February 22, 2008
By Evelyn Juan and Daisy Maxey
Dow Jones Newswires
Brokerage firms are scurrying to set up loans for customers frozen in auction-rate securities, and neither brokers nor their clients appear to be very happy about it.
As brokerage firms scramble to come up with alternatives for cash-hungry clients, major Wall Street firms such as Merrill Lynch & Co. (MER), Morgan Stanley (MS) and UBS AG ( UBS) are offering loans to provide liquidity in an illiquid auction-rate securities market.
Auction-rate securities are long-term bonds that behave like short-term debt as their rates are periodically reset at auction. Some financial advisors have long touted them to clients as liquid, super-safe investments with interest rates slightly higher than those offered by conventional money-market funds.
But auctions have been failing due to the turmoil in the credit markets, with nervous investors and the auction agents – large Wall Street firms – that typically buy unpurchased securities shying away. That has left brokerage clients locked into the securities, and firms are scrambling to find ways to provide liquidity for at least some of them on a case-by-case basis.
Merrill, through its Merrill Lynch Bank USA, will accept investment-grade auction-rate securities issued by closed-end funds, municipalities, and corporations as collateral for loans of up to $10 million under its Loan Management Account.
The firm will also accept auction-rate securities issued by municipalities and corporations as collateral for loans of up to $10 million in a margin account, according to an internal memo detailing the firm’s lending program.
In both cases, the cash advance will be up to 50% of the collateral amount and standard pricing terms, acceptance criteria, and maintenance rates will apply.
Loans against auction-rate securities above $10 million will be subject to customized underwriting through the brokers’ structured lending or commercial finance team.
“We realize that the current lack of liquidity for many auction market securities can be a concern for you and some clients,” said the memo, issued jointly by Dan Sontag, head of Americas Wealth Management at Merrill, and Mitch Cox, head of global investment and insurance solutions for Merrill’s Global Wealth Management unit.
“GWM’s senior management team will remain actively engaged in finding solutions for clients throughout this period of illiquidity, and we will communicate with you as further developments occur,” the memo said.
UBS and Morgan Stanley are taking a similar tack. Both are dealing on a case-by-case basis with clients who need cash immediately.
“Such solutions will include lines of credit and margin loans,” said Kris Kagel, a UBS spokesman.
Jim Wiggins, a spokesman for Morgan Stanley, said the firm is extending loans sparingly while searching for any potential buyers. “As we work with clients on a case-by-case basis, we would look at the client’s entire portfolio for liquidity options, not just the auction-rate securities,” he said. Asked if the firm is mulling other options to help those who wish to sell, Wiggins said, “The whole industry is looking at ways to restore liquidity to this market.”
Sallie Krawcheck, head of global wealth management at Citigroup Inc. (C), told brokers during a conference call Friday that the firm will extend loans at an “inexpensive level.”
Broker: Foolish To Sell At Discount
Some brokers among major Wall Street firms said that thus far their clients haven’t asked for loans.
“I have not had the issue of liquidity with my clients. All are rollers who are just looking for a better tax-free yield,” said a veteran Merrill advisor who’s been paring back clients’ positions on auction-rate securities. The Merrill advisor expressed ambivalence about offering loans to provide liquidity because, “It’s not what they signed up for.”
But some investors with big sums at stake are at this point anxious to sell their securities, and they aren’t having any success. One parked his money in auction-rate securities believing he would have easy access if he wanted to make any real estate investments. Now, he said, he feels trapped and concerned that, should a deal come along, he’ll miss out.
Aside from a loan, which offers a quick liquidity fix, Wall Street firms are awaiting the development of a secondary over-the-counter market that could provide liquidity. However, that could take time and may mean that the securities end up trading at discounts, which some brokers consider unfair to clients.
“I’m just waiting it out until my clients get out at a full price,” said a Smith Barney broker, who has been having some success at auctions with individual issuers. “People shouldn’t be getting out at a discount; that’s foolish.”
Lawyers say using clients’ auction-rate preferred shares as collateral could cost a customer because margin rate loans carry higher interest rates than those generated by auction-rate securities.
Jacob Zamansky, a securities lawyer with Zamansky & Associates, said money-market types of investments typically generate an interest rate of 2% to 3%, while margin loans could fetch around 8% to 9% in annual interest.
“Rather than issuing loans which carry high interest rates, the firms should step up to the plate and make good of these auctions,” Zamansky said.
Lawrence Klayman, a securities lawyer at KlaymanToskes in New York, said using auction-rate securities as loan collateral could be problematic because firms are taking leverage out of an illiquid security.
“Unfortunately, this may be the only way that investors can quickly get their money,” Klayman said. “If this is a genuine offer for help, firms should provide no-interest loans.”
Some investors are holding out hope that the Federal Reserve will step in.
A spokesman for the Federal Reserve Bank of New York said that what is occurring in the auction-rate securities market, is “certainly on our radar.”