Retail Cash Management Products FAQ

Vanguard charges you $50 to participate in the ARSs.

Thanks,

I guess that takes me back to Fidelity or Smith Barney (or CD's). I have to admit, it would really suck to transfer my account to one of these guys, and then in a few months, for the MARS/VRDN premium to dry up. Perhaps as the premium will just shrink a little.

AMBAC appears to be on the verge of a ratings downgrade.

http://www.bloomberg.com/apps/news?pid=20601087&sid=aCTjpOZdfcYo&refer=home

If this happens, things could get dicier in muniland.

dolmar said: TexanInNYC said: AMBAC appears to be on the verge of a ratings downgrade.

http://www.bloomberg.com/apps/news?pid=20601087&sid=aCTjpOZdfcYo&refer=home

If this happens, things could get dicier in muniland.

Funny you mentioned that. I sold $225k I had of an ARS that was AMBAC insured today just because it was AMBAC insured and I bought another issue paying 1 bps less with a letter of credit from BOA. Thinking if there was a default the AMBAC insurance is 100% worthless and I think BOA would be more likely to make good if there was a default over AMBAC.

Also going to sell another ARS I have on tuesday that has MBIA insurance for the same reason.

I dont actually think the bond insurance would necessarily be "worthless". What would happen is that if a monoline lost its AAA rating, it would in all likelihood be unable to write future policies, since the entire business model depends on the AAA rating. The equity of the holding company would go down (possibly to zero/bankruptcy), but the insurance policies themselves are issued at a ring-fenced insurance subsidiary (with segregated capital that the holding company creditors have no claim on), and which is subject to Department of Insurance regulation. The insurance subsidiary would probably be put into a receivership by the DOI, and the existing policies would be run off. Remember, the insurance policies don't provide for acceleration in the event of default--only payment of principal and interest as they come due. Thus, if an underlying insured credit were to default, the insurance company would step in and pay the interest as it came due, with the right to recovery against any ultimate workout. It would take many years to runoff the entire insurance portfolio. Now what's problematic for muni holders is that if the CDOs and whatnot are defaulting and the insurance sub capital is getting bled off to pay P&I on the CDOs, there might be no capital left at the end of the day to pay muni obligations if/when the municipalities default. On the other hand, the CDOs might workout, and not actually call for a full payment of future P&I. And yet on the other hand again, the Insurance commissioner might determine that a payment of capital only to the CDO issues (which defaulted first) would be inequitable to all other insured policyholders, and might not let the insurance subsidiary capital be bled off like this. So in that case, the Insurance Commissioner in a receivership might establish a "good bank/bad bank" structure, where the insurance sub's capital is divided into pools according to asset class and net par insured outstanding, and the insured bonds could only claim against the capital left in their pool.

Net net: it is a whole new world if a major monoline gets downgraded, and it isn't clear what the long-term impact would be. That said, there would be a ton of short term trading price volatility in muniland for sure.

So what does this mean in terms of existing muni bonds insured by Ambac? Are they now topped off at a retail/resale rating of AA (unless the underlying credit was better or the same)?

It sure sounds like MBIA is going to be next.

I sure hope those municipalities dont start defaulting (at least those that had insurance).

Do you guys think there could be some bargins in muni inventory due to this? People dumping their MBIA & Ambac insured munis to go for other insurers?

I was just curious what other people are thinking.

I personally do not think because AMBAC got downgrade there was going to be a mass default of Muni issued bonds I figure I was buying AAA rated insured ARS. The problem is most of the Muni that have insurance are only AAA rated because of the insurance wrap and no one knows what that the real underlying issue would be rated without the insurance.

