Investors needed rescuing, and John Hancock Funds wanted to look like a hero.
Auction-rate securities, which had for decades been touted as being nearly as safe as savings accounts, fell victim to the credit crunch earlier this year. Hundreds of auctions had failed: Thousands of individual and institutional investors’ cash was suddenly frozen.
Almost four months later, and many securities issuers are still scrambling – “working day and night” said one analyst – to redeem as many funds as possible.
John Hancock Funds found itself in that harried pack of fund groups: When the auctions failed, more than $1.7 billion of Hancock investors’ money was tied up in auction-rate securities.
Hancock Funds, a division of John Hancock Financial Services in Boston, wasn’t under any legal obligation to help out investors. But the company’s reputation was on the line, and analysts say that unlike many fund groups, Hancock was in a position to rescue the preferred auction-rate securities investors.
While other fund groups are offering to redeem 50-65 percent of their auction-rate securities, or are still struggling to come up with a solution at all, John Hancock’s ARPs investors will be able to redeem 100 percent of their assets in six of its seven fund groups so far.
Parent company ManuLife Financial and John Hancock are large organizations with a comparatively small amount of resources tied up in auction-rate securities, said Richard McMillan, man-aging senior financial analyst with A.M. Best. That leaves Hancock better suited than many in terms of bailing out investors.
In May, Hancock’s Board of Trustees made a deal with an unnamed commercial bank to refinance its closed-end leveraged funds, and to change the form of leverage from securities into debt.
Investors will be able to redeem their funds in June; Hancock has promised to find a solution for the seventh and final fund as well, although the company declined to speak about when that deal might conclude.
Until now, auction-rate securities were considered nearly as safe as cash. Although these are long-term securities, banks held regular auctions to set the interest rates and allow investors to sell if they chose, combining aspects of long-term and short-term bonds.
Drawn to the promise of a safe investment, individuals used them to bolster kids’ college funds or mortgage payments before the securities failed, said Lance Pan of Capital Advisors.
“Only people very close to this market have a sense of how much pain was felt,” he said. “I would not be surprised if Hancock got a lot of angry phone calls.”
John Hancock, for its part, “wants to play the white knight in shining armor,” Pan said. Turning its securities into debt and offering 100 percent redemption allows it to save its reputation with what appears to be minimal damage.
Embarrassing Moment
Hancock refused to disclose the terms of its deal, including with which lender it was dealing.
Joesph Fichera, of Sabre Investments in New York City, said that without knowing the details of Hancock’s loan, there was no telling for sure whether all shareholders were out of the woods.
Debts can be rolled over indefinitely, he said, unless the company finds itself in a situation where it can’t refinance anymore. If it can’t get refinancing, Hancock would have to sell assets to pay off its debts, and that might hurt shareholders.
Still, A.M. Best’s McMillan said that no matter how safe its position, Hancock wouldn’t necessarily be keen to talk details publicly.
“It’s probably a double-edged sword. Yes, they’re stepping up to the plate [for their investors], however there’s a little bit of embarrassment that their funds got in trouble,” McMillan said.
They have plenty of company. Industry wide, about $64 billion was tied up in ARPs closed-end funds when the auctions failed.
According to Cecilia Gondor, executive vice president at Thomas J. Herzfeld Advisors, only about 25 percent of ARPs outstanding in February have been or are scheduled to be redeemed.
Most fund groups are waiting for the SEC to allow emergency temporary relief from asset coverage limits, she wrote in a recent commentary on the auction-rate securities crisis: Relief from asset coverage limits would allow the funds to more easily get debt financing. John Hancock stands out because the fund went ahead and de-leveraged its securities to be able to announce 100 percent redemptions.
For most funds, the headaches are far from over.
Goldman Sachs and Bank of America are now being sued by investors who say the company misled them about the funds’ dangers.
Some funds are redeeming as much as they can: In May, BlackRock Inc. announced that it will redeem 50 percent of its outstanding auction-rate securities for a total of $684.7 million. Eaton Vance Corp. has taken a more creative path, announcing that it was developing a new class of securities – liquidity-protected preferred shares – that could provide a form of leverage to its closed-end funds.
Others are still trying to figure it all out: As late as May 27, Massachusetts Financial Services Co., a subsidiary of SunLife, said that it “continues to actively explore options to restore liquidity to the auction preferred shares.”
