Many ARS holders find silver lining

One of the great ironies of the market cataclysm is that investors stuck with auction rate securities — among the earliest victims of the global credit freeze — are now enjoying some of the fattest returns. While most equities are losing ground and Treasury yields are flat-lining, auction rate securities from municipalities and other direct issuers as well as auction rate preferred securities from closed-end mutual funds are paying interest rates that are downright luscious. "They're the best investment of 2008 for me and a lot of people," said Harry Newton, a New York investor whose website, auctionratepreferreds.org, has been chronicling the auction rate debacle and its consequences since early this year. "If I hadn't been forced to keep my money there, I probably would have been doing something stupid like buying stocks." Mr. Newton, a retired publisher, owns $3.2 million in tax-free auction rate municipal preferreds issued by closed-end funds from Nuveen Investments Inc. of Chicago. Last Monday, those preferreds were paying 8.45%, down from more than 11% a week earlier. Similar issues from funds run by BlackRock Inc. and Neuberger Berman Inc., both of New York, Van Kampen Investments Inc.of Oakbrook Terrace, Ill., and Pacific Investment Management Co. LLC of Newport Beach, Calif., among others, were yielding close to 8% last week. Rates for some directly issued general obligation ARS — not to mention some auction rate revenue issues — were in double digits. A broker at Minneapolis-based RBC Wealth Management, who just a few months ago was apoplectic about his inability to help clients redeem hundreds of millions of dollars in auction rate preferred securities, said that he is now hearing from some who are reluctant to cash in the securities as Nuveen and other issuers proceed with their long-sought buyback programs. The broker asked not to be identified. Even some issuers of the securities — looking to build up demand in hopes of tempering rapidly rising penalty payments — are suggesting that financial advisers consider marketing auction rate securities more aggressively. "We have a few clients that have issued tax-exempt auction rate debt who are sending me their tickers and saying they're good for my other clients," said Mark Mirsberger, chief executive of Dana Investment Advisors Inc., a Brookfield, Wis.-based registered investment adviser with about $2.7 billion under management. That said, few are suggesting that investors pile into the troubled auction rate market — nor are they buying the securities for themselves on the secondary market. "Every time we've chased yield in the past year or so, we've got our fingers and toes cut off," Mr. Newton said. "I don't like things that aren't liquid, and even with the higher rates, I don't like the risk-reward characteristics," added William R. Gurtin, chief executive at Gurtin Fixed Income Management LLC of San Diego. "You're still better off buying a long-term bond with a high yield, even at a big price." Auction rate securities were sold for about 20 years by brokers, advisers and other investment professionals as cash-equivalent investments, with the added kick of paying a small percentage above money market rates. Investors thought that they could sell the debt at the frequently held auctions whenever they needed cash, while issuers enjoyed the certainty of long-term funding at short-term rates. All went well until February when auctions almost unilaterally began failing. That is because capital-starved securities dealers such as The Goldman Sachs Group Inc., Lehman Brothers Holdings Inc. and Merrill Lynch & Co. Inc., all of New York, and UBS AG of Zurich, Switzerland, backed away from making bids to support the auctions. When the market froze, more than $330 billion in auction rate securities held by more than 100,000 investors was outstanding. The standstill, which continues to this day, panicked investors who had been counting on redeeming their investments. Although dealers have been forced into settlements with state and federal regulators to pay penalties and to buy back billions of dollars of securities frozen in client accounts — Charlotte, N.C.-based Bank of America Corp. last week agreed in principle with the Securities and Exchange Commission to repurchase $4.7 billion in auction rate securities held by its clients — more than $200 billion in outstanding securities are still subject to auctions because issues haven't been redeemed by their issuers. When an auction fails, issuers must pay penalty rates. Those rates soared into double digits for many low-rated direct issuers of the securities. For issuers of tax-free municipal debt and auction rate preferred issues, penalty reset rates are generally lower. They too, however, have soared in recent weeks as the index against which they are benchmarked climbed amid the short-term credit crisis. Although few advisers to individual or corporate investors are biting, they concede that the yields are tempting. "If you don't need your money right away, you will get a good tax-exempt yield," said Joseph Fichera, chief executive of Saber Partners LLC, a New York-based financial advisory firm to governments and corporations. Mr. Fichera, who has long railed against the lack of transparency in the auction rate market, cautions investors to do as much homework as possible about the credit quality of the issuer and the mechanics of the auctions. Mr. Gurtin is skeptical that the high rates on auction rate securities will endure. When confidence in buying short-term debt revives, he said, yields will go down. Meanwhile, a growing number of issuers will be calling away the auction rates. Those who remain tempted by the high reset rates on the securities have limited options. They can attempt to bid at auctions, though many brokerage firms now curb participation. Or they can trade in the secondary market, where the securities change hands below par. The trading market, however, is largely restricted to professional bidders, such as hedge funds, though "plenty of retail investors" are selling in the market, said Kevin O'Connor, a managing director at SecondMarket, a New York-based company that makes markets in illiquid assets. That is because many individual investors bought their securities from dealers that aren't included in the regulatory settlements and aren't offering to repurchase the securities. E-mail Jed Horowitz at jhorowitz@investmentnews.com.