Barron's: Miles to go before Auction Rate Securities holders can sleep

Posted Aug 9th 2008 8:47AM by Peter Cohan
Filed under: Good news, Bad News, Consumer Experience, Magazines, Scandals, Personal Finance

Barron's (subscription required) reports that the news this week about Auction Rate Securities (ARS) leaves $220 billion worth of the $330 billion market still frozen. Those among the two-thirds of ARS holders who have not gotten any good news must have mixed feelings -- happy that some of their colleagues have the potential for relief, but wondering when they will get their money back.

The ARS market is complicated because the securities were issued in many different forms. Barron's reports that these issuers include "municipalities, closed-end funds, student-loan trusts and collateralized debt obligations [CDOs]." Many of these issuers have announced little, if any relief for those frozen in ARS hell. For example:

Municipal ARS market has fallen 40% from $175 billion to $105 billion since the beginning of 2008 and only "5% to 8% of muni auctions are proceeding -- at interest rates of 8% to 15%."
Closed-end funds have reduced the amount of ARS outstanding by 37% from $64 billion to $40 billion. For example, Nuveen's closed-end funds sold $500 million of variable-rate demand-preferred shares (VRDPs) last week to replace the same amount of ARS. (VRDPs' interest rates reset in auctions but have a put option that allows an investor to sell the VRDP to the bank running the auction if it fails). Barron's thinks that if the VRDP market functions, "more than 50% of closed-end-fund ARS could be redeemed" by the end of 2008.

The news is worse for the other remaining categories:

Student-loan trusts are having little luck refinancing. Only $2 billion of the $85 billion of student-loan ARS have been refinanced this year. Barron's reports that student loan originators are shrinking their unprofitable operations and thus cannot "sell new securities at a low enough rate to make refinancing an option."
CDO ARS have had $20 billion of securities outstanding since the start of 2008 -- none are believed to have been refinanced so far, according to Barron's. Due to "the deteriorating credit quality of the CDOs themselves" refinancing CDO ARS is tough.

This week has provided some good news for ARS-holders. But it looks like those who hold student-loan- and CDO- backed ARS might need to write them off. And for many of the rest, the struggle goes on.

Peter Cohan is President of Peter S. Cohan & Associates. He also teaches management at Babson College and edits The Cohan Letter.

Tags: auction rate, auction rate securites, auction rate securities, closed end funds, collateralized, collateralized debt obligations, inthenews, student loans, student loans goverment