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Florida Schools, California Convert Auction-Rate Debt (Update5)
Jeremy R. Cooke
Thousands of auctions run by banks to set rates on the debt failed this month as investors shunned the securities and bankers refused to submit bids, sending interest costs to 10 percent or higher on some bonds. Auctions covering as much as $26 billion of bonds a day failed to attract enough buyers since Feb. 13, according to Bank of America Corp.
Florida's Palm Beach County Schools converted $116 million of the securities into fixed-rate debt this week, while the Seattle area's Valley Medical Center refinanced $170 million. The Port Authority of New York and New Jersey, which runs JFK and other airports, bridges, tunnels and sea terminals around New York City, said it would redeem $200 million next month after its weekly interest rates rose as high as 20 percent.
``We expect to be out of the auction-rate market business in six to eight weeks,'' said Steve Coleman, a Port Authority spokesman.
Rates in the more than $300 billion auction market, where local governments, hospitals, museums, student-loan agencies and closed-end mutual funds borrow, are determined through a bidding process every seven, 28 or 35 days. Auctions fail when there aren't enough buyers. That's left bondholders who wanted to sell stuck with the securities and taxpayers or other backers of the debt such as fund holders with higher interest costs.
Two-Thirds Fail
Today, 386 auctions of publicly offered bonds resulted in 258 failures, or 67 percent, according to data compiled by Bloomberg from four auction agents, Deutsche Bank AG, Bank of New York Mellon Corp., Wilmington Trust Corp. and Wells Fargo & Co. The firms are responsible for receiving orders from broker- dealers and determining the winning rate. They also perform some administrative services for the borrower.
About two-thirds of auctions have failed per day since Feb. 15, according to data compiled by Bank of America and Bloomberg.
Just 44 failures were recorded between 1984, when the market was created, and the end of last year, Moody's Investors Service said in a Feb. 19 report.
The rates when auctions fail are spelled out in documents governing the bonds, and are set as high as 20 percent or based upon money-market benchmarks.
Penalty Rates
Borrowers must pay the penalty rates until buyers support future auctions or they can modify the bonds to another kind of variable-rate debt or apply a fixed rate.
The average rate for seven-day municipal auction bonds rose the most ever to a record 6.59 percent on Feb. 13 from 4.03 percent the previous week, according to indexes compiled by the Securities Industry and Financial Markets Association.
Palm Beach school officials started working on a conversion plan in December when rates exceeded 4 percent. They reached 9.75 percent this week, short of the 15 percent penalty rate. The district's interest payment for this week's auction was about $220,000, up from $107,000 in December.
``As a public entity, that's an unacceptable level of risk for us,'' said Leanne Evans, treasurer of the 170,000-student district, one of the five largest school systems in Florida.
After converting the debt, the district will pay 4 percent through a mandatory buyback in 2011, compared with 2.63 percent for top-rated three-year fixed-rate bonds. The bonds still carry insurance from downgraded insurer FGIC Corp.
Ahead of Rest
Renton, Washington-based Valley Medical Center expanded the size of its previously planned bond sale by about 90 percent this week to refinance all of its auction-rate debt. Failed auctions sent one of the hospital's rates to 15 percent the past two weeks from 3.75 percent the first week of February.
On $65 million of the debt, that's a difference of about $142,000 in interest costs from one week to the next.
``We're 30 to 60 days probably ahead of most of the rest'' of other borrowers looking to convert, said Jeannine Grinnell, treasurer of the medical center, which borrows as King County, Washington, Public Hospital District No. 1.
California, the biggest municipal borrower, plans to replace $1.25 billion of auction-rate bonds, debt manager Paul Rosenstiel said this week. New York City's Municipal Water Finance Authority yesterday said it will pay off auction debt by selling $684 million of variable-rate demand notes on March 18.
No Support
Until this year, banks that collect annual fees of about 0.25 percent to run auctions would step in to stop failures when bidding faltered. Goldman Sachs Group Inc., Citigroup Inc., UBS AG and Merrill Lynch & Co. stopped committing capital after banks sustained at least $146 billion in credit losses and writedowns from the subprime mortgage collapse.
