The Wall Street Journal-20080215-Auction-Rate Bonds May Come to Rescue- Sophisticated Buyers Begin to Show Interest- Aid for Clogged Billions-

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Auction-Rate Bonds May Come to Rescue; Sophisticated Buyers Begin to Show Interest; Aid for Clogged Billions?

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A corner of the U.S. credit markets, shunned by investors this week, is showing some signs of life.

Some sophisticated buyers who hadn't previously participated in this $360 billion auction-rate securities market are nibbling at the fringes. These investors are attracted by the high penalty rate issuers of this debt are forced to pay when dealer-banks can't place all of the bonds holders want to sell.

This could aid efforts to resell the billions of dollars of bonds at periodic auctions clogging this important, if arcane, source of financing for municipalities and resource for cash managers.

Opportunistic buyers yesterday, mostly hedge funds, also showed up at auction time to snap up securities that offered higher rates of return, helping to clear a higher proportion of sales than has been seen in the past few days, people familiar with the situation said. International banks, bond funds and some high-net-worth clients were also said to be interested. Securities capped at lower rates still struggle.

A fledgling market is also developing to trade the failed securities between scheduled auctions. "We're seeing early signs of liquidity coming back to the market," said Lee Epstein, chief executive of San Francisco institutional broker-dealer Money Market One.

Auction-rate securities are initially sold as long-term bonds but are effectively turned into short-term securities through auctions typically held every seven, 28 or 35 days. Issuers reap the low financing costs associated with short-term debt, while investors gain liquidity through the frequent sales.

While the bulk of the market is municipal debt, student lenders and closed-end mutual funds also raise money in this market. Estimates on the breakdown vary, but the municipal sector is thought to be $200 billion to $250 billion, with student lending accounting for less than $100 billion.

Failures to resell these securities began cropping up last month, but this week the number jumped, leaving investors -- mainly corporate treasurers but also wealthy individuals -- with paper they expected to exchange for cash. Auction-rate securities are preferred by those looking for a place to park funds for short periods of time.

The new crop of buyers don't face the same time constraints and can't resist a bargain. Among those prospective buyers are money managers drawn by the higher yields who don't mind holding a security for a while, say six months to two years, Mr. Epstein said.

With the penalty rates on some bonds reaching 20%, they are eagerly testing the waters. Some are trying to buy securities between auctions to reap the benefits of these rates, he said.

When all bonds being offered for sale fail to attract bids, the issuer's rate goes up, often markedly, until the next successful auction, when a new clearing rate goes into effect. Even investment banks, whose auction desks are eager to rid themselves of failed securities, are interested in picking them up as bargains, he said.

Many of the auctions have failed because a large percentage of the bonds are insured, and investors have turned gun-shy about possible downgrades of the insurers -- some of which have already taken place -- beneath the triple-A credit ratings they now provide. But municipal bonds have extraordinarily low default rates -- less than 0.1% for high-grade issues -- and many are valuing the debt on its own rating without insurance.

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Kate Haywood contributed to this article.

Long Treasurys Decline;

Yield Jumps to 4.653%

Longer-term Treasury prices were sharply lower amid mortgage-related selling and speculation of more to come.

The 30-year Treasury note fell 2 8/32 points, or $22.50 for every $1,000 invested, to 95 17/32, with its yield jumping to 4.653%. The benchmark 10-year note fell 1 1/32, or $10.3125 for every $1,000 invested, to 97 12/32 to yield 3.818%, up from 3.692% Wednesday.

Mortgage-bond investors -- particularly mortgage servicers -- were forced to sell Treasury notes as the 10-year yield rose above 3.70% to keep their portfolios balanced, said Carl Lantz, strategist at Credit Suisse. That set off a vicious circle with other investors, anticipating more of this mortgage selling, also fleeing the long end, Mr. Lantz said.

-- Deborah Lynn Blumberg

Treasury Sale to Be Tuesday

The Treasury plans to raise $8.995 billion in new cash with the sale Tuesday of about $46.000 billion in short-term bills to redeem $37.005 billion in maturing bills.

The weekly offeringdelayed a day by Presidents Day Mondaywill be divided between $24.00 billion 13-week and $22.00 billion 26-week bills maturing May 22 and Aug. 21, respectively.

The Cusip number for the three-month bills is 912795E56 and for the six-month bills is 912795G21. Noncompetitive tenders for the bills, available in minimum $1,000 denominations, must be received by noon EST Tuesday and competitive tenders by 1 p.m.

AUCTION RESULTS

Here are the results of the Treasury auction of 60-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 ..................................... $94,280,336,000

Accepted bids .................................... $30,000,086,000

Bids at market-clearing yield accepted ........... 23.58%

Accepted noncompetitively ........................ $0

Auction price (rate) ............................. 99.581667 (2.510%)

Coupon equivalent ................................ 2.563%

Cusip number ..................................... 912795UD1

The bills are dated Feb. 15 and mature April 15.