Of 242 firms with disclosed auction-rate holdings, fewer than half have owned up to their losses
So far this year, companies with exposure to auction-rate securities have provided a litany of mea culpas in their quarterly filings with the Securities and Exchange Commission, and approximately 50% of those companies have taken impairment charges on the value of their illiquid securities. But that raises questions about why more companies holding auction-rate securities have not yet marked down their value.
According to data compiled by Pluris Valuation Advisors, which specializes in valuing illiquid securities, 119 of the 242 companies that have thus far disclosed exposure to auction-rate securities had taken an impairment charge as of mid-May.
"You would've expected to see many more companies taking impairment charges, that the reality would start to sink in," said Espen Robak, president of New York-based Pluris. "But there's been a great amount of differing viewpoints on how to analyze these securities."
Auction-rate securities are long-term bonds turned into short-term investments via interest rates that are reset every seven to 49 days in a Dutch auction process. The $330 billion market began experiencing disruptions last fall, and froze in February when most of the major dealers stopped backing the auctions.
That left companies that had invested in the illiquid paper with a lot of questions about what to do with it. "We're seeing examples of some that are being proactive, taking charges and writing them down, and others that are not doing that," said Charles Mulford, professor of accounting at Georgia Tech.
Auction-rate securities used to be accounted for as cash equivalents. But in 2005, the major accounting firms decided to reclassify the securities as short-term investments, which are generally due in one year or less. Other than that, "there's no guidance that speaks directly to this issue," said Jeremy Perler, co-head of accounting research at RiskMetrics Group, a risk-management firm. That's left each company stuck holding ARS and its auditor with a decision about how to handle the accounting for the securities.
Auction-rate securities come in myriad structures, each backed by different underlying collateral and paying a different penalty rate when auctions fail, factors that could lead auditors to offer companies varying advice about how to account for the failed securities, said Mr. Mulford.
Companies that held auction-rate paper backed by collateralized debt obligations, for example, had little hope of recovering their money and were more likely to take a charge. That happened at Bristol-Myers Squibb, whose ARS have a par value of $807 million. The company has taken $456 million in impairment charges, $300 million of which were permanent.
Companies that have thus far decided against an impairment charge may think a restructuring of the debt within a year is a possibility, suggesting that it's appropriate to continue to hold the securities in the short-term investment category of their balance sheets. Or perhaps they are holding ARS in which the credit quality of the underlying securities has not been affected, so companies may expect to get the full value of their investment back at some point, even if it is 30 years from now.
That was the case at Texas Instruments, which at the end of last year had $1.04 billion in ARS, most of which were backed by student loans. In the first quarter, the company was able to sell $473 million of the securities before the market tanked, and it took a $20 million unrealized loss charge on the illiquid securities. That left it with $551 million in ARS, which it reclassified as long-term investments. A Texas Instruments spokeswoman said the firm did not expect to take a charge on the illiquid securities, but added, "In today's environment, you can never say never."
The question of whether or not to write down often comes down to the culture of the firm, said James Cox, professor of securities law at Duke University. "I think some people act opportunistically, some people act optimistically and some people act fairly."
And perhaps some act fearfully. CFOs and treasurers could worry their boards, not to mention shareholders, will call for their heads in the wake of a big impairment charge. That happened at Bristol-Myers, where several members of the treasury department, and ultimately, the CFO, Andrew Bonfield, were fired over the matter.
"A reluctance to take a charge, while it shouldn't play a role, probably does" said Mr. Mulford.
Regardless of how a company decides to account for ARS, "you would at least hope that they had an interesting conversation with their auditors," Mr. Cox said. To ensure that is the case, George Diacont, director of inspections at the Public Company Accounting Oversight Board, recently told Reuters the audit watchdog would keep an eye on how auditors handle the treatment of ARS this accounting season.
Going forward, companies will probably be much more forthcoming about their exposure to auction-rate securities. Mr. Perler noted that until the market stalled, many companies did not disclose they held such securities. Bristol-Myers, for instance, made no mention of auction-rate securities in SEC filings prior to the announcement of its write-down, he said. "Often these things happen backwards; something happens, and then you get the information."