That's left corporate treasurers and wealthy individuals, some of whom bought the debt as cash equivalents, unable to access their money.
``The auction-rate market was not as deep or as wide as people thought it would be,'' said Christopher ``Kit'' Taylor, former executive director of the Municipal Securities Rulemaking Board, in an interview from Washington. ``People were borrowing short to fund a long-term project. Issuers were trying to take advantage of that yield curve. It didn't work out for them.''
About 87 percent of auctions on Feb. 14 failed, up from 2 percent a week earlier, according to Bank of America. By Feb. 20, the rate declined to about 66 percent.
Demand from hedge funds and other investors attracted by the higher rates helped some auctions succeed this week, especially those offering the possibility of yields above 10 percent, said Evan Rourke, a portfolio manager at M.D. Sass Associates in New York.
Emblematic Rate
The Port Authority's 20 percent taxable rate, cited by New York Governor Eliot Spitzer and U.S. Senator Charles Schumer last week as emblematic of the crisis, fell to 8 percent. That's still twice what the authority was paying in January.
For $100 million of such debt, the authority owes more than $544,000 in interest for the past two weeks, up from $156,000 during two weeks in January.
Other borrowers planning to get out of some or all of their auction-rate obligations are the state of New Jersey, New York's Nassau County, Children's Hospital of Philadelphia and utility units of Charlotte, North Carolina-based Duke Energy Corp. that sold tax-exempt debt.
Investors focused on opportunities in auction-rate bonds sapped demand for fixed-rate debt this week. Concern that ailing bond insurers will continue to lose top credit ratings also weakened municipal bonds, even as Treasuries gained.
Yields Rise
The Bond Buyer 20, a yield index of 20-year general obligation bonds, rose 19 basis points, the most in more than four years, to 4.66 percent. A basis point equals 0.01 percentage point. Municipal borrowers sold $2.3 billion of fixed-rate bonds, down from $4.5 billion last week, Bloomberg data show.
Unlike Treasuries or equities, there is no central daily source of information about auction-rate bonds. Issuers have relied on banks to be buyers of last resort when bidders couldn't be found at their auctions.
Since the first of the securities were sold in 1984 for American Express Co., the market has expanded as investors sought the bonds as a higher-yielding alternative to money- market funds, which aren't eligible to buy the debt.
Along the way, New York-based Lehman Brothers Holdings Inc. was fined $850,000 in 1995 by the Securities and Exchange Commission for manipulating auctions conducted for American Express. Almost two years ago, 15 securities firms paid the SEC $13 million to settle claims of bid-rigging in auction-rate bonds. The banks neither admitted nor denied wrongdoing.
Disclosing Knowledge
While the SEC required dealers to disclose that they may use insider knowledge to place bids, they don't have to say how frequently they bid or how much. Dealers also aren't obligated to disclose rates on auction debt when the securities trade.
State regulators are scrutinizing sales of auction-rate securities by closed-end mutual funds after investors complained they couldn't sell their holdings. Massachusetts Secretary of State William Galvin asked nine fund companies for information on failed auctions, his office said in a statement.
Ohio Attorney General Marc Dann might file lawsuits after state funds bought the securities, according to spokeswoman Jennifer Brindisi.
``Any time that there are actions which are not transparent or not in the public interest, and if they have a detrimental effect upon the carrying out of appropriate public policy, it's hurtful and detrimental,'' Ohio Governor Ted Strickland, a Democrat, said in an interview from Columbus.
IRS Rules
The Internal Revenue Service said this week that it plans to issue new rules that would make it easier for local governments to convert high-rate auction bonds to lower-cost debt. The changes wouldn't be such a significant modification that it would amount to a re-issuance of the bonds, the federal agency said.
Regulators are calling for more disclosure in the wake of the failures. The Municipal Securities Rulemaking Board, which makes rules for dealers in the municipal bond market, is considering rules that would force dealers to reveal the number of bidders and disclose how often auctions fail, Executive Director Lynnette Hotchkiss said in a Feb. 14 interview.
To contact the reporter on this story: Jeremy R. Cooke in New York at jcooke8@bloomberg.net .
Last Updated: February 22, 2008 18:12 EST