Tuesday, September 9, 2008

Issuers Left in Debt After Auction Rate Securities Settlements

Many issuers of auction-rate bonds have been left in a bind after the collapse of the auction-rate securities market .With no buyers for auction-rate securities - and unwilling to wait for the federal government or regulators to fix the liquidity crisis - their only alternative is to exit the auction market and replace the auction-rate bonds with lower cost and less volatile debt.

And that can be a pricey endeavor. From Indiana to California to New York, issuers of auction bonds are encountering sky-high costs and countless headaches as they try to put the auction-rate securities debacle behind them. In total, issuers have had to pay an extra $2 billion in interest costs following the collapse of the auction market in February.

Making matters even worse: These same borrowers may be on the hook for billions of more dollars in refinancing fees to convert their auction-rate bonds - money that in most cases will go to the very same Wall Street institutions that caused all of their problems in the first place by pulling out of the auction-rate market in April of 2008.

As reported Sept. 9, 2008 on Bloomberg.com, the biggest state issuer of auction rate debt is New York State, with $4 billion in auction-rate bonds. To date, that state has spent $138 million to rid itself of the securities. One of its unexpected costs in dumping the auction bonds was $101 million to repay borrowings by the state Dormitory Authority on behalf of the City University of New York. Those are funds that could have gone toward providing preschool classes for more than 30,000 children, according to the article.

But that’s just the beginning. Total expenses for New York to covert its auction bonds into other forms of financing will climb to $340 million or more, according the Bloomberg article.

Based on Bloomberg data, states, cities, hospitals, and other municipal borrowers have now refinanced or plan to refinance approximately $104 billion of their $166 billion in auction-rate debt, which amounts to 62% of all auction-rate bonds.

When all is said and done, the final bill for replacing the $166 billion in auction rate debt could reach upwards of $7 billion, which does not include extra interest costs, according to Bloomberg.

As of August 2008, eight Wall Street banks - Citigroup, Morgan Stanley, JPMorgan Chase, Wachovia, Deutsche Bank AG, Merrill Lynch, Bank of America and Goldman Sachs - have agreed to buy back more than $50 billion of auction-rate securities from retail investors and settle claims of misleading investors about the liquidity risks of the securities. As part of the settlements, issuers of the auction bonds will be reimbursed refinancing fees on bonds sold after Aug. 1, 2007 and replaced after Feb. 11. 2008 That covers only about 1 percent of public-sector borrowings, according to Bloomberg.

Even more disturbing to issuers: When they do pay a bank refinancing fees for converting their auction-rate bonds, they simultaneously reduce that institution’s losses on the very securities that state regulators forced them to buy back. In the end, replacing auction-rate debt has become an expensive, unpleasant and arduous process for many issuers of auction-rate bonds. Not only is it creating financial havoc on already strained state budgets for some public-sector borrowers, but it also means numerous worthwhile and needed public projects must be placed on the backburner for years to come.

Auction-rate securities are now planned to take center stage at a hearing held by the U.S. House Financial Services Committee On Sept. 18, 2009. The Committee plans to examine the actions of regulators and investment banks and their possible connection to the collapse of the $330 billion auction-rate securities market in February of 2008.

No comments: