsed and ratings agencies faced criticism over how they had rated CDOs, Moody's elected to change to a market-based formula focused on future prices rather than current prices. That change would result in the immediate drop of supposedly safe mortgage-backed securities into the realm of junk.
When Pursuit paid UBS more than $50 million for pieces of the CDO, the transaction was for investment-grade securities. When Moody's announced its new ratings formula on Oct. 10, 2007, the CDOs were immediately reduced to junk status. Although there was no change in the performance of the underlying mortgages, the ratings revision triggered a default clause in underlying derivatives contracts and Pursuit lost its entire investment. Pursuit also claims UBS took both sides of a derivatives contract, allowing it to liquidate the CDOs without sustaining a hit of its own.
Pursuit’s lawsuit also touches on allegations made in the previous lawsuit from German bank HSH Nordbank which accused UBS of pawning off toxic mortgage investments on unsophisticated buyers. In February, HSH Nordbank sued UBS for $275 million, claiming that it bought $500 million in complex mortgage-backed securities that Dillon Read, UBS’s now-closed hedge fund, later stuffed with troubled subprime loans as a way to reduce its own losses.
Thursday, March 6, 2008
Fidelity pays $8 million to settle SEC charges
Fidelity agreed to pay $8 million to settle regulatory claims that current and former employees — among them Peter Lynch, the legendary investor behind its Magellan Fund — accepted improper gifts in exchange for business.
Mr. Lynch, a vice chairman of Fidelity, was among 13 employees accused by the Securities and Exchange Commission of accepting gifts from brokers. Over the years, he asked Fidelity traders to secure tickets from brokers to 12 concerts and sports events, including shows by the rock bands U2 and Santana and passes to the 1999 Ryder Cup golf tournament, the S.E.C. said.
Fidelity’s self-imposed limit on gifts to its employees is $100.
Mr. Lynch, who ran the Magellan fund until 1990, agreed to pay back the value of the tickets that brokers had given him over the years — almost $16,000 — plus interest.
Mr. Lynch, a vice chairman of Fidelity, was among 13 employees accused by the Securities and Exchange Commission of accepting gifts from brokers. Over the years, he asked Fidelity traders to secure tickets from brokers to 12 concerts and sports events, including shows by the rock bands U2 and Santana and passes to the 1999 Ryder Cup golf tournament, the S.E.C. said.
Fidelity’s self-imposed limit on gifts to its employees is $100.
Mr. Lynch, who ran the Magellan fund until 1990, agreed to pay back the value of the tickets that brokers had given him over the years — almost $16,000 — plus interest.
Morgan Stanley's March 2008 Auction Rate Disclosure
"Important Notice Regarding Pricing of Auction Rate Securities"
"Due to recent market conditions, certain auction rate securities are experiencing no or limited liquidity. Therefore, the price(s) for any auction rate securities shown on this statement may not reflect the price(s) you would receive upon a sale at auction or in a secondary market transaction. There can be no assurance that a successful auction will occur or that a secondary market exists or will develop for a particular security. Please contact your financial advisor for more information about current conditions in the auction rate securities market."
"Due to recent market conditions, certain auction rate securities are experiencing no or limited liquidity. Therefore, the price(s) for any auction rate securities shown on this statement may not reflect the price(s) you would receive upon a sale at auction or in a secondary market transaction. There can be no assurance that a successful auction will occur or that a secondary market exists or will develop for a particular security. Please contact your financial advisor for more information about current conditions in the auction rate securities market."
Wednesday, March 5, 2008
More Writedowns for Investment Banks
During the first quarter of 2008 investment banks were estimated to face an additional 30 billion in writedowns largely due to subprime backed securities. Coming on the heels of record losses and write downs in 2007, especially in the fourth quarter, the news from Wall Street remained gloomy.
Among the hardest hit was Citigroup. Having taken writedowns totaling $24 billion since October 2007, Citi was expected to take more write down on leveraged loans totaling $2-3 billion in the first quarter. Citi’s $43 billion exposure to leveraged loans is the largest of the big investment banks, meaning further writedowns were likely beyond that quarter. But Citi was not alone.
Recently, Wall Street banks had been slashing their estimates for first quarter earnings. Goldman Sachs estimates dropped from nearly $6 at the beginning of 2008 to $3.62. JPMorgan Chase’s estimate is now 98 cents, down from $1.12. Others including Morgan Stanley, Merrill Lynch, and Bear Stearns, announced similar cuts in earning estimates.
About half of that was borne by U.S. financial institutions. So far, only $160 billion of losses have been registered by brokerages and banks since the credit crunch began last fall. Economists calculated the mortgage credit toll on the financial system would be between $400-600 billion.