TexanInNYC might be more verse in how insurance works than I am personally and could be 100% correct on how the insurance pay out would work if there was a mass default except I prefer to be buying at this point uninsured bonds that have a high rating. At least you know what the true credit quality of the bond. The FHA ARS I bought today was only AA rated but it was AA rated based on the quality of the underlying assets and not because of a insurance warp. It is also very possible that other ARS had underlying assets that would have been rated AA but unfortunately we will never know. I am sure some Muni get insurance warps just because it makes some investors fell good knowing that they are holding AAA rated debt. While other Muni without the insurance warp would be junk rated.

Personally I have no problem buying uninsured A rated debt. I just personally do not fell conformable buying debt who was rated solely based on the insurance warp which could be ultimately end up being unable to cover the losses. I have a felling at this point the reason for the downgrade is just that. If Ambac suffered major claims it does not have funds nor the assets or ability to raise funds to cover the insurance obligation it already has otherwise there would be no reason for the downgrade.

Btw I guess enough other people must have thought the same thing I did as NYS FHA ARS I bought reset down to 5.25% from 6.04% and WA FHA bond I sold reset at 6.65% up from 6.05% last week.

dolmar said: The problem is most of the Muni that have insurance are only AAA rated because of the insurance wrap and no one knows what that the real underlying issue would be rated without the insurance.

Actually, at least in the case of GO bonds, the municipality has an underlying "shadow rating" typically, meaning the credit rating of the issuer without regard to the insurance wrap. NYC, for example, has a AA rating (typically up to certain debt covenants, etc.) With project/revenue bonds, the rating would exist only if the city went to the agencies and sought a rating (which typically they would have to, in order to place the debt).

Asking what might be a semi related obvious question. Any muni Ambac insured AAA bonds are now AA bonds (and the valuations should also have been lowered from AAA to AA)?

ETF
Money Market ETF Not as Safe as it Appears
By Lawrence Carrel
TheStreet.com Senior Writer
11/26/2007 5:36 PM EST
URL: http://www.thestreet.com/funds/etf/10391081.html

Updated from Nov. 21.

PowerShares has come out with an exchange-traded fund designed to act like a tax-free money market fund, but it's not quite the low-risk investment it appears to be.

The VRDO Tax-Free Weekly Portfolio (PVI) tracks the performance of a pool of variable-rate demand obligations, or VRDOs, which are long-term, fixed-rate municipal bonds that act like short-term floating-rate notes.

They are popular with money market funds because they yield slightly more than some other short-term instruments, like Treasury bills and certificates of deposit, and have widely been perceived as safe.

VRDOs act like money market instruments because investors can demand repayment at par with seven days' notice. Also, the interest rate on the notes is reset each week at prevailing money market rates. This interest, which is paid out on a monthly basis as dividends, is exempt from federal tax. Depending on where you live, it may also be exempt from state tax.

In the past, they have been considered relatively safe because many of the municipal bonds are insured, and the issuers' ability to repurchase them is typically also guaranteed by a letter of credit from a bank.

PowerShares says PVI pays about 3.5% pretax, which would equate to a 5% after-tax yield. The ETF tracks the Thomson Municipal Market Data VRDO Index and charges an annual expense ratio of 0.25%.

PowerShares expects PVI will have a lot of appeal with institutional investors as place to park money for short periods of time and earn tax-free interest. "It's weekly paper with guaranteed principal," says John Southard, a managing director. "It's not risky at all."

(The Securities and Exchange Commission has since asked for clarification as no investment is risk-free. "Obviously, I didn't mean it has no risk," says Southard. "I meant compared to other investments, it's lower risk.")

Typically, that's true. But these are not typical times for municipal bonds or the broader credit markets. "VR" could stand for "very risky" with all the trouble brewing.

The subprime mortgage crisis and credit crunch have spilled into the $2.5 trillion muni bond market. Munis swooned in August when some troubled hedge funds dumped them to raise cash. They recovered some of the lost ground in September and October as the credit markets stabilized, but over the past few weeks, there have been fresh signs of trouble.

This time the fear is that companies like Ambac Financial Group (ABK) and MBIA (MBI) that insure muni bonds will run into trouble. These same companies also insure securities backed by subprime mortgages, and as more of these loans go bad, the insurers are being called on to cover missed interest and principal payments.

