In the News: Recent Developments

February 15, 2008

Muni Regulators Seek Disclosure on Auction-Rate Bonds (Update5)

By Michael Quint

Fichera of Saber Says Municipals Need More Transparency

Published in Bloomberg News / BusinessWire
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Feb. 15 (Bloomberg) — Securities regulators may impose new rules on brokers in the $330 billion auction-rate bond market where rigged bids left investors unable to sell their holdings and taxpayers with higher borrowing costs.

The U.S. municipal bond market’s main regulator, the Municipal Securities Rulemaking Board, plans to seek comment on whether dealers should reveal the number of bidders and disclose how often auctions fail in the market for the securities, whose rates are set periodically at auctions, said Executive Director Lynnette Hotchkiss.

Banks including Goldman Sachs Group Inc. and Citigroup Inc. allowed hundreds of auctions to fail this week after they were unable to attract bidders and decided to stop buying unwanted securities. Investors had come to rely on the banks to prevent failures by submitting their own bids, without ever knowing how much dealers stepped in to support the market or the range of offers at auctions.

An unsuccessful auction nearly doubled seven-day borrowing costs on $15 million of bonds sold by Harrisburg International Airport in Pennsylvania to 14 percent, while a $100 million Port Authority of New York & New Jersey bond reset at 20 percent, up from 4.3 percent a week earlier. The rise in the port authority’s rate increased interest costs on the securities by $305,278 this week alone.

Not Enough Demand

“The problem with most auction bonds isn’t the bonds’ credit quality or default risk,” said Joseph Fichera, chief executive at Saber Partners, a New York-based financial adviser to local governments. “The problem is that there isn’t enough demand for the bonds because some issuers gave monopolies on the distribution to a few banks.”

Auction-rate bonds are long-term debt with interest rates reset according to bids submitted to banks and securities firms every seven, 28 or 35 days.

Banks stopped buying the securities for their own accounts to prevent failures as investor demand for the bonds faded at the same time as banks’ financial health came under pressure from $146 billion in credit losses and writedowns from subprime mortgage securities.

Regulators, who have allowed dealers to retain control of basic information in the market and manipulate prices at auctions even after the Securities and Exchange Commission fined banks in a settlement over bid-rigging two years ago, are calling for more disclosure now as the failures squeeze borrowers and investors alike.

Information ‘Inadequacy’

“The inadequacy of pricing information for floating-rate municipal bonds, such as auction rate securities” was one of the “significant shortcomings” identified by Christopher Cox, chairman of the Securities and Exchange Commission said in a Feb. 8 speech in Washington describing the regulator’s agenda this year. “A rule aimed at improving the pricing transparency for these securities,” will be forthcoming, Cox said.

The SEC, which enforces regulations of the municipal board, must approve any new rules.

Failed auctions starting in August 2007 for some corporate securities were followed this year by downgrades of bond insurers, and announcements of writedowns at companies such as Bristol-Myers, unable to sell their auction securities. Buyers including corporate treasurers held auction-rate securities as a higher-yielding alternative to money market mutual funds or certificates of deposit.


As banks backed away from the market, the failed auctions have left investors who wanted to sell the debt unable to unload the securities and boosted interest costs for cities, hospitals and other issuers. The higher rates were stipulated when the bonds were initially sold and don’t necessarily indicate diminished credit quality.

New York City owes about $3.5 billion on auction bonds, or 5 percent of the city’s total indebtedness. The city carries ratings of AA from Standard & Poor’s and Aa3 from Moody’s Investors Service, two and three levels below the top investment grade, respectively.

The city’s failed auctions were “certainly nothing related to our credit,” said Alan Anders, deputy budget director. Failures don’t mean investors won’t continue to get their interest payments or that a default has occurred, he said.

Zurich-based UBS AG will no longer buy auction-rate securities that fail to attract enough bidders, and Merrill Lynch & Co. in New York is reducing purchases, people with direct knowledge of the matter said this week.

Allaying Concerns

Hotchkiss at the Alexandria, Virginia-based Municipal Securities board declined to detail disclosures that will be included in the agency’s proposed rulemaking notice because it hasn’t been approved. She said the notice for comment may be issued within two or three weeks after a special board meeting.

Providing more information on auctions, such as the amount of bids and sale orders, might help the market because it “could allay some investor concerns about getting stuck holding a security,” said Fichera.

The staff at the Securities and Exchange Commission has talked with the board about enhanced disclosure of the auction process, Hotchkiss said.

The board began work in October on changing its trade reporting system to include the interest rate on auction bonds, not just the price. At that time, Frank Chin, chairman and head of the public finance group at New York-based Citigroup, the biggest underwriter of auction-rate debt, said disclosures on details of auctions beyond the rate would be the “subject of additional dialogue with the SEC.”

SEC Probe

The board began looking at ways to increase auction-rate disclosure at the request of the SEC, which in 2006 fined 15 banks a total of $13 million for using inside information to submit bids on auction-rate securities. Banks have been allowed to continue the practice so long as they disclose to investors that they might bid, though they haven’t been required to reveal if, or how much they paid at auctions or what the range of offers was.

Revealing the interest rate would help investors and issuers, Martha Haines, head of the SEC’s Office of Municipal Securities, has said.

Investors have few publicly available sources of information on yields of auction-rate securities, beyond indexes published on the Web site of the Securities Industry Financial Markets Association, the bond market’s trade group. The indexes are based on securities whose rates reset on Tuesday or Wednesday, and are published with a lag. The most recent indexes are for Feb. 13.

—To contact the reporter on this story: Michael Quint in Albany, New York, at

—Last updated: February 15, 2008 16:19 EST

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