The Wall Street Journal-20080214-Train Pulls Out On New Corner Of Debt Market- Auction-Rate Securities Failing to Draw Bidders- A Toll on Port Authority

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Train Pulls Out On New Corner Of Debt Market; Auction-Rate Securities Failing to Draw Bidders; A Toll on Port Authority

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The New York area's port authority has come face to face with turmoil in the large but obscure corner of the credit markets called auction-rate securities. This week, market disruptions pushed up its weekly interest cost on $100 million worth of debt by nearly $300,000.

It is a dilemma gripping an array of debt issuers in the $360 billion auction-rate securities market. These securities are issued by municipalities, student-loan authorities, museums and many others, with interest rates that reset through bank-managed auctions every week to 35 days.

The auction-rate securities are essentially long-term debt, but investors treat them like a liquid, short-term holding because of the auctions. The problem is that investors have balked at the auctions lately, sending interest rates on these securities on a wild ride.

The Port Authority of New York and New Jersey's interest rate jumped Tuesday to 20% from about 4.2% when bidders didn't show up at an auction of its securities by Goldman Sachs Group Inc. For the next week at least -- until the rate is reset again in the next auction -- the Port Authority, which oversees New York-area transportation facilities such as bridges and tunnels, will have to pay close to $390,000 in interest payments to holders of the securities. That is up from $83,611 the week before, said a Port Authority spokesman.

Several factors are behind these auction failures. Many of the auction-rate securities are insured by troubled bond insurers, like Ambac Financial Group Inc. and MBIA Inc. The bond insurers face billions of dollars in potential claims because of exposure to subprime mortgage debt. Investors are worried that might jeopardize the other policies the companies have written. MBIA backs the Port Authority's debt.

More broadly, the credit crisis has many investors wary of instruments with complex structures. In their search for holdings that are simple and straightforward, they're diving into Treasury securities and shifting away from products such as auction-rate securities.

Beyond driving up the costs for borrowers such as the Port Authority, disruptions in the market are a potential problem for holders of these securities, many of whom bought the instruments thinking they could be sold easily. They are finding that they might be stuck with these instruments longer than planned.

In a sign of the headaches this can cause for holders of these instruments -- which include many corporate treasurers -- US Airways Group Inc.revealed in a recent Securities and Exchange Commission filing that the airline's cash fund of $3.13 billion had $411 million of "short-term investments in auction-rate securities which failed to settle at auctions." The filing said that, "in the event US Airways needs to access these funds, it may have to sell these securities at an amount below par value."

Of the Port Authority's $11.5 billion of debt outstanding, $700 million is in auction-rate mode, Port Authority Treasurer Ann Marie Mulligan said. "The Port Authority, together with its financial advisor, Depfa First Albany, have been reviewing and discussing the various options that we have available, including refunding the auction-rate securities into other forms of Port Authority obligations," Ms. Mulligan said in an email.

Every day, Wall Street conducts billions of dollars worth of auctions of these instruments. In the past few days, hundreds have failed to attract enough bidders to complete auctions run by firms including Goldman, Citigroup Inc., J.P. Morgan Chase & Co., Royal Bank of Canada's RBC Dain Rauscher unit and UBS AG's UBS Securities.

In less tumultuous times, the banks might be expected to step in and buy some of these securities themselves to help smooth the process. But their balance sheets are already stuffed with other holdings -- loans to corporate borrowers, lines of credit to customers, mortgage debt and more -- so they have decided not to intervene in this market.

As a result, well over $10 billion worth of auction-rate securities have been frozen. These included borrowings for Massachusetts prep school Deerfield Academy, Carnegie Hall and California's De Young Museum, among many others.

Issuers have said that they were originally drawn to the auction- rate market because it offered them low short-term interest rates on long-term debt. It also gives them an easy way to pay down debt if they become cash rich: simply participate in the auction and take it back.

Investors have liked them because they have offered slightly higher interest rates than other plain-vanilla liquid holdings, such as Treasury bills. Corporate treasurers often hold them as alternatives to cash.

Now, they are having second thoughts. Several government and pension funds, some of which sustained steep losses during last year's credit crisis, are rewriting their investment rules and are adopting more conservative strategies.

Yesterday, the Montana Board of Investments approved stricter guidelines for the state's $2.5 billion investment pool. That could include tighter limits on purchases of asset-backed commercial paper and structured investment vehicles. It follows outflows of more than $300 million last year, after local governments learned the fund held downgraded asset-backed securities and withdrew their cash.

The retirement board for Middlesex, Mass., for example, recently moved $32.5 million out of a short-term cash account that had indirect exposure to subprime investments, to one limited to government securities. The fund's chairman, Tom Gibson, said that would reduce yield, but "people are refocusing on risk."

Short-Dated Treasurys Rise

On Outlook for Credit Woes

Short-dated Treasury bond prices gained as concerns about the spreading credit-market problems overshadowed a strong gain in retail sales, while the 10- and 30-year sectors lost ground on speculation the government's $168 billion stimulus plan will boost growth in the long-term and increase inflation risks.

The long bond, the most sensitive to price pressure, was the biggest loser, falling $8.125 for every $1,000 invested to yield 4.512%. The two-year note, the most sensitive to Federal Reserve rate changes, was up 4/32 for a yield of 1.897%.

-- Min Zeng

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AUCTION RESULTS

Here are the results of the Treasury auction of 63-day cash-management

bills. All bids are awarded at a single price at the market-clearing yield.

Rates are determined by the difference between that price and the face value.

Applications ..................................... $66,306,053,000

Accepted bids .................................... $19,000,103,000

Accepted noncompetitively ........................ $13,053,000

Auction price (rate) ............................. 99.573000 (2.440%)

Coupon equivalent ................................ 2.491%

Bids at market-clearing yld accepted ............. 74.18%

Cusip number ..................................... 912795D81

The bills are dated Feb. 14 and mature April 17, 2008.