Several banks/brokers, lead by Citigroup, have either reached a settlement regarding auction-rate securities (ARS) or are offering to repurchase the securities from customers. As of this writing, Merrill Lynch, Morgan Stanley, and UBS are among those ready to buy back at least some ARS from customers. Several others are either in negotiations with the New York AG or remain part of the inquiry.
Citigroup's settlement states the bank will purchase approximately $7 billion in ARS which are currently not clearing from individuals, small institutions and charities. The announcement on Thursday immediately sent Citi's stock down 4%, and pushed the shares of other major municipal bond dealers sharply lower as well.
There is a key element of this that hasn't been well reported. A very large percentage, something like 80%, of the true "municipal" auction-rate securities have either been refinanced or are actually succeeding at auction. Most of what's left are related to student loan financings. In a typical student loan securitization, a trust is formed which holds the actual loans. The trust then sells securities to the public. This trust is bankruptcy remote from the originator of the student loans. So if Citigroup arranged your student loan, they probably put it into a trust labled Student Loan Corporation. The loan is then considered off Citi's balance sheet.
Very few student loan auction rate securities (SLARS) have been refinanced. This is because the trust which issued the SLARS has no incentive to refinance. Or more precisely, there is no real decision maker for the trust, at least in terms of their outstanding debt. In addition, SLARS typically have relatively low maximum coupon rates in the event of an auction failure. Without a tight limit on the rate, it would be possible for the SLARS to carry a higher rate than the underlying student loans.
So now Citi (and others) are going to need to find a way to create liquidity in these securities. Unfortunately with many SLARS, a simple refinancing, even if Citi were willing to somehow subsidize the transaction, may not be possible. Its also not realistic for Citi to just starting making a market in the ARS and assume liquidity will follow. In other words, Citi cannot just go back to their market-making role of years past. Investors will be once bitten, twice shy this time around.
So this is going to take some creativity. You can bet that Citi already has legions of investment bankers working on structuring something to create an out. Perhaps some sort of resecuritization where Citi puts a series of these SLARS into yet another trust and then sells bonds with a legal put to fund the trust.
Either way, its good news for investors stuck in ARS. It should free up some cash which will most likely flow into short-term municipal bonds. Ultimately it should be something with which Citi (and other dealers) can handle liquidity wise. Remember that student loan ABS are eligible collateral at the discount window and the TSLF, and most of the underlying loans are government-backed. But it will be a distraction.
Citigroup's settlement states the bank will purchase approximately $7 billion in ARS which are currently not clearing from individuals, small institutions and charities. The announcement on Thursday immediately sent Citi's stock down 4%, and pushed the shares of other major municipal bond dealers sharply lower as well.
There is a key element of this that hasn't been well reported. A very large percentage, something like 80%, of the true "municipal" auction-rate securities have either been refinanced or are actually succeeding at auction. Most of what's left are related to student loan financings. In a typical student loan securitization, a trust is formed which holds the actual loans. The trust then sells securities to the public. This trust is bankruptcy remote from the originator of the student loans. So if Citigroup arranged your student loan, they probably put it into a trust labled Student Loan Corporation. The loan is then considered off Citi's balance sheet.
Very few student loan auction rate securities (SLARS) have been refinanced. This is because the trust which issued the SLARS has no incentive to refinance. Or more precisely, there is no real decision maker for the trust, at least in terms of their outstanding debt. In addition, SLARS typically have relatively low maximum coupon rates in the event of an auction failure. Without a tight limit on the rate, it would be possible for the SLARS to carry a higher rate than the underlying student loans.
So now Citi (and others) are going to need to find a way to create liquidity in these securities. Unfortunately with many SLARS, a simple refinancing, even if Citi were willing to somehow subsidize the transaction, may not be possible. Its also not realistic for Citi to just starting making a market in the ARS and assume liquidity will follow. In other words, Citi cannot just go back to their market-making role of years past. Investors will be once bitten, twice shy this time around.
So this is going to take some creativity. You can bet that Citi already has legions of investment bankers working on structuring something to create an out. Perhaps some sort of resecuritization where Citi puts a series of these SLARS into yet another trust and then sells bonds with a legal put to fund the trust.
Either way, its good news for investors stuck in ARS. It should free up some cash which will most likely flow into short-term municipal bonds. Ultimately it should be something with which Citi (and other dealers) can handle liquidity wise. Remember that student loan ABS are eligible collateral at the discount window and the TSLF, and most of the underlying loans are government-backed. But it will be a distraction.
