Thursday, February 14, 2008

Auction Rate Securities, Part II

I posted an article earlier about the auction rate market failures. Today I spoke with the bond traders at Fidelity about the possibility of purchasing some of these securities. One example was a bond issued by a hospital in Colorado Springs that was available at a rate of 10%. The ultimate maturity on these bonds is 2030 and while the bonds are insured by AMBAC, the underlying credit is A-. 10% for A- rated long term tax free bonds is a damn good deal. I also talked with a doctor client in Colorado who is familiar with the hospital. It is a relatively new 200 bed hospital owned by the city.

I didn't buy this issue today because there are more disruptions to come. A large part of the auction rate market are preferreds issued by closed end muni funds. These funds borrow in the auction rate market and purchase long term bonds with the proceeds. If they can't get funds at the auctions, they will be forced to liquidate part of their portfolio. We may be able to find bargains in the straight muni market soon.

There is nothing wrong with this paper. The problem is that the underwriters who routinely bought anything that didn't get purchased at auction are now constrained and cannot support the market. I know of at least two firms that have told their brokers that auction rates cannot be purchased. So we're going to have some forced selling by the leveraged muni closed end funds and brokers are being told not to bid at the auctions. There is a lack of liquidity in the market. Those who can provide some liquidity will be able to find major bargains. I'll be looking at closely at these for clients in the next few weeks.

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