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.