One upset venture capitalist complained to me that UBS charged one of his companies a 9.1 percent interest rate -- at least two full points above the going market interest rate (Libor) -- after the start-up faced problems accessing money it had invested via UBS into auction-rate securities. Given that UBS and other banks advised start-up clients to invest in these auction-rate securities, it came as a bit of a shock that the bank would turn around and charge clients a premium when the securities turned sour.
It's a cruel double whammy. First, your money is no longer there, then you have to pay a high rate to borrow against it. Add to that the fact that you can't even borrow the full amount of the security.
Many auction-rate securities turned bad after the sub-prime credit crunch worsened earlier this year. UBS, of course, isn't the only bank hitting its clients with this problem, but UBS's exposure to the crisis has been starker than most. A few weeks ago, regulators began investigating it for moving to actually lower the face-value of the securities involved. See the Wall Street Journal story here.
Many banks advised start-ups that the securities were as safe as cash. Other banks, however, such as Silicon Valley Bank, refrained from advising clients to invest in auction-rate securities.
The problem is large, though. A fifth of start-ups have money in auction-rate notes, according to Venture Wire, which surveyed 60 venture-backed start-ups about their exposure. That's assuming all the start-ups surveyed are owning up to their exposure.
The notes make up a $330 billion market. They represent debt from city governments and other tax-exempt organizations, and the rates are reset at auctions every week.
In response to my questioning about the problem, UBS spokeswoman Karina Byrne told me she "can't confirm or deny the 9.1 percent specifically, as we don't speak about particular client accounts." But she said UBS is generally charging 30-day Libor, plus 25 basis points, which is significantly lower than 9.1. Moreover, for its clients suffering losses from auction-rate securities, the bank is only letting clients take out loans of up to 50 percent of their whole value, but may boost that loan amount to 75 percent in some cases when a client has other assets with the bank. Several weeks ago, we first reported that bank Comerica had frozen the auction-rate security funds for several start-ups after those securities turned bad. Merrill Lynch is another bank that asked start-up clients to borrow funds when its clients were hit by the meltdown, but we were told it was doing so at a discount rate in recognition that it was partly responsible for allowing its client to get into the mess. However, we also heard that it is only committing to loan on the bad auction-rate securities at a 50 percent loan-to-value (in other words, it would ensure liquidity on the security at only half its value). Merrill Lynch spokeswoman Danielle Robinson declined comment. Comerica is lending up to 70 percent of the par value of AAA rated auction-rate securities, according to Gregory Belanger, president of the bank's technology and life sciences division.
Another bank, ING, has offered to ensure liquidity of $1 million on securities and says that, over time, it will try to make good on the rest. We also checked with Square 1 Bank. Like SVB, however, it had not advised its clients to invest in auction-rate securities, and so stayed clear of this particular problem, its executives told me in a recent interview. SquareOne has had to mark down certain assets in its real-estate related holdings, but it doesn't appear to have affected the start-up community.