Among the hardest hit was Citigroup. Having taken writedowns totaling $24 billion since October 2007, Citi was expected to take more write down on leveraged loans totaling $2-3 billion in the first quarter. Citi’s $43 billion exposure to leveraged loans is the largest of the big investment banks, meaning further writedowns were likely beyond that quarter. But Citi was not alone.
Recently, Wall Street banks had been slashing their estimates for first quarter earnings. Goldman Sachs estimates dropped from nearly $6 at the beginning of 2008 to $3.62. JPMorgan Chase’s estimate is now 98 cents, down from $1.12. Others including Morgan Stanley, Merrill Lynch, and Bear Stearns, announced similar cuts in earning estimates.
About half of that was borne by U.S. financial institutions. So far, only $160 billion of losses have been registered by brokerages and banks since the credit crunch began last fall. Economists calculated the mortgage credit toll on the financial system would be between $400-600 billion.
Nonprofits Want to Bid on own Bonds
Soaring debt costs due to the massive failure of the auction-rate securities in the last month have driven hospitals and nonprofits to seek permission from the SEC to bid on their own bonds.
The idea is to allow hospitals, universities, nonprofits, and government agencies a way to avoid interest rates driven up by the global credit crunch by participating in auctions that set rates on their own securities. When auctions fail, many reset at interest rates as high as 20 percent and create millions of dollars in extra borrowing costs.
Anne Phillips Ogilby, a Ropes & Gray attorney representing 14 hospitals such as Beth Israel, Dana-Farber Cancer Institute, and UMass Memorial Medical Center, estimates that one of the hospitals she represents would have to eliminate more than 250 full-time equivalent nurses to compensate for rising costs.
Hospitals and their allies in Congress are asking the SEC to allow institutions to bid on their own securities in such situations without raising concerns they are manipulating markets. Such bids would allow the institutions to avoid the highest rates that kick in when auctions fail, without the expense of retiring or refinancing the entire borrowing.
Most of the hospitals are among more than a dozen Massachusetts institutions that in recent years borrowed money at variable rates to lower costs, and purchased bond insurance to make the debt more attractive to investors. But many of these insurers have come under scrutiny recently for the subprime mortgages they held in their portfolios, scaring off many wealthy investors who previously bid at the auctions.
So far, SEC actions are unclear. Hypothetically, allowing borrowers to bid on their own bonds could give them the chance to drive down interest rates artificially, which is why the SEC has frowned on the practice in the past. Unlike share repurchases by companies, bond issuers’ options usually are more limited by original offering documents.
The SEC is also weighing a separate suggestion from a trade group, the Securities Industry and Financial Markets Association, that the commission not object if issuers bid on their own securities such as those that had failed to sell at auction, effectively reducing their interest rates or canceling the securities altogether.
The idea is to allow hospitals, universities, nonprofits, and government agencies a way to avoid interest rates driven up by the global credit crunch by participating in auctions that set rates on their own securities. When auctions fail, many reset at interest rates as high as 20 percent and create millions of dollars in extra borrowing costs.
Anne Phillips Ogilby, a Ropes & Gray attorney representing 14 hospitals such as Beth Israel, Dana-Farber Cancer Institute, and UMass Memorial Medical Center, estimates that one of the hospitals she represents would have to eliminate more than 250 full-time equivalent nurses to compensate for rising costs.
Hospitals and their allies in Congress are asking the SEC to allow institutions to bid on their own securities in such situations without raising concerns they are manipulating markets. Such bids would allow the institutions to avoid the highest rates that kick in when auctions fail, without the expense of retiring or refinancing the entire borrowing.
Most of the hospitals are among more than a dozen Massachusetts institutions that in recent years borrowed money at variable rates to lower costs, and purchased bond insurance to make the debt more attractive to investors. But many of these insurers have come under scrutiny recently for the subprime mortgages they held in their portfolios, scaring off many wealthy investors who previously bid at the auctions.
So far, SEC actions are unclear. Hypothetically, allowing borrowers to bid on their own bonds could give them the chance to drive down interest rates artificially, which is why the SEC has frowned on the practice in the past. Unlike share repurchases by companies, bond issuers’ options usually are more limited by original offering documents.
The SEC is also weighing a separate suggestion from a trade group, the Securities Industry and Financial Markets Association, that the commission not object if issuers bid on their own securities such as those that had failed to sell at auction, effectively reducing their interest rates or canceling the securities altogether.
