August 8, 2008

UBS Costs in Auction-Rate Accord May Top Citigroup’s

By Michael McDonald and Karen Freifeld

UBS AG, Switzerland’s biggest bank, may pay more than Citigroup Inc. or Merrill Lynch & Co. to settle state and federal claims that it fraudulently sold auction-rate securities, a person briefed on the negotiations said. UBS is close to resolving the claims by promising retail and institutional clients it will buy back the securities, valued at $25 billion by regulators, the person said. Merrill Lynch offered yesterday to purchase about $10 billion in auction-rate debt from individual investors. Citigroup set a framework for settling state and federal regulators’ claims yesterday when it agreed to buy $7. 3 billion of debt from individual investors, pledged to help 2,600 institutional customers unload $12 billion of securities and said it will pay $100 million in fines. Bank of America Corp. analyst Jeffrey Rosenberg estimates banks that purchase the auction-rate debt may have to write it down by a total of $4 billion. “We reach settlements that are appropriate for the circumstance,” New York State Attorney General Andrew Cuomo said yesterday at a press conference announcing the deal with New York-based Citigroup, the largest U.S. bank by assets. “UBS would be a different circumstance. ” UBS spokesman Mark Arena, asked to comment on a possible settlement, said: “We have consistently worked with regulators toward a comprehensive solution for all ARS investors. ”

Deal Is Close

UBS is very close to announcing an agreement with state and federal regulators to purchase about $20 billion of the securities in addition to a fine to settle the probes, the person briefed on negotiations said last night. An accord might be announced as early as today, the person said. UBS on July 16 said it planned to offer to buy back as much as $3. 5 billion in auction-rate preferred shares it sold for closed-end funds. The settlement covers the rest, the person said. It also allows some investors to get their buy backs faster than with those who purchased auction-rate securities with Merrill or Citigroup. The Boston Globe reported today that UBS would also pay a fine of $150 million to resolve the auction-rate investigations. “They appear to be trying to outdo each other to make whole their biggest losers,” Jacob Frenkel, a former federal prosecutor in private practice in Maryland, said last night. “They’re trying to say, `We’re going to be around. We’re not on the verge of an unprecedented financial crisis. We are riding out this storm and it’s OK to ride with us. ”

Compounds Losses

The decision by investment banks to abandon the $330 billion auction-rate market in February threatens to compound their losses from the global credit-market contraction. Zurich- based UBS reported a net loss of 25. 4 billion Swiss francs ($25. 6 billion) in the nine months through March, more than any other bank. UBS may have to take a writedown of about $1 billion if it buys back about $20 billion in auction-rate securities, Kian Abouhossein, a London-based analyst at JPMorgan Chase & Co. said. That would increase the estimate for writedowns still to come this year to about 9. 4 billion francs, with as much as 5 billion francs in markdowns forecast for the second quarter, according to Abouhossein. UBS fell 50 centimes to 21. 24 francs by 2:27 p.m. in Swiss trading.

Decline in Value

Citigroup may have to record a pretax loss to reflect a decline in the value of the $7. 5 billion in auction-rate debt, the bank said yesterday. Pluris Valuation Advisors LLC in New York said in an Aug. 6 report that 281 publicly traded companies have written down a combined $32. 3 billion of the securities they hold by a total of $2.1 billion. Merrill, the largest U.S. brokerage, extended its offer to individual investors, charities and small businesses starting in January, six hours after the Citigroup accord was announced. New York-based Merrill, which booked almost $19 billion of net losses in the past four quarters, was accused last month by Massachusetts Secretary of State William Galvin of misleading investors about the stability of the auction-rate market. “It’s a start I suppose. I’m glad they did it, but I think for most investors it’s not the solution they need,” said Galvin, who also filed a complaint against UBS. “It’s not satisfactory from our point of view in terms of the timelines of redemption. Therefore, clearly, we’ll pursue our complaint. ” Cuomo said he would review Merrill’s plan, which dealt with “one of the goals” he’d established to resolve the matter.

Market Collapse

Municipalities, closed-end funds and student loan organizations sold auction-rate securities, long-term bonds with interest rates that are reset every week or month through bidding run by dealers, for about two decades. Wall Street banks, facing declining demand for the bonds and preferred shares, stopped their once-routine support of auctions in February, permitting thousands to fail and leaving investors unable to sell the debt. UBS and the other banks knew the market was failing in the months prior to abandoning the auctions, according to e-mails and other evidence the state regulators discovered. They ratcheted up their marketing efforts, targeting individual investors with securities that were billed as cash equivalents, the regulators charged.

Bank of America

Galvin is still probing Bank of America Corp. Cuomo sued UBS, and last week announced that he planned to sue Citigroup. The Citigroup settlement included the other state and federal regulators. Texas also filed a complaint against UBS. Bank of America in a regulatory filing yesterday disclosed it received subpoenas and requests for information from various state and federal governmental agencies regarding auction-rate securities, saying it is cooperating fully with those requests. In addition to buying back some bonds and helping holders find a market for others, Citigroup agreed to reimburse refinancing fees to municipal borrowers that issued auction-rate securities through the bank since Aug. 1, 2007. James Nix, a senior attorney with the Illinois Securities Department, which is part of a group of 12 state regulators coordinating efforts, said he expects the Citigroup settlement to serve as a framework for deals with other banks. “They’re all very critical elements of the settlement and I think the framework of what regulators are looking for the future as well,” Nix said. Illinois is leading efforts to investigate Morgan Stanley and Goldman Sachs Group Inc.

Other Talks

UBS has been in talks this week with Massachusetts, Texas, New York and the Securities and Exchange Commission to settle the claims, including negotiations yesterday related to a required buyback of auction-rate debt, another person familiar with the negotiations said. One of the higher costs the bank faces is liquidating securities sold by student loan organizations, according to Joseph Fichera, chief executive officer of Saber Partners. Less than $3 billion in student loan auction-rate debt has been refinanced, a fraction compared with the municipal and closed- end funds, which often faced higher penalty rates when the market collapsed. “They were big in the student loans,” said Fichera, a financial adviser and former investment banker based in New York. “That’s a more problematic issue.”

–With reporting by Martin Z. Braun and Jeremy R. Cooke in New York and Elena Logutenkova in Zurich. Editors: Beth Williams, Patrick Oster

To contact the reporter on this story: Michael McDonald in Boston at +1-617-210-4639 or mmcdonald10@bloomberg.net; Karen Freifeld in New York State Supreme Court at +1-212-374-1590 or kfreifeld@bloomberg.net

To contact the editors responsible for this story: Beth Williams at +1-212-617-2307 or at bewilliams@bloomberg.net; Patrick Oster at +1-212-617-4088 or poster@bloomberg.net