NEW YORK — The $330 billion auction-rate securities market will “cease to exist” after it collapsed in February when Wall Street firms stopped using their own capital to buy unwanted bonds, Citigroup Inc. said.
While the death of the market will trim brokers’ earnings by only 1 to 2 percent, investor anger over their inability to liquidate their holdings may be significant if the frozen market doesn’t thaw soon, Citigroup analyst Prashant Bhatia wrote in a report.
New York-based Citigroup was the top underwriter of municipal auction-rate securities in 2006, managing $8.4 billion in sales, according to Thomson Financial.
“Basically, clients could stop using the services of their brokerage and/or asset management firms as a result of a loss of trust,” Bhatia wrote.
Auction-rate bonds allowed issuers such as local governments, hospitals and closed-end mutual funds to issue debt maturing in as long as 40 years at short- term rates that reset every seven, 28 or 35 days through bidding. Investors began abandoning the auction- rate market this year on concerns that companies insuring the bonds wouldn’t meet their obligations in case of default.
Thousands of the auctions began failing when dealers, who had stepped in when there weren’t enough bidders, pulled back as investment banks and securities firms worldwide took $245 billion in credit losses and write-downs. As a result, investors weren’t able to turn the securities into cash, while some issuers were left paying penalty interest rates as high as 20 percent.
As with structured investment vehicles, “the liquidity providers were unwilling to provide liquidity,” the Citigroup report said.
Brokerage clients that hold $100 billion to $150 billion of auction-rate securities control more than $750 billion in assets, according to the report.
Banks are letting customers borrow against their illiquid auction-rate bonds. UBS AG last week said it would allow customers to borrow the full value of their auction debt starting in May.