Tuesday, March 4, 2008
Merrill Lynch and Citigroup Caught in Whirlwind after Failed Pursuit of CDO Fees
Stan O’Neal, who took over as CEO of Merrill in 2002, saw CDOs as a source of significant fees for his firm making him the reason for the firms heavy pursuit of these securities. In 2002, Merrill Lynch & Co. was in the issuance of collateralized debt obligations (CDOs). By 2007 they were number one. O’Neal was right, in 2007 Merrill earned $395 million in fees associated with CDOs.
What O’Neal and Merrill did not see were the risks associated with bundling bonds backed by subprime mortgages into complex debt instruments. When delinquencies on these subprime mortgages began mounting in the summer of 2007, the value of CDOs plummeted.
The fees generated by the issuance of CDOs now pale in comparison to the write-offs Merrill Lynch and others are facing. According to Bloomberg’s Hamish Risk, Merrill has written down $24.5 billion in losses from CDOs and other assets to date.
In addition, Citigroup Inc. was behind only Merrill in the number of CDOs issued in 2007. The result was $347.2 million in fees for Citigroup. Like Merrill, when the bottom fell out of the market for these investments, Citigroup, and scores of individual and institutional investors who were sold these investments by Wall Street, was left holding the bag. Citigroup has announced write-downs of $22.4 billion.
What O’Neal and Merrill did not see were the risks associated with bundling bonds backed by subprime mortgages into complex debt instruments. When delinquencies on these subprime mortgages began mounting in the summer of 2007, the value of CDOs plummeted.
The fees generated by the issuance of CDOs now pale in comparison to the write-offs Merrill Lynch and others are facing. According to Bloomberg’s Hamish Risk, Merrill has written down $24.5 billion in losses from CDOs and other assets to date.
In addition, Citigroup Inc. was behind only Merrill in the number of CDOs issued in 2007. The result was $347.2 million in fees for Citigroup. Like Merrill, when the bottom fell out of the market for these investments, Citigroup, and scores of individual and institutional investors who were sold these investments by Wall Street, was left holding the bag. Citigroup has announced write-downs of $22.4 billion.
No Abating in Auction-Rate Bond Failures
In a continuing downslide, 521 auctions for auction-rate securities failed yesterday, amounting to a rate of 66 percent in the $330 billion market. From 1984 through 2006, only 13 auctions failed as brokers usually bought the bonds when demand was weak. Brokers like Goldman Sachs Group Inc. and Citigroup Inc. stopped bidding on the auctions last month based on concerns that insurers backing the bonds might be downgraded. The rate of failure has since reached 87 percent on Feb. 14 and has ranged from 61 percent to 69 percent, according to Bank of America Corp.
When auctions fail, bondholders are left holding the securities and interest rates reset at a level spelled out in official statements issued at the initial bond sale. Rates on Port Authority of New York and New Jersey bonds rose to 20 percent on Feb. 13, up from 4.3 percent a week earlier after an auction failed.
State and local governments use the market to raise capital and they alone account for roughly $166 billion of the outstanding auction-rate debt. States and lawmakers are trying to revive the market as their budgets are pinched by rising yields on debt and a slowing economy and real estate market slashes tax revenue. Some of the proposed plans of action include:
The California Statewide Communities Development Authority said yesterday it is considering raising $10 billion to finance buying back the bonds it sold for local governments and hospitals. The issuers would then pay fixed interest on the debt, which would be held by the authority, for a year.
The New York Dormitory Authority said on Feb. 26 it plans to disclose bidding details and open the process to more banks for about $1.3 billion of its auction bonds in the hopes of lowering interest rates.
New York Comptroller Thomas DiNapoli is considering buying auction bonds for the state's $154.4 billion pension fund.
Last month, issuers, including 14 hospitals in California and Massachusetts, asked the SEC to let them bid on their own securities to prevent failures and lower rates until they could refinance the debt. Bond lawyers are concerned the issuers will run afoul of securities laws by bidding at their own auctions. In February, Lehman Brothers Holdings Inc. forbade the University System of New Hampshire to bid on some of it’s $150 million in auction debt. A growing list of lawmakers this week is urging regulators to let borrowers bid on their own bonds. However, the SEC is skeptical about issuer bids and hesitant to change the terms of contracts between buyers and sellers.
When auctions fail, bondholders are left holding the securities and interest rates reset at a level spelled out in official statements issued at the initial bond sale. Rates on Port Authority of New York and New Jersey bonds rose to 20 percent on Feb. 13, up from 4.3 percent a week earlier after an auction failed.
