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US secondary auction-rate market shrugs off lawsuit

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By: Lisa Lampert | July 24, 2008

WASHINGTON, July 25 (Reuters) - The secondary market for U.S. auction-rate securities did not miss a step this week despite the New York attorney general's demand that Swiss bank UBS AG (UBSN.VX: Quote, Profile, Research) buy back the securities from its clients at par as part of a lawsuit over alleged fraud.

"The (securities) holders aren't saying, 'We're going to get our money back in three weeks, so we'll hold on,'" said Barry Silbert, chief executive officer of Restricted Stock Partners. Restricted Stock is a trading platform that established an auction-rate resale market in March.

"This could go on for years," Silbert said.

One of the victims of the global liquidity crisis of the past year, the $330 billion municipal bond auction-rate market froze in late January this year when buyers stopped participating in the auctions.

That left investors, who thought the securities were as liquid as cash, stuck with debt whose maturities can be as long as 30 years.

Restricted Stock and its rivals offer a way for investors to sell the securities quickly but at discounts. Some critics say, though, investors should hold out for the full value of their holdings, however illiquid.

Unless they are facing an emergency, investors should take up the loans banks are now offering and collect any interest charges, legal fees, and the full value of their debt through arbitration, said New York City securities lawyer Lewis Lowenfels.

"I would advise anybody not to sell in the secondary market ... it's probably a pretty big discount," he said.

Under the New York lawsuit, and similar complaints filed in Massachusetts and Texas, UBS would have to buy back the securities it sold at full price. The states say that UBS knew the auction-rate market was frozen and left its clients holding $25 billion in illiquid investments.

Still, many investors may not want to wait for arbitration, which could take months, Silbert said. He warned they may not get all their money back even if they win a favorable ruling.

"UBS doesn't have $25 billion to go buy these back," he said. "Even if they agreed to it, I'm not sure from a practical perspective how they would handle it."

After the state of Massachusetts announced the first law suit over auction rate securities, the secondary market saw a slight pause in activity as investors considered their options, he said. But traders did not pause this week.

Espen Robak, president of New York's Pluris Valuation Advisors, which values illiquid securities, agreed with Silbert that the secondary market did not slow down this time.

"We haven't heard anything," he said, noting that his firm keeps in close contact with many of the market's participants.

But, he added the possibility of a buyback by UBS might inspire sellers to hold out for higher prices. "I don't think anyone thinks this is a done deal or there is a certainty you'll be repaid at par," he explained. He added: "If that probability has gone up a little, then the discount you're willing to accept probably has gone down."

The discounts could shrink enough to eliminate the need for a legally-imposed buyback, said Perrie Weiner, a Los Angeles-based lawyer at DLA Piper, who declined any specific comment on UBS. "If the secondary market is paying for the securities in full..the parties would be made whole," he said.

DISCOUNTS RUN FROM 2 TO 50 PERCENT

In the last four to six weeks, securities tied to student loans have seen the most activity on the Restricted platform, Silbert said, with discounts ranging between 15 and 30 percent.

The steep discounts result from the low yields on these securities. Also, many issuers are buying back their securities.

Closed end funds, also called auction-rate preferred shares, are trading at discounts of 5 to 15 percent. Municipal bond discounts are 2 to 8 percent, as many issuers are refinancing so there's an "expectation that they will be restructured," he said.

On the other hand, CDOs are barely trading and sellers are having to take up to 50 percent cuts in price.

The Pluris valuation company does not expect the lawsuits to dent the secondary market. Robak said there are about 50 to 60 weekly trades with many hedge funds stepping in to buy.

 

(additional reporting by Joan Gralla)