Merrill and Citi to repurchase ARS after New York applies pressure

Under plans announced yesterday, Merrill will buy back ARS paper at par from retail clients who have been stuck holding the notes since broker-dealers abandoned the market in mid-February.

The move will affect 30,000 customers holding an estimated $12 billion in the frozen securities, although the offer is only effective from January 15, 2009, meaning some small investors will have been trapped holding the instruments they bought as 'cash equivalents' for 11 months by the time they manage to escape their positions. The pain of being locked into these notes has been offset somewhat by the substantial penalty rate coupons investors have collected in recompense for inconvenience since the market froze up.

The Merrill repurchase coincided with Citi’s announcement that it too will offer to buy at par all frozen ARSs held by individual investors and small institutions by November 5. The value of the ARS notes eligible for purchase totals approximately $7.3 billion, with Citi estimating the difference between the purchase price and the currently depressed market price to be in the region of $500 million.

Citi also disclosed that it will pay a $50 million fine to the State of New York and an additional $50 million to other state regulatory agencies, with the New York attorney general retaining the right to take legal action against Citi with respect to the resolution of its institutional investor clients’ ARS positions as of November 4.

The attorney general’s office has already bared its teeth over the ARS matter. Last month, Cuomo announced a lawsuit against UBS, alleging that senior managers sold off their personal auction rate holdings just days before UBS pulled out of its role in supporting the market as an auction agent and buyer of last resort.

With both Merrill and Citi acknowledging the role played by Andrew Cuomo and other agencies in taking this action, it appears likely that the other major ARS dealers – JP Morgan, Goldman Sachs, Morgan Stanley, Lehman Brothers, Royal Bank of Canada and Wachovia – may present similar pledges to assist retail customers in the coming weeks.

Analysts at Bank of America Securities have estimated that, based on an ARS market value of $330 billion at the end of 2007, if settlements such as those seen at Merrill and Citi are replicated, the total potential for additional writedowns across all dealers would be approximately $4 billion.

See also: New York sues UBS for alleged auction rate securities fraud

Investors caught short by auction rate meltdown

Auction rates securities investigations gathering steam

UBS to write down $5.9bn auction rate securities book

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