State and local governments use the market to raise capital and they alone account for roughly $166 billion of the outstanding auction-rate debt. States and lawmakers are trying to revive the market as their budgets are pinched by rising yields on debt and a slowing economy and real estate market slashes tax revenue. Some of the proposed plans of action include:
The California Statewide Communities Development Authority said yesterday it is considering raising $10 billion to finance buying back the bonds it sold for local governments and hospitals. The issuers would then pay fixed interest on the debt, which would be held by the authority, for a year.
The New York Dormitory Authority said on Feb. 26 it plans to disclose bidding details and open the process to more banks for about $1.3 billion of its auction bonds in the hopes of lowering interest rates.
New York Comptroller Thomas DiNapoli is considering buying auction bonds for the state's $154.4 billion pension fund.
Last month, issuers, including 14 hospitals in California and Massachusetts, asked the SEC to let them bid on their own securities to prevent failures and lower rates until they could refinance the debt. Bond lawyers are concerned the issuers will run afoul of securities laws by bidding at their own auctions. In February, Lehman Brothers Holdings Inc. forbade the University System of New Hampshire to bid on some of it’s $150 million in auction debt. A growing list of lawmakers this week is urging regulators to let borrowers bid on their own bonds. However, the SEC is skeptical about issuer bids and hesitant to change the terms of contracts between buyers and sellers.
Investors and Homeowners suffer at the Hands of Lenders
When it came to soaring home prices, Wall Street gambled and now homeowners and investors in the subprime housing market are paying the price of lenders’ arrogance. What goes up must come down!
Amid rapidly rising home prices in 2005, irresponsible lenders took advantage of Americans eager to live the dream. With such come-ons as No credit? No problem! and No down payment required, lenders had no shortage of eager borrowers, especially when they didn’t require proof of income or even ask how long a potential borrower had held a job. A shocking number of subprime and Alt-A loans even financed 100% of the home’s purchase price.
Low teaser rates and interest-only payments made the deals irresistible, and if hesitant applicants dared to wonder aloud how they’d afford higher payments in the future, their lenders gave a breezy answer: With home prices soaring into the foreseeable future, their equity would rise more quickly than their debt.
Don’t worry; be happy! With news stories daily about defaulting homeowners unable to sell, we know just how unhappy many of these homeowners are and, by extension, those who invested in these mortgages, often unwittingly. What if Wall Street had been right and home prices had continued upward? Were these loans and investments guaranteed to fail no matter what?
Default in less than a year
Yes. A bad loan is a bad loan. Industry analysts are predicting record mortgage defaults and foreclosures this year, when teaser rates, interest-only payments and other introductory options expire. But the problem is not that homeowners won’t be able to afford the higher loan payments then. The problem is that homeowners haven’t been able to afford their loans since the moment they signed the application. A review of the collateralized debt obligations (CDOs) and other subprime securities sold to investors in 2006 and 2007 estimated at $362 billion reveal that borrowers have been in default for some time, and investors would have lost millions even if home prices had lived up to Wall Street’s wishful thinking.
How do we know? On subprime mortgages issued in 2007, the November delinquency rate exceeded 11% — while the teaser rate was still in effect. This means 300,000 homeowners defaulted on loans they had for less than a year. Some homeowners defaulted within just a few months. Some failed to make even the first payment.
Investors fed lenders’ enthusiasm
Experts took notice in 2006 and 2007 when a reported 60% of subprime and Alt-A borrowers got loans without proving they could repay them. In light of a waning housing market in 2006, these experts urged lenders to tighten their underwriting practices.
Instead, lenders made more, not fewer, of these dubious loans. They made so many exceptions to their already lax rules that although they made up no more than 5% of subprime loans before 2006, they represented the majority of these loans issued in 2006 and 2007, said analyst Michael Youngblood in a CNNMoney.com article by Les Christie.
Lenders continued to make these loans because investors continued to buy them, according to Doug Duncan, chief economist of the Mortgage Bankers Association (CNNMoney.com). Merrill Lynch, Citigroup, UBS, Morgan Stanley, Bank of America and others eagerly bought the subprime loans, packaged them with other assets into mortgage-backed securities and collateralized debt obligations (CDOs) and earned huge profits from investors lured by the promise of high yields and AA or AAA ratings.
Investors who believed they purchased low-risk mutual funds but actually invested in CDOs and other securities backed by subprime mortgages will be shocked by significant losses resulting from a dramatic rise in already-high default rates. Investors can expect the worst as the bulk of these loans move to their higher interest rates and new repayment terms during 2008.
Amid rapidly rising home prices in 2005, irresponsible lenders took advantage of Americans eager to live the dream. With such come-ons as No credit? No problem! and No down payment required, lenders had no shortage of eager borrowers, especially when they didn’t require proof of income or even ask how long a potential borrower had held a job. A shocking number of subprime and Alt-A loans even financed 100% of the home’s purchase price.
