Secondary Market for Auction-Rate Securities at Discount Prices

Some relief is appearing for investors with illiquid auction-rate securities. Investors can now sell their auction-rate securities in the developing secondary market for an average of 75 to 95 cents to the dollar. That average range of bids which is 5% to 25% below par.

These lower bids provide clues to the losses facing cash-starved investors and dealers with auction-rate securities. The Restricted Securities Trading Network began trading auction-rate securities in early March after the $330 billion auction-rate market collapsed in the face of a global credit crunch and investors’ cash became stuck in these illiquid securities. Currently over 150 different securities are listed for sale and activity is expected to increase when investors realize that they may never recover the full face value of their securities in the future anyway.

For example, UBS AG has already begun lowering its clients’ auction-rate securities value by about 5 percent and some limited cases were lowered 15 percent. This was a jolt of reality to investors and some may conclude that they could achieve more liquidity if they sold their securities at a discount in the secondary market.

Bids for auction rate bonds sold by U.S. municipalities have the smallest discounts; student loan bids could get as cheap as 75 cents on the dollar; and closed-end fund preferred securities could get bids of around 80 to 90 cents on the dollar. Student loan bids are the highest because they pay below market penalty rates when auctions fail to sell.

While most auctions continue to fail, few transactions in secondary markets are taking place as investors are hoping current crisis won’t last and that issuers will buy back these securities. However, the secondary market will stay even though municipalities and closed-end fund like Nuveen, Eaton Vance, and BlackRock have begun redeeming their auction rate securities. The reason being is that the current credit environment won’t be able to help refinance this $330 billion market. Also, some states and cities have high penalty rates at failed auctions but other issuers actually have below market penalty rates and have no incentive to redeem their auction-rate securities.