"The floating-rate market in munis is in turmoil," says Matt Fabian, senior analyst at Municipal Market Advisors, an independent research and strategy firm. "There is a lot of concern about the bond insurers in VRDOs.

Fitch Ratings has already raised questions about the cash reserves of several bond insurers. If the insurers are downgraded and lose their triple-A ratings, the muni bonds they insure would lose some value. "In the near-term, trading and liquidity would likely be disrupted," says Fabian. He says that might induce holders of VRDOs to demand repayment, depleting the cash reserves of the banks that provide liquidity.

"It appears to be very poor timing for the ETF because of all the concerns about the big bond insurers," says Peter Crane, president and publisher of Crane Data and Money Fund Intelligence.

He notes that the subprime mortgage crisis has made investors extremely averse to complex instruments such as the securities backed by mortgages. "And anything with 'variable' in the name means structure, complex or both," he says, referring to VRDOs.

VRDO investors are by nature cautious, so any market disruption would likely be compounded by the number heading for the exits. "Currently tax-free and municipal money market mutual funds hold 75% of their assets in rated demand notes," says Connie Bugbee, managing editor of Imoney.net. "I would hate to say they are no longer safe."

Safe or not, now might not be the best time to buy the VRDO ETF.

bejota3 said: Good article on why some resets are spiking in yield:

U.S. tax-free funds liquidate bond insurer exposure
LINK

These funds need to dump VRDOs and ARSs because the securities in their portfolio has to be (1) highly rated and (2) have a backstop line of credit so they can put the security back to the issuer.

Liquidity seems fine right now -- as long as the banks don't run out of money. But the funds have to sell because it seems likely the securities will be downgraded.

Methinks there is opportunity here in the short term to pick up extra yield. Look for resets insured by Ambac, MBIA, FGIC, SCA and XL. Then check the CUSIP at Moodys to see what the underlying issuer rating is.

Money Market funds are not allow to hold ARS at all because they are subject to an auction to get in or out and have no liquidity support or demand component. VRDN are tied to a spread over or under LIBOR depending if they are tax-free or taxable issues. So it makes no difference if institutional funds buy or dump them as LIBOR does not move based on demand by institutional investors.

That article talks about VRDN only. So I assume if enough of them dump VRDN maybe banks will raise LIBOR rates but still does not make a lot of sense.

TexanInNYC said: I think the best deal right now for ARSs is with private activity bonds subject to the AMT; if you happen to make enough money to be AMT-exempt, you can pick up after tax yields of 4.5% or more, which can work out to as much as 8% pretax (depending on your state and local taxation).

You know that is a very nice find. My broker never thought of looking at ATM bonds. Currently AMT ARS and VRDN are paying the same rate as fully taxable paper. So for me that means I can end up buying any state paper and shelter it from federal taxes and if I find high yielding one which is from CA even better I pay no state income tax either.

I am never subject ATM as all my deduction are done on my K-1 so for me this is a great find. My broker said he has no idea how long this will last as normally taxable paper pays a much higher yield over non taxable AMT paper.

TexanInNYC said: I was also surprised to see the yields that AMT paper is paying. I didnt realize there's such a thing as private activity municipal VRDN--maybe I should look into this. This would basically be a zero risk instrument due to the embedded put. Can you point me in the right direction.

I deal with Citigroup PB. I am looking at there web page do not get so excited there are a total of 5 VRDN subject to AMT. Most of the VRDN are tax-free and not subject to ATM.

VRDN subject to AMT pay less than ARS subject to AMT.

VRDN subject to AMT are paying 3.70%(but fully taxable paper is paying the same thing) and ARS subject to AMT are paying between 4-5% which is the same as fully taxable ARS.

