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ARS deals snub corporate buyers

Financial Week

Recent regulatory settlements by Citigroup and other big banks have set the tone for what corporate investors can expect out of the auction-rate securities mess. Bottom line, advisers say: Wait and see, but keep your lawyers on speed dial.

Citi said earlier this month that it will buy back $7.5 billion in ARS from retail investors, small businesses and charities within three months, but will use only its “best efforts” to repurchase $12 billion from institutional holders by the end of 2009.

Just last week, Merrill Lynch, Goldman Sachs and Deutsche Bank settled with regulators, agreeing to buy back the securities from smaller investors but only to help large institutional investors find markets for their holdings.

It stands to reason, given the impetus, one securities lawyer said. “Remember that attorneys general are elected by voters, not corporations,” said Columbia University professor John Coffee, referring to New York’s Andrew Cuomo, who has been investigating the collapse of the ARS market. The Securities and Exchange Commission is also investigating the failure of the ARS market.

Some banks have mentioned specific redress for institutions. In its settlement announced Aug. 8, UBS said $10.3 billion will be set aside for them, but the bank has until June 2010 to pay up. Wachovia gave itself until the end of June 2009 to buy back $3.1 billion from such investors.

But until then, an estimated $100 billion to $150 billion in ARS remains on the books, leaving companies saddled with the illiquid securities facing uneasy choices: trying to make a deal with brokers, arbitration or litigation, selling or holding on.

Some say deals are taking place.

“There are a number of conversations,” said Tim Batchelor, a managing director at investment banking and financial advisory firm Duff & Phelps. “We’re seeing a higher percentage of activity. I have half a dozen conversations every day with one side or the other.” He said that some clients are receiving 90 cents on the dollar, above what they could get in the open market.

And terms may even improve, since the firms are under pressure. “The genie is out of the bottle,” said Adam Dean, president of SVB Asset Management. “Sooner or later, brokers will have to make [institutional] clients whole or face further legal pressure. They’re thinking now, “Who’s going to sue us, and how bad is it going to be?'”

Mr. Dean said he advises his clients to hold on to the securities if they can afford to, and wait for a decent offer.

When it comes to negotiations, companies may have the upper hand, given the amount of business they do with their brokers, Mr. Coffee said. “Often a company will have a strong economic relationship with the broker-dealer. They have a lot more negotiating leverage.”

When asked about negotiations with institutional clients, a spokeswoman at Wachovia said she could not comment beyond the press release. A Citi spokeswoman wrote in an e-mail that the bank “will continue to marshal its resources to work diligently with issuers and regulatory authorities to provide liquidity solutions for all holders of auction rates.”

The ARS market fell apart in February, when banks that had been buyers of last resort abandoned it. In recent weeks, banks have pledged to buy back a total of about $35 billion.

According to Tony Carfang, co-founder of Treasury Strategies, just having some of the supply taken out is a good sign for the market. “What you have is a smaller problem, and more liquidity.” he said. “Overall, that’s bullish. It increases the likelihood that some of these auctions may begin clearing.”

But no matter what course a company decides on, the first step is writing a letter to let the brokers know you’re not happy, Mr. Carfang said. “Say, “I’m damn pissed off, and you pay me off first.’ Then you have something to wave around later.”

Mark Conner, owner of Corporate Treasury Investment Consulting, agrees. “I’m advising companies to prepare for arbitration, while they monitor other developments, because I think that’s how it’s going to turn out,” he said.

Since the market seized up, more than 200 ARS arbitration cases have been filed with the Financial Industry Regulatory Authority, according to FINRA spokeswoman Nancy Condon.

Arbitration is the most common route because it’s a cheaper and more informal process, Mr. Coffee of Columbia explained. Also, companies usually have a securities arbitration agreement with their broker that restricts them to settling disputes in this manner.

Since the market is still frozen, selling should be an option only for the most cash-poor, market participants agree, since they’d be selling at a steep discount.

Prices depend on the type of underlying asset behind ARS, according to Barry Silbert, CEO of Restricted Stock Partners, which operates an electronic trading marketplace for illiquid assets. Discounts are about 50% for ARS backed by collateralized debt obligations; 2% to 8% for municipals; 5% to 15% for closed-end funds’ auction-rate preferred securities; and 20% to 30% for student loans.

Some who are less sanguine about the ARS market are advising their clients who need cash to sell, then file an arbitration. “I tell my clients to get what they can and then go after the haircut,” a securities lawyer in California, said.

Mr. Silbert said he’s seen an uptick in the number of sales done on his Restricted Securities Trading Network, up from about 10 a week in April to more than 40 a week currently. Most sellers are wealthy individuals, he said, but more companies are joining in now.

No matter what a company decides to do with its ARS, FASB’s FAS 157 requires that companies mark to market their ARS on the books each quarter. Some who are in the valuation business say that even for private companies, determining the fair value may be a worthwhile exercise to help evaluate what the options are.

“What we’re doing right now is helping corporations and institutions understand what the underlying economics are, and where they stand, and more importantly, what the potential financial risk is given the current market,” Mr. Batchelor of Duff & Phelps said. “The devil’s in the nuances. [Fair value] really depends on the type of ARS that the company has.”

If companies can afford to hold on and see how the market shakes out, thoroughness and patience are probably the best course, Mr. Carfang suggested. “Mark to market, and over-disclose. And don’t enter into any rash transactions.”