Citigroup and Merrill to buy back auction-rate debt

NEW YORK (Reuters) - Citigroup and Merrill Lynch said they would buy back billions of dollars of illiquid auction-rate securities from retail clients, and Citigroup agreed to pay a $100 million fine to settle charges it fraudulently misled investors about the debt's risk.

The announcements could pave the way for settlements or buybacks by UBS AG and other financial companies whose clients own such debt, following the February meltdown of the $330 billion auction-rate market.

Citigroup agreed to buy back about $7.5 billion of the debt, as part of settlements with New York Attorney General Andrew Cuomo and the U.S. Securities and Exchange Commission.

Meanwhile, after U.S. markets closed, Merrill offered for a one-year period beginning January 15, 2009 to buy back auction-rate debt it sold to retail clients. It estimated that its clients hold $12 billion of the debt.

Both companies offered to buy back the debt at face value.

For Citigroup, which said it may face a $500 million pre-tax loss, Thursday's settlement will hinder efforts by Chief Executive Vikram Pandit to cut costs and restore profitability following $17.4 billion of losses in the last three quarters.

"It's really a face-saving attempt," said Brian Yelvington, an analyst at CreditSights Inc in New York, referring to Citigroup. "Other banks that have sponsored these programs could be under pressure to do something similar."

Merrill's buyback offer, meanwhile, comes after a year when the bank and brokerage suffered $19.2 billion of losses.

Denise Voigt Crawford, the Texas securities commissioner, late on Thursday said state regulators are examining auction-rate practices of 11 banks and brokerages in addition to Citigroup, and that she expects more settlements soon.

Richard Blumenthal, Connecticut's attorney general, in an interview said he hoped the Citigroup settlement "sends a very compelling message that others should follow Citigroup's example and do the right thing."

Auction-rate debt has interest rates that reset through periodic auctions, typically held every seven, 28 or 35 days.

Once thought safe, much of the market has been frozen since Wall Street brokerages stopped supporting the debt. This led to higher borrowing costs for state and local governments, hurting taxpayers.

Late on Thursday, Bank of America Corp, the largest U.S. retail bank, said it received subpoenas from federal and state regulators over auction-rate debt.

Meanwhile, STMicroelectronics NV this week sued Credit Suisse Group AG, saying the bank invested $450 million of the chipmaker's cash in auction-rate debt without permission. A Credit Suisse spokesman declined to comment.

DOING CONSUMERS JUSTICE

Regulators said Citigroup would buy back auction-rate debt from about 40,000 retail customers, charities and small or mid-sized businesses by November 5. Citigroup agreed to fully reimburse retail investors who sold the debt at a loss.

The SEC said the bank would also use its "best efforts" to liquidate, by the end of 2009, an additional $12 billion of the debt held by more than 2,600 institutional investors.

New York and the North American Securities Administrators Association will split Citigroup's $100 million fine.

Cuomo had accused Citigroup of wrongly telling customers the debt was safe, liquid and the equivalent of cash.

"This is not just a Wall Street issue, this is a Main Street issue," Cuomo said at a news conference.

He said Thursday's settlement "will help restore confidence in this market," and added, "It does justice for consumers."

Merrill said its buyback covers more than 30,000 clients.

"Our clients have been caught in an unprecedented liquidity crisis," Chief Executive John Thain said. "We are solving it by giving them the option of selling their positions to us."

Massachusetts' top securities regulator, William Galvin, plans to continue pursuing his lawsuit accusing Merrill of fraud in marketing the debt, a spokesman said.

Cuomo said he would review Merrill's plan.

New York and Massachusetts also have accused UBS of fraud in marketing the debt. UBS spokeswoman Karina Byrne said the Swiss bank was working with regulators toward "a comprehensive solution" for investors in auction-rate debt.

Citigroup and Merrill said their buyback offers would not materially affect capital. Citigroup said it has liquidated more than half its retail clients' auction-rate holdings, while Merrill said it has liquidated more than 40 percent.

The settlement by Citigroup follows costly and embarrassing scandals the bank faced earlier this decade, including inflated stock research, its Japanese private bank, a rogue bond trade in Europe, and the collapses of Enron Corp and WorldCom Inc.

In Thursday trading on the New York Stock Exchange, Citigroup shares closed down $1.23 at $18.47, while Merrill fell $2.40, or 8.4 percent, to $26.10.

JUST ONE MORE PROBLEM

Citigroup has incurred more than $58 billion of write-downs and credit losses since mid-2007 as the housing market deteriorated and capital markets seized up, causing losses on subprime mortgages and other risky debt.

"It's just one more product that's blown up in the face of the investment banks," said William Smith, president of Smith Asset Management Inc in New York. "The problem is they've got to take all these billions of dollars on the balance sheet."

Citigroup was the largest underwriter of auction-rate debt in all but one year this decade, Thomson Financial data show. Merrill ranked among the top 10 underwriters each year.

Analysts said the auction-rate market might struggle to regain its equilibrium.

"You used to just see the rating and take things for granted," said William Bellamy, director of fixed income at Thompson, Siegel & Walmsley in Richmond, Virginia. "People have to do a little bit more due diligence."

(Additional reporting by Elinor Comlay, Joan Gralla, John Parry, Walden Siew, Jonathan Spicer and Dan Wilchins in New York; Murali Anantharaman and Scott Malone in Boston; John Poirier and Rachelle Younglai in Washington, and Duncan Martell in San Francisco; editing by John Wallace, Braden Reddall and Carol Bishopric)