Hypersion said: If the Municipal Resets lists Insurer -- Than is there is NO 3rd party insurance? correct?You are essentially correct, however, it could be helpful to review the Muni Fillings just be be sure. Unfortunately, the Muni Fillings are sometimes difficult to find by searching 'free' sources on the Internet.

Good luck.

FIdelity does not offer VRDN only ARS.

SnoopDoug said: I have noticed a few goofy things with Fidelity lately...a couple of ARS that I very recently purchased have now been removed from their inventory, and one of them is a 7 day reset that is now showing as a 35 day reset.

Check the CUSIP. I know for example on Fl Citizen ARS there are a total of 12 different series and some of them are 7 day and other are 28 days. It is very possible Fidelity stopped offering a 1 series of a bond and is now offering another series that just happens to be 28 day issue.

This article reports about municipal reset auction failures over the past two weeks. I can't yet source this news elsewhere, but if true, it would be a significant event for those considering an investment in muni auction rate securities.

EDIT:

The story appears to be true.

Reuters

Reuters Update

Georgetown University Newspaper

Bloomberg (describing a litigation involving auction failure)

I think another lesson is concentration/liquidity risk, when selecting ARSs. If you're putting a few hundred thousand to work in a large reset issuance--no big deal. But if you're putting a large amount to work in a small issuance, it seems to me more likely that you could run into liquidity problems.

XL is a second or third tier monoline. The Fitch downgrade obviously hurts XL significantly, as the company is sort of put in between a rock and a hard place (i.e., runoff the existing insured portfolio vs. sell/dilute the equity to somebody willing to recapitalize it to AAA levels).

The reset to 7% could be either an auction failure rate, or it could be the market clearing price. Call your broker to figure out which one it is. Even if it is an auction failure rate, that's not necessarily a bad thing--provided that the issuer takes you out by taking out the floating rate instrument with a fixed refi.

A lot comes down to your view of the creditworthiness of the underlying issuer. If you're talking about GOs or utility bonds, I have little concern, particularly if the underlying muni is a creditworthy entity like NYC etc, or a large utility. OTOH, if the underlying issuer is below A-rated, you're basically taking credit risk without the duration risk, so you need to decide how you feel about that. It's surely no longer risk-less, but I wouldn't say it's high risk either.

Personally, I'm in the process of trying to evaluate the AMT issues, regardless of monoline insurance, and find issuers I'm okay with holding long term. I care little about short term liquidity problems, just persistent auction failure w/out a refi, and of course, default risk.

I would not be to worried about it personally while ARS are no longer risk-free they are still pretty safe and very low risk.

Also notice from the article that both failures happened with ARS underwritten by Lehman and administered by them as well.

I can not speak for other underwriters but for example Citigroup providers Liquidity for the ARS they offer and they disclose that on there web page Here

Bidding with Knowledge
Citigroup may routinely place one or more bids in an auction for its own account to acquire ARS for its inventory, to prevent a failed auction (i.e., an event where there are insufficient clearing bids which would result in the auction rate being set at the Maximum Rate) or an auction from clearing at a rate that Citigroup believes does not reflect the market for the particular ARS being auctioned. Citigroup may place such bids even after obtaining knowledge of some or all of the other orders submitted through it. When bidding for its own account, Citigroup may also bid outside or inside the range of rates that it posts in its Price Talk

I am sure other issuers act this way too. So it is very possible that over the last couple of weeks Citi has prevented failed auction by bidding like they disclose they do. While there bidding at times will make some auction clear at a lower price it will also stop other auctions from failing. This could also explain why the rates from Citi and Fidelity can vary greatly because Citi is rigging the outcome of there ARS so they clear at a fair price to both the issuer and buyer while providing liquidity for all parties involved while other dealers might let the market set the true clearing price which could be higher or lower than true market condition dictate.

dolmar said: I can list some of the underlying ratings for issues that Citigroup and Fidelity have if people are truly interest and it is not against TOS of FW.

If it's not too much trouble, I'd be very interested in seeing that Dolmar.