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November 28, 2012

MSRB to Change ARS Data As Urged by Advisor

By Jonathan Hemmerdinger

WASHINGTON - The Municipal Securities Rulemaking Board said Wednesday that it will change how it calculates bid-to-cover ratios for auction-rate securities, one day after the chief executive officer of a Manhattan-based financial advisory firm called for the reform.

The board told The Bond Buyer it is planning to make the change after Saber Partners LLC., led by CEO Joseph Fichera, issued a media release calling the board's ratios "inaccurate" and "potentially misleading" to investors.

In its release, Saber Partners acknowledged improvements the board has made to muni-market transparency, but said the MSRB's bid-to-cover ratios for ARS, published on the board's EMMA system, indicate inflated demand.

"The published ratio fails to accurately inform sellers, buyers or potential buyers of the amount of demand for the securities from independent investors as opposed to broker- dealers bidding for their proprietary accounts," the release said. "The current disclosures are essentially useless to investors since they cannot be meaningfully applied to evaluate ARS risks and bidding in past auctions."

The MSRB responded, saying that improvements to the calculation, which have been planned for months, would take effect in mid-December.

"We have gone back to work on a better calculation. We plan to release it in the next couple of weeks," said MSRB deputy executive director Ernesto Lanza. "We all agree that we can come up with a better number."

ARS are muni bonds with interest rates that are reset through auctions, typically every seven, 14, 28 or 35 days. ARS issuance peaked in the years before to the recession, but ceased around 2008, when dealers stopped supporting the auctions and concerns abounded about liquidity and the viability of insurance firms that backed the bonds.

Still, some $40 billion of the notes are auctioned every month, according to Fichera.

Bid-to-cover ratios published by the MSRB measure the dollar amount of bids against the dollar amount of bonds offered, and are meant to indicate market demand.

Fichera, who has long urged the board to make changes to its ARS rules and data, said the ratios distort the security's liquidity because they are calculated using so-called "back- stop bids" placed by program dealers. Those dealers bid on their own behalf to keep auctions from failing.

The ratios don't distinguish between the demand from independent investors actually interested in buying the bonds, and the demand from program dealers. In some cases, ratios can reach 4,000 to 1, a level Saber Partners called "absurd."

"If the published auction market data is wrong, the MSRB should correct it or take it down. If this information cannot be made useful to investors, the money spent on creating it should be spent elsewhere," Fichera said in the release.

The ARS crisis in 2008 was partly caused because investors overestimated liquidity, he said.

The MSRB's Lanza said that, after months of development work, the board will change the calculation to be more useful to investors.

He said the board has recognized the need for improvements nearly since it began publishing the ratio about one-and-a-half years ago, but only recently has it collected the needed "underlying raw data" to make the changes. That data is submitted by dealers and auction agents to the MSRB's Short- Term Obligation Rate Transparency System.

The MSRB will stop including bids from program dealers in the calculation, and will use only bids from non-dealers, Lanza said. The calculation will also include the outstanding principal amount of issues.

Even with the improved ratio, investors should review the detailed auction data on the EMMA website to estimate a bond's liquidity, paying special attention to the amount of demand, according to Lanza.

MSRB officials said the board would explain the new calculation in the education section of its website.

Fichera, who has worked in the auction-rate securities market since the mid-1980s, said he is pleased that the MSRB is making the change.

"Saber Partners are happy they have been responsive. We have been talking with them since the beginning," he said.

Fichera sent a 2008 letter to the board recommending that a host of additional information about muni auctions be made public. His firm raised additional concerns, including those related to bid-to-cover ratios, in a internet posting five months ago.

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