Legg Mason funds take more hits

The Baltimore Sun

Legg Mason Inc., which has already committed almost $2 billion to shore up money market funds hit by the mortgage meltdown, will take another hit to bail out investors in closed-end funds hurt by the collapse of the market for so-called auction-rate preferred stock.

The Baltimore asset manager, the seventh-largest U.S. manager of closed-end funds, said yesterday that it is borrowing up to $130 million to allow investors in its LMP Real Estate Income Fund and Western Asset Zenix Income Fund to redeem their holdings.

Closed-end funds are investment pools that are like mutual funds in many ways but trade on a major exchange like a stock.

Both Legg funds are heavily invested in auction-rate preferred stock, a class of security sold regularly by municipalities, student-loan lenders and closed-end funds as an alternative to cash investments.

Funds invested in these securities rely on being able to refinance them regularly when new auctions take place. But since February, the market for those securities has virtually dried up. The securities in the portfolio couldn't be sold because there were no buyers. So when investors in these closed-end funds wanted out, the funds couldn't raise the money to pay them off.

"You have lots of people who are very anxious about having money tied up in these things," said Eric Jacobson, director of fixed-income strategies at Morningstar Inc. "When people thought they were buying short-term liquid investments, what they were really buying was a piece of stock that was set up with an auction mechanism to get rid of it in a hurry. Because the mechanism is failing, they wound up with a stock they can't sell."

Unlike mutual funds, closed-end funds generally have no legal obligation to repurchase or redeem these securities. But Legg said it wanted to respond to concerns of brokers and clients who have been unable to sell these investments.

Another $542 million in preferred stock issued by five other LMP and Western Asset closed-end funds remains outstanding. Legg is considering refinancing options for them.

"We're looking at each fund individually to determine a solution," spokeswoman Mary Athridge said.

Since November, Legg has infused nearly $2 billion into some of its money market funds - which are never supposed to lose value - to cover unrealized losses from structured investment vehicles. SIVs issue debt that has lost value as the market continues to worsen for mortgage-backed securities. Legg suffered its first quarterly loss in its 25-year public history, $255.5 million, during the period that ended March 31.

The Closed-End Fund Association, a trade group for the industry, said managers of closed-end funds with auction-rate preferred stock "are diligently working to address the concerns of the shareholders." In recent months, money managers such as Nuveen Investments Inc., Eaton Vance Corp. and BlackRock Inc. have taken steps to help investors sell their shares.

Nuveen, the largest closed-end manager, is working to refinance all of its $15.4 billion in auction-rate preferred stock outstanding. Easton Vance is buying back these securities issued by three of its funds. And BlackRock is refinancing $1.9 billion in such preferred stock issued by its closed-end funds.

Morningstar's Jacobson said closed-end funds realize it's in their best interest to help investors get out of a jam.

"They want to avoid reputational risk, he said. "A lot of dealers, brokers and clients who are involved in this part of the business are wealthy big clients of the industry in general, so no firm wants to alienate them ... and potentially lose them as clients."

LMP Real Estate Income Fund, managed by a Legg subsidiary, plans to redeem all of its $95 million in outstanding auction-rate preferred shares by using a new line of credit or a combination of borrowing and some sales of portfolio securities. The fund expects to begin redemptions late in the second quarter or early third quarter.

Separately, Western Asset Zenix Income Fund, which has $35 million in outstanding auction-rate preferred stock, will be merged into the larger Western Asset High Income Fund II.

If the deal is approved by Zenix Income Fund shareholders, payments to preferred-stock shareholders would be made by borrowing under High Income Fund's existing credit line.

Legg Mason Partners Fund Advisor, which manages both funds, said it would pay the costs of the merger.


An article in Saturday's Business section did not make clear that Legg Mason Inc.'s balance sheet is not affected by moves by two of its affiliated closed-end funds to borrow money. Also, auction-rate preferred stock is not in the funds' portfolios but rather is used as a financing tool for them.The Sun regrets the error.
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