Auction-Rate Securities May Get Help

Money-market funds are emerging as a potential white knight for some troubled auction-rate securities.

Auction-rate securities are debt investments that reset their interest rates as regularly as every seven to 35 days. In recent weeks, the $330 billion market for such securities has seized up, leaving many investors unable to cash out.

That's where tax-exempt municipal money-market funds come in. They hold conservative short-term debt offerings and are subject to strict rules that typically prevent them from owning auction-rate securities.

Now there is an effort under way to convert auction-rate securities into more-liquid investments that would be acceptable to municipal money-market funds. The effort would benefit the money-market funds, which have been struggling in recent weeks to find attractive securities amid problems with the bond insurers backing many of their normal holdings.

Overall, the conversions are "a win-win for tax-free money funds," says Deborah Cunningham, a money-fund manager at Federated Investors Inc.

Converting auction-rate securities into money-fund eligible investments is often done under the original bond documents. The biggest sticking point could be that the borrower of the auction-rate securities or another financial institution must agree to buy the securities in the event no other buyers emerge. That backstop is what essentially differentiates auction-rate securities from investments called variable-rate demand notes that can be held by municipal money-market funds. But with financial institutions suffering losses, few may want to step up and take on that risk.

In some of the first deals, the borrowers using the auction-rate securities are providing the backing, rather than an outside financial institution. Restructurings are happening on a "deal-by-deal" basis says Federated's Ms. Cunningham.

The Georgia Power unit of Southern Co., for instance, recently had $700 million in tax-exempt auction-rate securities, and is now in the process of converting about $500 million of that into variable-rate demand notes, says David Brooks, managing director of capital markets at Southern. As the auction-rate market "got really ugly," in recent weeks, "we started putting out conversion notes," he says. Georgia Power priced about $33 million of the converted securities yesterday, and was planning to price another $100 million today and tomorrow that would be money-fund eligible. Rather than use an outside bank guarantee, it issued the new securities with the backing of its own credit. The benefit of such a move is lower borrowing costs than have recently been available in the auction-rate market. The pricing yesterday, for instance, was approximately 2.70%, while the borrower had recently seen auction rates from 5% to 7%.

The Massachusetts Health and Educational Facilities Authority had $79 million revenue bonds remarketed yesterday on behalf of Partners HealthCare System in Boston, with more to come next week. The borrower is using Bear Stearns Cos. and J.P. Morgan Chase & Co. as remarketing agents as the new securities are pitched to outside investors, and has elected to support the bonds with self-liquidity rather than an external bank facility. "We'd definitely look at that" deal says Joe Lynagh, a tax-exempt money fund manager at T. Rowe Price Group Inc.

Write to Diya Gullapalli at diya.gullapalli@wsj.com and Shefali Anand at shefali.anand@wsj.com