While markets seemed to take comfort from last week's moves by Citigroup (C), Merrill Lynch (MER) and UBS (UBS) to buy back about $30B of illiquid auction-rate securities [ARS] from clients at face value, Barron's Jacqueline Doherty says the mess is still far fom a happy ending. Here's why:
- With about $220B in ARS still outstanding, look for regulators - bolstered by their initial successes - to go after more issuers, such as Credit Suisse (CS), Wachovia (WB) and Bank of America (BAC).
- Aside from potential losses arising from the buybacks (Citi estimates a $500M loss, UBS is looking at $900M, while Merrill says the impact won't be material), the banks and brokers need to come up with the cash to finance the purchases. Most will likely have to sell debt.
- The deals do more for retail clients than institutional investors (Citi offered its 'best efforts' to help corporate clients with $12B in ARS, and UBS says it will buy back $10.3B by June 2010). Some large investors are already suing banks that sold them ARS, while others have thrown their weight around - and procured 'sweetheart deals' of $0.90 on the dollar, vs. a street value of about $0.70.
Municipal ARS issuers have successfully exited and/or restructured more than half their $175B in ARS debt, and the trend should continue. Same for closed-end funds. Student lenders ($85B) and CDOs ($20B) that sold auction-rate debt have made little if any progress; the former, because it can't sell new debt at low-enough rates to make it plausible, and the latter because of the deteriorating credit quality of the underlying.