Auction Rate Securities

Bank of America is apparently set to become the eighth bank to agree to buy auction rate securities it sold to customers. According to Reuters, Bank of America spokeswoman Shirley Norton, said BofA is “ready and willing to enter into an agreement that follows the same basic terms of previously announced settlements.”
They may be jumping the gun by making this statement however. New York Attorney General Andrew Cuomo scolded Merrill Lynch for assuming it had reached an adequate settlement with his office without first going through the bother of actually reaching an agreement. In response to word of BofA’s “settlement” Cuomo’s office seems to have scoffed.
“Our investigation into Bank of America is ongoing,” a spokesman for Cuomo’s office said.
So far Citigroup, Deutsche Bank, Goldman Sachs Group, JPMorgan Chase, Merrill Lynch, Morgan Stanley, UBS and Wachovia Corp have settled auction rate cases, agreeing to buy back something in the order of $50 billion of the securities. Two Credit Suisse brokers face civil and criminal fraud charges for selling auction rate securities.
Bank of America: Ready to settle on auction rates [Reuters]

Is Andrew Cuomo going to force Wall Street to bailout institutional investors who bought auction rate securities? So far most of the offers to buy back auction rate securities that have come from brokers have applied to retail investors, charities and municipalities. The idea was that these investors were probably the focus of regulator protection and more sophisticated investors knew or should have known the risks in the market.
CNBC’s Charlie Gasparino is reporting that Cuomo’s dissatisfaction with the settlement offers from Merrill Lynch and Morgan Stanley stems, in part, from a concern for institutional investors. Pension funds and others own large amounts of the securities, and Cuomo may be pushing Wall Street firms to offer relief to these customers as well. This could seriously increase the cost of bailing out this market to the firms involved.

Investors in auction rate securities got some relief when UBS and Citi said they would buy back those bought by retail investors and charities. Merrill followed suit, although its buy back would be delayed until next year. But when Morgan Stanley made a similar buy back offer yesterday, the New York Attorney General’s office characterized the offer as “too little, too late.”
“Our investigation into Morgan Stanley continues,” a spokesman for Attorney General Andrew Cuomo said.
It was not immediately clear what about Morgan Stanley’s offer to settle with regulators and investors failed to satisfy Cuomo, although perhaps Cuomo rejected plans to delay the buyback until as late as September 30th. It may be that Cuomo plans to demand an immediate buyback. Merrill’s offer is also said to be under review by Cuomo. There has been some speculation that both Merrill and Morgan hope to use the delay to pressure issuers to redeem the securities, reducing their costs in any buy back.
Another possibility is the Cuomo will require Morgan and Merrill to reimburse customers who sold the securities at a discount from par. Citigroup’s offer included this provision, while Morgan’s and Merrill’s did not.
Earlier Monday, Cuomo sent a letter to Morgan Stanley, JPMorgan Chase and Wachovia, requesting the banks “immediate talks” to relieve investors. Wachovia is expected to announce a deal as early as today.

Bank Offers to Buy Back $4.5 Billion in Securities
[Bloomberg]

Across Wall Street, brokers are pressuring closed-end mutual funds to redeem their auction rate preferred securities, hoping to shift the cost of the market meltdown to the issuers before regulators and others forces those who sold the securities to make investors whole.
Yesterday we mentioned that Merrill brokers were upset that BlackRock, one of the largest issuers of ARPS, hadn’t redeemed a larger percentage. This is just one example of a dynamic playing out across Wall Street. Citigroup is reportedly considering buying out the ARPS it sold to investors, a move widely seen as an attempt to hold off regulatory scrutiny. Now other firms, especially those already laden with debt in frozen markets, are attempting to avoid incurring the costs of bailing out ARPS investors by drawing attention to the role of the issuers.

So how did Wall Street convince all those corporate treasurers to invest the cash holdings of their companies in disastrous auction rate securities? A new study shows that more than 85 percent thought that Wall Street firms would bail out the market if it failed, according to this morning’s Financial Times.
Nearly 70 per cent of corporate treasurers who bought auction-rate securities said dealer support was implied. A full 17 per cent of the treasurers said that they were “told explicitly that the investment bank would ensure that the auctions would not fail.”
For years, the firms selling auction rate securities did support the market by buying excess securities, guaranteeing the auctions would not fail. When scrambling to increase balance sheet capital earlier this year, nearly every firm on Wall Street that had sold the products decided to let the auctions fail. Since then issuers have been forced to bail out those securities paying the highest interest rates, while investors with those paying the lowest interest rates have simply been unable to access their funds.

Auction-rate securities ‘implied support’
[Financial Times]

ARS Lockdown: Banks Making It Even Worse

Bank customers with funds locked up in auction rate securities are discovering that even if they find willing buyers for their securities, they may not be able to sell them. Earlier this year, nearly all the auctions for the securities failed as banks pulled their support for the auction. Customers, many of whom believed the securities were safely liquid cash-equivalents, found themselves unable to access their funds. While some issuers who faced high penalty rates following auction failures have redeemed their ARS, hundreds of millions of dollars remains locked-up.
It is an ugly situation that has bank customers bringing lawsuits against their brokers and the issuers of the securities. And it just got worse. According to Bloomberg’s Darrell Preston, Bank of America, UBS, Wachovia and at least four dozen other firms that sold ARS are blocking attempts to create a secondary market for the securities. They say they are preventing customers from selling at a discount and incurring needless losses.
Maybe the banks really do only have their customers’ best interests in mind. But the move also serves the interests of the banks. For one thing, preventing customer losses also makes it harder to sue the banks for their role in the ARS market.

“By allowing customers to sell at a discount, the banks allow customers to establish damages,” said Bryan Lantagne, the securities division director for Massachusetts Secretary of State William Galvin.

And the banks may have another reason to avoid allowing a secondary market. It’s still unclear about how much ARS are held directly by the banks themselves but some reports suggest they may hold a great deal. Since few of these default, the banks can carry these on their balance sheets at par value or close to it. But if they start trading at a discount in the secondary market, the banks will have to mark these at market value, incurring another round of write-downs. In short, the banks have an interest in preventing the formation of a transparent market in auction rate securities.

Banks Say Auction-Rate Investors Can’t Have Money
[Bloomberg]

Lawyers in the two dozen or so proposed class action suits filed in connection with the failure of the auction rate securities markets may be “unable to prove their clients lost money or collect fees for themselves,” writes Bloomberg’s Thom Weidlich. We’re not so sure the defendant broker-dealers and issuers in these cases should be so confident.
Find out why after the jump.

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