Auction-rate securities a struggle for Nuveen

Firm works to liquefy $15 billion worth of shares issued to boost fund yields

Apr 21, 2008 @ 12:01 am

By Brooke Southall

Nuveen Investments LLC is working to liquefy $15 billion of preferred auction-rate securities issued by 100 of its closed-end funds.

The market for the preferred securities, which were sold to individual investors as a higher-yielding alternative to money market funds, has been frozen for weeks as broker-dealers have ceased to conduct the auctions that determine the securities' rate of interest.

The Chicago-based closed-end-fund manager said that it is also working hard to explain to investors why they may have to wait months to receive cash for their securities as a solution is hammered out.

Nuveen said that it has held three conference calls with anxious financial advisers since February and is handling about 1,000 phone calls a day to keep them apprised of the liquidity crisis, according to Anne Kritzmire, a managing director of the firm and head of its closed-end-fund business.

"People are losing sleep here too," she said.

The preferred-auction-rate problem has become a massive headache for Nuveen and BlackRock Inc. of New York, the two giants in closed-end municipal bond funds, said Cecilia Gordon, executive vice president of Thomas J. Herzfeld Advisors Inc. of Miami, which follows closed-end funds.

"This [mode of leverage] worked so well for so long that it became the favored way for municipal bond funds to leverage themselves," she said.

CREDITWORTHINESS FEARS

Preferred auction-rate securities were issued by the closed-end municipal bond funds to help enhance performance. Proceeds from the sale of the preferred securities, which were paying relatively low interest rates when issued, were reinvested by the funds into higher-yielding municipal bonds to boost performance to fund shareowners.

The preferred shares were in-tended to be liquid investments, but large investment-banking firms, which had conducted the auctions to determine the securities' interest rate, have stopped conducting the auctions because of fears over the creditworthiness of their counterparties.

The market for the preferred shares has come to a standstill, leaving their holders in limbo.

Last Tuesday, BlackRock announced plans to cash out holders of its municipal funds' preferred shares by raising $1 billion through the sale of tender option bonds and $900 million through credit lines and reverse purchase agreements.

Nuveen has no specific plan to refinance the $11 billion held in the preferred shares of its muni bond funds, but it is telling advisers that it is trying to create a preferred money market fund for the purpose.

"It's a concept in the design phase, but we feel good enough about it to" let advisers know about it, Ms. Kritzmire said. "But [the liquidity problem] ain't over till it's over."

On April 1, Nuveen announced a refinancing effort that would raise $714 million to provide about 70% of the liquidity needed to holders of four closed-end equity funds: Nuveen Multi-Strategy Income and Growth Fund (JPC), Nuveen Real Estate Income Fund (JRS), Nuveen Tax-Advantaged Total Return Strategy Fund (JTA) and Nuveen Tax-Advantaged Dividend Growth Fund (JFP).

"This is a massive problem," said Greg Phelps, principal with Red Rock Private Wealth Consulting LLC in Las Vegas, whose clients are big holders of the frozen Nuveen assets and who listened to the most recent conference call April 3. "There were some really grumpy advisers [on the teleconference]. They were saying they need the liquidity for clients at tax time. 'How do I pay my taxes?' 'I sell stocks at a loss.'"

Red Rock manages $45 million.

While Nuveen and investors in its funds and their securities are in a terrible bind, the company did nothing wrong, said Steve Winks, principal with SrConsultant.com of Richmond, Va.

"They're impeccable," he said. "You can't find anything more reliable than Nuveen. It's not Nuveen's fault [that the auctions are failing]; it's the fault of the [securities'] underwriters."

Because of the actions of these underwriters, Nuveen will no longer rely on them to create leverage in its closed-end funds, said Maria Schwieder, spokeswoman for Nuveen.

"I don't think there's any turning back to the old auction-style fund," she said.

BORROWING FROM BANKS

Instead, Nuveen will achieve leverage in its closed-end funds by borrowing from banks, she said.

While refinancing the preferred shares of the 13 funds that hold taxable bonds may unfreeze them, the process won't work for the preferred shares of Nuveen's 87 municipal bond funds, which account for $11.1 billion of the $15.4 billion of securities that are affected by auction failures since March 12.

Since bank borrowing will be more expensive than issuing preferred shares, there will be little benefit from the leverage and yields on the closed-end fund itself will decline, Ms. Kritzmire said.

Meanwhile, because of the freeze, "my allocation is now out of whack," Mr. Phelps said. "It's a real mess."

E-mail Brooke Southall at bsouthall@investmentnews.com.

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