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Auction-Rate Securities Give Firms Grief


By: Liz Rappaport | May 26, 2008

The credit crisis is receding, but hundreds of U.S. companies still are struggling to clean up the problems caused by auction-rate securities.

A review of first-quarter earnings reports showed that more than 400 companies, including Google Inc., Bed Bath & Beyond Inc. and Starbucks Corp., held at least $30 billion in the securities, instruments they once thought were as dependable as cash.

Some companies have had to scramble for funds in the months since the market froze up in February. The securities also are creating an accounting problem for businesses not used to pricing complicated securities. While some companies have written down the value of their auction-rate holdings, many others haven't, even though market prices have fallen substantially.

CFOs Learn the Lesson

"There is not a CFO in the world that hasn't had a significant lesson on what auction-rate securities are this year," says Dario Sacomani, chief financial officer at Sunnyvale, Calif., semiconductor company Spansion Inc., which held $122 million in such illiquid securities that it hadn't marked down at the end of the quarter.

According to a study of earnings reports conducted by securities-valuation firm Pluris Valuation Advisors LLC, 402 public companies disclosed that they held variations of auction-rate securities. Half had written down the value of their holdings. Of those that did, the average markdown was 13.2%, the study shows.

Individuals and companies bought auction-rate debt from municipalities, charitable organizations, student lenders and closed-end mutual funds.

The securities are long-term debt with short-term features. Their interest rates are meant to reset in weekly or monthly auctions conducted by Wall Street brokers. Buyers were attracted to their relatively high yields and a promise from Wall Street of an easy exit from the instruments.

But in February, auctions failed to attract sufficient bidders. Wall Street firms stopped supporting the market, causing it to freeze up.

Spansion cites the high quality of government-guaranteed student loans that are collateral for the securities it holds as one reason it hasn't taken a charge. Another reason, Mr. Sacomani says, is that the company doesn't need to access the cash immediately.

"This is triple-A," he says.

Still, Moody's Investors Service cut the company's credit rating in late March to the lower rungs of junk with a negative outlook, and to the lowest possible liquidity rating, which is a measure of a company's access to cash.

Hands Tied

"It hampers your financial flexibility," says Gregory Fraser, senior analyst at Moody's, a unit of Moody's Corp. He says the company would have to take a "substantial discount" to sell its securities.

About 25% of the $330 billion auction-rate market has been bought back by municipalities or refinanced with a different type of debt, says Alex Roever, fixed-income analyst at J.P. Morgan Chase & Co. Those left, he adds, probably aren't worth their face value.

Barry Silbert, who runs the Restricted Securities Trading Network, which has arranged 200 auction-rate bond sales, says sellers have taken discounts ranging from 2% for municipal debt to 30% for student-loan-backed bonds.

Salt Lake City self-storage company Extra Space Storage Inc. sold its securities at the end of February at a 10.6% discount to their face value.

Biotech pharmaceutical company ImClone Systems Inc. took an $85 million impairment charge in the first quarter, $69 million of which came from auction-rate securities it marked down by 43%.

Bed Bath & Beyond, the home-furnishing retailer, took a temporary 2.2% markdown on $327 million of the securities; Google a 4.2% markdown on $260 million of the securities; and Jet Blue Airways Corp. a 3.4% impairment on $324 million of the debt. Starbucks took no impairment on $70.5 million of such debt.