Auction-Rate Market To Shrink By $51 Billion
The collapse of the auction-rate securities market - and the resulting higher interest rate penalties - has caused municipal borrowers from New York to California to take flight from the once-stable $331 billion market.
Since February, more than 70 percent of the auctions sold by cities, colleges, student lenders and closed-end funds have failed due to lack of interest from investors. As a result, the auction-rate market is shrinking by at least 15 percent, or $51 billion, with states, cities, hospitals and colleges from across the country converting or planning to replace at least $43.1 billion of that debt.
Meanwhile, Chicago-based Nuveen Investments Inc., along with seven other fund managers plan to redeem $7.8 billion in taxable preferred shares, which have rates set through periodic dealer-run auctions. Specifics of the redemption have yet to be revealed.
Auction-rate securities - which are long-term bonds sold by issuers such as municipalities, student loan companies, hospitals and closed-end funds - have interest rates that reset every seven, 14, 28 or 35 days. Much of the debt is guaranteed by bond insurance companies that also backed subprime mortgage-related securities. If an auction fails to draw enough bidders, the interest rate resets to a level previously determined in documents issued at the time of the bond sale. In recent months, the interest rate resets have been as high as 20 percent, leaving thousands of would-be sellers in limbo.
For many municipal borrowers and not-for-profit organizations, the higher interest rate penalties are forcing them to exit the auction-rate market entirely, and convert auction debt to fixed-rate bonds.
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