Their staff was great to work with, delivering a thorough, well-written report in a timely manner, with excellent follow-up throughout.

Victoria Kaempf
Lakin Spears, LLP

Auction-Rate Losses Cost Google, UPS $1.8 Billion


By: Michael McDonald and Jeremy R. Cooke | May 18, 2008

The collapse of the auction-rate bond market is costing shareholders of companies from Google Inc. to Royal Bank of Canada more than $1.8 billion in investment losses.

Google, owner of the most popular Internet search engine, reported on May 12 that it lost $10.8 million on $259.6 million it had invested in the bonds, marking down the debt by about 4 percent. Royal Bank of Canada, that country's largest lender, told shareholders on May 14 that the value of its investments fell by $185 million.

More than 300 companies are struggling to value auction- rate bonds after dealers battered by subprime-related losses abandoned the $330 billion market in February, said Barry Silbert, chief executive officer of New York-based Restricted Stock Partners, which operates the largest trading system for the securities. About half the companies reported losses totaling $1.8 billion as the market for the securities, sold as higher-yielding alternatives to money markets, seized up.

"We've seen a real acceleration in the number of companies announcing they hold them, and also a greater portion of them taking writedowns," Silbert said.

Companies owned $98 billion of the securities on Jan. 1, according to a survey by Treasury Strategies Inc., a Chicago- based firm that advises treasurers on managing their cash. Treasurers bought the bonds instead of money-market funds and U.S. government bills, expecting to earn about 0.25 percentage point in additional yield, the Association for Financial Professionals said in a report last year.

Auction Failures

Rates on the bonds and preferred shares sold by municipal governments, student-loan organizations and mutual fund companies are determined by bidding every seven, 28 or 35 days. If demand is insufficient, the auction fails and some holders are left with securities they wanted to sell. The issuer gets stuck with a penalty rate as high as 20 percent. In some cases, the rate can temporarily drop to zero.

The market collapsed three months ago when investors soured on the securities because of concerns about the creditworthiness of bond insurers backing the debt. As demand waned, dealers that supported the market for 20 years suddenly stopped acting as buyers of last resort. About 98 percent of the student-loan and closed-end fund auctions and 48 percent of the municipal bids failed last week, data compiled by Bloomberg show.

Unprecedented Situation

United Parcel Service Inc., the world's largest package- delivery company, said in a May 9 filing with the U.S. Securities and Exchange Commission that it wrote down the value of $383 million invested in auction-rate bonds by $33 million.

"As a result of the persistent failed auctions, and the uncertainty of when these securities could be successfully liquidated at par, we have reclassified all our investments in auction-rate securities to non-current marketable securities," the Atlanta-based company said.

"This is an unprecedented situation," said Jeff Glenzer, a managing director at the Association for Financial Professionals, a 16,000-member trade group in Bethesda, Maryland. "There's not been a default but there's a complete loss of liquidity."

While Google's auction-rate securities "are primarily student loans which are substantially guaranteed by the U.S. government," they "do not have a readily determinable value and are not liquid," the Mountain View, California-based company said in SEC filings.

'High Credit Quality'

The securities are of "very high credit quality," Andrew Pederson, a Google spokesman, said in an e-mail, adding that they "represent a small percentage of our overall portfolio."

Hill-Rom Holdings of Batesville, Indiana recorded an "unrealized loss" of $1.5 million on its balance sheet and said it believes it will convert its $48.6 million in auction- rate securities into cash within the next 12 months. Companies don't have to book the loss in their income statement if the writedown is considered temporary, according to Espen Robak, president of Pluris Valuation Advisors LLC in New York.

HCA Inc., the largest U.S. hospital chain, said in a May 12 filing with the SEC that the "best estimate of fair value" for the $661 million in auction-rate securities it holds was at par, or 100 cents on the dollar, because the underlying credit quality of the bonds is unchanged and expects they will be refinanced.

Municipal borrowers, which make up about half the market, are replacing at least $68 billion of auction-rate bonds by July 7, according to data compiled by Bloomberg. Mutual fund firms redeemed $3.8 billion in so-called auction-rate preferred securities and announced plans to pay off another $16 billion.

JPMorgan, Teva

JPMorgan Chase & Co. shareholders may wind up with several hundred million dollars of writedowns on auction securities, Chief Executive Officer Jamie Dimon said last week at a conference in New York sponsored by UBS AG.

Royal Bank of Canada held $4.6 billion of auction-rate debt as of Jan. 31, most from student lenders, according to Beja Rodeck, a spokeswoman for the Toronto-based company.

Teva Pharmaceutical Industries Ltd., the world's biggest maker of generic drugs, said May 6 it was taking a $55 million charge for its auction-rate securities, which totaled $334 million as of March 31. Bristol-Myers Squibb Co. said Jan. 31 that it booked an unrealized pretax loss of $142 million on $811 million. The New York-based drugmaker's treasurer, Edward Dwyer, was subsequently replaced.

Near the End?

Gerdau Ameristeel Corp., a Tampa, Florida-based steelmaker, posted a $22.7 million first-quarter charge on $105 million of investments.

"We would hope this market begins to have some more liquidity and that this would be the end of it," Barbara Smith, the company's chief financial officer, said on a May 12 conference call.

The market is so toxic that companies are going out of their way to tell investors when they don't own auction-rate debt.

"The company does not have any auction-rate securities in its investment portfolio," Seattle-based Alaska Air Group Inc. said in a March 25 SEC filing.