WASHINGTON - Allstate Investments LLC is urging the Municipal Securities Rulemaking Board to require broker-dealers to disclose how they calculate the interest rates for auction-rate securities when the auctions fail, saying this is the critical ARS information currently needed by investors.
The Northbrook, Ill.-based company made the request in a two-page comment letter on proposed rule changes that would require broker dealers to disclose more information through the Electronic Municipal Market Access system on ARS and variable-rate demand obligations.
The letter was signed by senior managing director Patricia W. Wilson, who said Allstate serves as investment manager for investors that currently hold $2 billion of auction-rate debt.
While Wilson applauded the MSRB's proposals, she said the ARS information it wants broker dealers to disclose "will be helpful only if the auctions ever restart."
Most market participants believe that, absent major changes, the ARS market is dead. But investors still hold billions of dollars of the securities that no one else wants to buy.
The market collapsed in February 2008 when dealers withdrew support for auctions, shunning the securities because they were backed by insurance from downgraded bond insurers. The auctions failed when the banks stopped using their own capital to prop them up.
Some issuers have been able to convert their ARS to other modes, but many investors have been stuck with the securities. When auctions fail, the interest rates typically revert to "failed" or "maximum rate" modes, but these have been low in recent months because in many cases they are tied to interest rate indexes that are at or near zero.
Allstate told the MSRB: "Currently, and since February 2008, holders have not been able to determine if the interest rate that the auction agent or the broker-dealer is stating is, in fact, the correctly calculated rate."
While offering documents define the "failed auction rate," the definitions are complex and rely on other terms, which also must be defined, the company said.
Allstate gave the MSRB an example of typical language defining the failed auction rate:
" 'Maximum rate' means, with respect to the bonds and with respect to any interest period applicable to the bonds, the lesser of (a.) either (i.) the applicable Libor rate plus 1.50% (if both of the ratings assigned by Moody's and Fitch to the bonds are "Aa3" and "AA-," respectively, or better), or (ii.) the applicable Libor rate plus 2.50% (if any one of the ratings assigned by Moody's and Fitch to the bonds is less than "Aa3" or "AA-," respectively, (b.) the net loan rate, and (c.) the highest rate the issuer may legally pay, from time to time, as interest on such bonds."
This definition requires investors to check the indenture for the definitions of three other terms, Allstate said, noting the investor may not have access to the document. In addition, some of the definitions, such as "net loan rate," include statistical information that is not usually available to investors, it said.
"Thus, an investor typically cannot check the calculations of the auction agent and is at the mercy of the quantitative staff of an auction agent or broker dealer," Allstate told the board. "We have tried to confirm that we are receiving the correct interest rate on our ARS with failed auctions and have found generally that the percentage of correct calculations is low."
Allstate gave the MSRB an example of the language it could use in requiring broker-dealers to disclose "the step-by-step process of determining" the failed or maximum interest rate.