Auction Market Preferred Stock (AMPS)

What Is Auction Market Preferred Stock (AMPS)?

Auction market preferred stock (AMPS) refers to preferred equity shares that have interest rates or dividends that are periodically reset through Dutch auctions. The interest rate on an AMPS issue is reset periodically through such auctions, typically at intervals of every 7, 14, 28, or 35 days.

Auction market preferred stock is also known as auction-rate preferred stock.

Understanding Auction Market Preferred Stock (AMPS)

Adjustable preferred stock shares much of the same attributes as traditional, or “fixed-rate” preferred shares. In both cases, corporations must first pay out dividends to preferred stockholders before paying out any dividends to common stock shareholders. But unlike regular preferred shares, the value of the dividend from the adjustable preferred share is set by a predetermined mechanism to move with rates, and because of this flexibility preferred prices are often more stable than fixed-rate preferred stocks. In the case of AMPS, this mechanism is in the form of a Dutch auction.

Institutional borrowers began issuing auction-rate securities in the 1980s when the interest rate environment was quite high. These variable rate securities were marketed to investors looking for higher yields at the time, although they provided less liquidity than traditional investments like stocks, bonds, or CDs.

Traditionally, auction rate securities become short-term investment vehicles, because auctions are held so frequently. The benefit for investors has always been that they are holding a relatively liquid security that can be bought and sold rather seamlessly. In a liquid investment, buyers and sellers of a security are not hard to find.

Another benefit to investors is that they essentially are investing in a short-term security because they have the option to sell so frequently, but they typically earn interest rates that exceed other short-term investments. This is because, although auction-rate securities are technically issued as long-term contracts, they are liquid investments that can change hands at auctions before the contract expires. Investors in auction-rate securities are mainly institutional investors and wealthy individuals.

The auction market preferred stock can be a beneficial investment for larger investors. The auction process will most likely reveal the current market yield for less-risky asset classes, such as preferred stock, and will self-adjust for the effects of alternative investments and inflation.

Auction Market Preferred Stock During the 2008 Financial Crisis

During the global financial crisis of 2008, the AMPS market failed when the auctions could not attract enough bidders to establish a clearing rate. This meant many investors were left holding illiquid investments with long-term maturities they could not sell, where lead underwriters chose not to step in to support the auctions rather than commit to holding toxic securities.

Since its collapse, the SEC, FINRA, and state regulators have reached settlements with major financial institutions, including agreements to repurchase AMPS from qualified investors.