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ARS settlements galore, but corporate holders left in the lurch

8/11/2008

Financial Week

While Merrill Lynch, Citigroup and UBS have said they will buy back a total of $36.7 billion in illiquid auction-rate securities, the settlement agreements focus mostly on retail investors. Those pacts leave serious questions for corporate money managers, many of whom still hold hundreds of millions of the illiquid securities.

Citi, for example, said in its announcement last week of a $7.3 billion settlement that it “will use its best efforts to facilitate issuer redemptions and/or to resolve its institutional investor clients’ liquidity concerns.”

Securities lawyers weren’t impressed.

“I’m very uncomfortable with the ‘best efforts’ language,” said Philip Aidikoff, a securities lawyer and litigator in Los Angeles. “If you’re the CEO of a corporation, how do you read that? My corporate clients are completely in the dark as to what the treatment they receive will be.”

Mr. Aidikoff said he is recommending that if his clients need the cash, they sell at a loss, then seek securities arbitration to “go after the broker-dealer for the haircut.”

Depending on the type of instrument involved, that haircut can be steep. According to Barry Silbert, CEO of Restricted Stock Partners, which operates an electronic trading marketplace for illiquid assets, the discounts on ARS at the time of sale are about 2% to 8% for municipals; 5% to 15% for closed-end funds ARPs; 15% to 30% for student loans; and in excess of 50% for CDOs.

Mr. Silbert said he’s seeing selling from two types of institutions: those that need the money now and those that simply want a higher yield on their investments. He said the number of deals done has gone from about 10 a week in early April to 40 or more a week now.

“The volume’s definitely increasing,” Mr. Silbert said, but the pace is “choppy.” Buyers include hedge funds and foreign investors, he noted.

Many companies have delayed cashing out their auction-rate securities because they put the matter on hold after a painful first quarter of valuations and write-downs, said Tony Carfang, co-founder of Treasury Strategies, a treasury management consultancy.

After the first quarter, “many hunkered down, hoping for a solution,” he said. But managers at those businesses also focused on more pressing business matters. “From a financial and accounting standpoint, that makes a lot of sense.”

Mr. Carfang said he sees the banks’ settlements as good news for the companies involved. With each settlement, “The problem gets smaller; the cash available to solve the problem goes up.”

He added that “the more liquidity there is, the more likely that there will be opportunities to get out at or near par value.”

It’s also in the best interests of broker-dealers to come through for clients, said Adam Dean, president of SVB Asset Management. “It could be a long, winding path for them to be unwound, but ultimately, [ARS] will be replaced.”

Joe Morgan, chief investment officer at SVB, added, “From a business perspective, [Wall Street firms] have damaged a very important client constituency. It’s to their benefit to try to get that goodwill back, and the only way to do that is to make those clients whole, or as close as possible.”


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