Low teaser rates and interest-only payments made the deals irresistible, and if hesitant applicants dared to wonder aloud how they’d afford higher payments in the future, their lenders gave a breezy answer: With home prices soaring into the foreseeable future, their equity would rise more quickly than their debt.
Don’t worry; be happy! With news stories daily about defaulting homeowners unable to sell, we know just how unhappy many of these homeowners are and, by extension, those who invested in these mortgages, often unwittingly. What if Wall Street had been right and home prices had continued upward? Were these loans and investments guaranteed to fail no matter what?
Default in less than a year
Yes. A bad loan is a bad loan. Industry analysts are predicting record mortgage defaults and foreclosures this year, when teaser rates, interest-only payments and other introductory options expire. But the problem is not that homeowners won’t be able to afford the higher loan payments then. The problem is that homeowners haven’t been able to afford their loans since the moment they signed the application. A review of the collateralized debt obligations (CDOs) and other subprime securities sold to investors in 2006 and 2007 estimated at $362 billion reveal that borrowers have been in default for some time, and investors would have lost millions even if home prices had lived up to Wall Street’s wishful thinking.
How do we know? On subprime mortgages issued in 2007, the November delinquency rate exceeded 11% — while the teaser rate was still in effect. This means 300,000 homeowners defaulted on loans they had for less than a year. Some homeowners defaulted within just a few months. Some failed to make even the first payment.
Investors fed lenders’ enthusiasm
Experts took notice in 2006 and 2007 when a reported 60% of subprime and Alt-A borrowers got loans without proving they could repay them. In light of a waning housing market in 2006, these experts urged lenders to tighten their underwriting practices.
Instead, lenders made more, not fewer, of these dubious loans. They made so many exceptions to their already lax rules that although they made up no more than 5% of subprime loans before 2006, they represented the majority of these loans issued in 2006 and 2007, said analyst Michael Youngblood in a CNNMoney.com article by Les Christie.
Lenders continued to make these loans because investors continued to buy them, according to Doug Duncan, chief economist of the Mortgage Bankers Association (CNNMoney.com). Merrill Lynch, Citigroup, UBS, Morgan Stanley, Bank of America and others eagerly bought the subprime loans, packaged them with other assets into mortgage-backed securities and collateralized debt obligations (CDOs) and earned huge profits from investors lured by the promise of high yields and AA or AAA ratings.
Investors who believed they purchased low-risk mutual funds but actually invested in CDOs and other securities backed by subprime mortgages will be shocked by significant losses resulting from a dramatic rise in already-high default rates. Investors can expect the worst as the bulk of these loans move to their higher interest rates and new repayment terms during 2008.
Sunday, March 2, 2008
Jefferson County Sewer Bonds Cut to Junk Status
Jefferson County's sewer-bond credit rating was cut to junk status Friday, increasing the odds of the largest bankruptcy filing ever by a governmental body.
Standard & Poor's, which ranks the creditworthiness of borrowers, downgraded the sewer rating to junk level, citing uncertainty that the county can make debt payments to lenders such as pension plans and money managers who bought bonds. The sewer-bond rating was cut six levels to B, five levels below investment grade, from BBB.
The downgrade intensifies pressure on the county's finances and makes it possible for creditors to demand payment on $341 million of investment contracts called swaps.
Standard & Poor's, which ranks the creditworthiness of borrowers, downgraded the sewer rating to junk level, citing uncertainty that the county can make debt payments to lenders such as pension plans and money managers who bought bonds. The sewer-bond rating was cut six levels to B, five levels below investment grade, from BBB.
The downgrade intensifies pressure on the county's finances and makes it possible for creditors to demand payment on $341 million of investment contracts called swaps.
Saturday, March 1, 2008
Falcon Hedge Fund: Citigroup enters $500 million credit facility
Citigroup entered into a $500 million credit agreement with a leveraged fund mana Falcon Hedge Fundged by its Falcon Plus Strategies, which makes it the primary beneficiary of the fund.
As part of this agreement, Citigroup will move the fund's assets and liabilities onto its balance sheet, increasing Citigroup’s assets and liabilities by about $10 billion.
Separately, Citigroup is in discussion with the SEC about a letter the SEC’s finance division sent primarily regarding Citigroup’s hedging activities and variable interest entities.
As part of this agreement, Citigroup will move the fund's assets and liabilities onto its balance sheet, increasing Citigroup’s assets and liabilities by about $10 billion.
Separately, Citigroup is in discussion with the SEC about a letter the SEC’s finance division sent primarily regarding Citigroup’s hedging activities and variable interest entities.
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