Interested in a triple-A, insured, tax-exempt bond yielding 12.6%?
Apparently no one else is.
Yesterday, for the 16th consecutive month, a dutch auction to reset rates on the issue by the Tucson Electric Co. failed to lure enough investors.
That means the utility will have to pay the highest possible yield allowed under the indenture for its 1988 $121 million issue -- 265% of a special J.J. Kenny short-term variable-rate index, or 12.6%. The Bond Buyer's revenue bond index -- which does not even include triple-A credits -- is currently yielding 550 basis points less.
But a 19% yield on a taxable equivalent basis and a triple-A rating based on insurance from Financial Security Assurance have apparently not been strong enough selling points to attract investors, according to Goldman Sachs & Co., the marketing agent for the deal.
Why? Sources involved in the deal say the problem is mainly investors' liquidity concerns. But lax marketing efforts and a kind of self-fulfilling prophecy are said to be contributing to the mess.
The Tucson deal was the debut for Goldman Sachs's dutch auction product, known as Periodic Auction Reset Securities, in 1988. The security was marketed as a method of providing issuers with short-term interest rates without the risk of a put normally associated with short-term term debt.
Over the past four years, Goldman Sachs and other firms have used the dutch auction clearing mechanism on 40 bond issues, totaling about $2.6 billion, according to Securities Data Co./Bond Buyer.
In a dutch auction, potential investors submit bids indicating the yield they would be willing to accept to purchase the bonds. Yields are then set at the lowest point needed to sell the entire issue, and each bidder at or below that level receives that yield.
But in a failed acution, there are not enough bidders to cover the entire issue, so none of the bids are accepted, nobody sells their bonds, and the new monthly rate is set according to the penalty provisions for a failed auction in the indenture.
Bondholders are not required to sell if they do not want to, and apparently the high yields are keeping some Tucson investors content with holding the bonds. But the auctions continue to fail, indicating that at least a few are trying to sell the bonds without success.
The trouble started last spring, when Tucson's already fire financial problems worsened and its auctions began to show signs of strain. Potential bidders -- mostly investors interested in short maturities -- shied away, worried they would be unable to unload their bonds at will if the auctions failed. That would leave them stuck with 20-year bonds, instead of a security that had an effective maturity of 30 days.
"People can't afford the luxury of extra yield if it's a 20-year commitment," said Peter Hoey, a managing director at FSA.
As more potential investors decided the risk of auction failure was too high, their fears became reality: The auctions failed.
For Tucson, that initially meant paying a penalty yield set at 140% of the Kenny index. But then the utility, in the midst of an internal restructuring aimed at averting bankruptcy, stopped making any payments at all, which triggered even higher penalties for the continually failing auctions. For the past seven months, the percentage rise above the Kenny index has increased in 20% increments until it capped yesterday at the 265% maximum, where it will stay each month until an auction succeeds.
The theory is that increasing yields will eventually rise high enough to attract somebody willing to take on the liquidity risk. So far that has not happened.
Prior to the August auction, rates settled at around 8% and in some months nearly 9% -- but that was still not high enough to attract enough bidders. Even the 11.5% yield resulting from last month's auction could not do the trick yesterday.
FSA's M.r Hoey likened the situation to the auction rate preferred market or the variable-rate note market in London, which are also long-term investments dependent on auctions for short-term liquidity.
"When you are depending on market-clearing mechanisms as opposed to having a hard put option to a bank, you are at the whim of market moods and market perceptions," Mr. Hoey said. When the market began to view the credit with skepticism because of fiscal problems at Tucson, the psychology turned from positive to negative.
Mr. Hoey said the universe of potential investors in the bonds is limited anyway, because the lack of a put and the 20-year maturity excludes many money market funds that can only invest in short-term debt.
"An enthusiastic [marketing] effort might produce a larger group, but right now we're only dealing with a limited number of buyers," Mr. Hoey said. David C. Clapp, a general partner at Goldman Sachs, agreed the problem has been liquidity concerns, but he said the marketing effort has been adequate.
"Everybody in the world has been shown these things," Mr. Clapp said. "We've done everything known to man and then some." But he said despite the high yields and faith in the credit based on the FSA backing, the lack of a liquidity line has kept investors away.
Mr. Clapp added that the liquidity problem with the Tucson deal does not mean all dutch auction securities are vulnerable.
"Most of them work like a dream," Mr. Clapp said. "But the problem here is the company was rated much higher when the bonds were sold than it is now, so people are shying away from it," creating the liquidity problems at the auctions.
A provision in the indenture allows Tucson to eliminate the auction mechanism by converting the bonds to long-term fixed-rate securities. Mr. Clapp said Goldman Sachs has suggested that option to the utility.
But until recently, when the auction yields hit double digits, yields have not been much higher than Tucson's normal cost of capital. Officials at the utility declined to comment on their future plans for the issue.
As a result of Tucson's failure to make its required debt service payments, Ford Motor Credit, the owner of the energy-generating plant built by the bonds, stepped in to make several of the monthly payments. Starting last month, however, that arrangement ended and FSA began making the payments under the terms of the insurance contract.
"We will make any future payment as necessary on principal and interest," an FSA spokeswoman said.
She noted that Tucson has agreed to deposit cash into an escrow fund equal to the amount FSA is paying on the bonds through the end of 1991.
"We believe any ultimate loss to FSA is unlikely because the plant is very important to Tucson's longterm strategy," the spokeswoman said, noting that the utility has singled out the plant as a vital part of its restructuring plans.