No Underwriter Support For Failed Muni Auctions

Bloomberg is reporting UBS Won't Support Failing Auction-Rate Securities

UBS AG won't buy auction-rate securities that fail to attract enough bidders, joining a growing number of dealers stepping back from the $300 billion market, said a person with direct knowledge of the situation.

The second-biggest underwriter of the securities, whose rates are reset periodically at auctions, notified its 8,200 U.S. brokers of the decision yesterday, said the person, who declined to be identified because the announcement wasn't publicly disclosed. Goldman Sachs Group Inc., Lehman Brothers Holdings Inc. and Citigroup Inc. allowed auctions to fail as mounting losses from the collapse of subprime mortgages causes capital markets to seize up.

Bank of America Corp. estimated in a report that 80 percent of all auctions of bonds sold by cities, hospitals and student loan agencies were unsuccessful yesterday. That may mean as much as $20 billion of bonds failed to find buyers, based on the $15 billion to $25 billion of auction-rate bonds scheduled for bidding daily, according to Alex Roever, a JPMorgan Chase & Co. fixed income analyst.

"We are kind of in uncharted territory right now," said Anne Kritzmire, a managing director for closed-end funds at Nuveen Investments in Chicago.

Until recently, UBS and other banks that collect fees for running auctions have stepped in with their capital to prevent failures when bidding faltered. These firms have grown unwilling to commit their money to auction-rate securities after suffering at least $133 billion in credit losses and mortgage writedowns stemming from the subprime mortgage collapse.

Local governments are obliged to pay the high rates until either the auctions start attracting more buyers or they modify the bonds to some other kind of variable-rate debt or a fixed interest rate. Bankers and borrowers have been working on conversion plans for several weeks.

If higher costs to municipalities persist, this will mean budget overruns, followed by either tax hikes, reduced services, or cutbacks in employment.

Todd Harrison was writing Things That Scare Me: Failed Bond Auctions.

• UBS (UBS), the second-biggest underwriter of auction-rate securities, will no longer buy deals that fail to attract enough bidders, joining a growing number of dealers stepping back from that $300 billion market.
  
  
• The largest underwriter of those instruments is Citigroup (C).
  
  
• According to a report by Bank America (BAC), 80% of all auctions of bonds sold by cities, hospitals and student loan agencies were unsuccessful yesterday.
  
  
• That, Minyans notwithstanding, Mom and Pop retail won’t know about this until it’s too late. Just like the subprime.
  
  

Closed End Muni Funds

I have a contact that calls himself "D Man" with this perspective about closed end muni funds and Smith Barney. The following is describing muni-action on February 13th 2008.

My contacts in Smith Barney are reporting massive failures again today in the Muni Bond Auction rate market. This information is coming directly from the computer screens at Smith barney.

No deals were done in the Closed End Muni Funds. Among issuers with failed auctions are Van Kampen, Eaton Vance, Black Rock, Nuveen, Alliance Bernstein, MFS, Morgan Stanley, Western Asset Mgmt., and Drefyus. In the direct Municipal area, there were many failures as well. Issuers such as State of New York G.O., NY State Thruway, New Jersey Turnpike, City of San Mateo, CA and Alaska Housing Authority failed as well.

These auction failures do not mean the issuers are Bankrupt or are defaulting, it simply means the issues are illiquid. There are clauses usually in these issues that reset to some level of interest, usually much higher. This higher borrowing costs will eventually cause the issuer to do a new offering in the normal and traditional manner of Muni Bond offerings with longer fixed rates and maturities, the proceeds will be used to pay off the holders of the floating rate securities.

The reason for the failures is that the broker dealer refused to put up their own capital to complete the auction. This is an indication of extreme fear or perhaps worse, a lack of investment capital to fund “normal operations”, i.e. operations that were commonplace only a few months ago. Either way, this is another sign of an increasing stress in the credit markets and points to much larger looming problems ahead.

Is there any chance that toll-roads will default? I do not think so. Still there were no bids. Worse yet, all the major underwriters are so capital impaired they cannot support those deals. No one has any money. It's all committed. Rather it's all so miss-committed no one can step up to the plate for what would appear to be a good use of capital.

I smell more writeoffs coming from capital impaired brokerages and underwriters. There is little else this could mean.

Addendum:

The following from the Soft "D" Man...

Many of the ARS munis are held by leveraged closed end mutual funds. Since the auctions are failing, my guess is they will liquidate the leveraged portion of the portfolio, meaning a cascade on muni paper into the market. Plus, other issuers will be trying to re-finance their ARS, (NY, Tollways, etc.), we should be watching the yields going forward and they should spike sometime in the future. There might be an opportunity in here!

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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