Now that Citigroup (C) and Merrill Lynch (MER) have announced that they will buy back auction-rate securities sold to their private clients, the question arises about how financial companies with weaker balance sheets will handle this. Merrill will purchase as much as $12 billion of the paper and Citi is taking in over $7 billion.

One of the hard-up banks which has a significant auction-rate exposure is Wachovia (WB). About two weeks ago, securities regulators from several U.S. states, investigating Wachovia Securities’ auction rate securities sales practices, went to the company’s St. Louis headquarters and requested its documents and records.

According to MarketWatch, "There are now about two dozen lawsuits pending against brokerages, and regulators in at least nine states are examining how investment firms marketed the securities."

Research firm Morgan Keegan recently said that Wachovia faces "increasing credit losses. The losses are due to the bank’s high concentration of option adjustable-rate mortgages and commercial real estate loans, which are likely to continue defaulting at an increasing rate."

If Wachovia is forced to buy-in $10 billion in auction-rate securities at the same time it has to book mortgage losses, Wall St should wonder whether the bank’s balance sheet can stretch to accomplish both?

Douglas A. McIntyre

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