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Auction-Rate Market Winners And Losers
By John Carney
As Credit Market Woes And Accounting Changes Drove Buyers Away, Some Firms Got Stuck Holding The Bag
Earlier this morning we discussed how changes in the way accounting rules treated auction-rate securities helped drive corporate investors out of the market. (For a rousing debate of exactly which accounting changes stamped out demand, click here.) Credit market concerns and the changes in the way auction-rate securities are treated on cash flow statements contributed to the rush out of the securities by bringing additional scrutiny to the once obscure financial instruments. At the end of 2007, many companies made the decision to shift assets out of auction rate securities as these changes were implemented for the new fiscal year.
The Apollo Group owned as much as $365 million in ARS at the end of 2007, according to a recent filing. But by February 19, 2008, all but $107 million of the ARS investments had been liquidated and not reinvested in the ARS market. Apollo says this well-timed exit was part of a plan to intentionally reduce its exposure to the auction rate securities, although they do not reveal what prompted the exit. The timing wasn’t perfect, however, and Apollo found itself unable to liquidate approximately $79 million in ARS due to auction failures.
Despite not completely exiting the ARS market, we’ll count Apollo a winner. So who’s still holding the securities? After the jump, we reveal two companies trapped by the auction failures.
When turmoil in the credit markets began to impact a wide variety of credit products, some companies engaged financial advisors to assist in determining the fair values of investments that they had once considered as good as cash. US Airways, for instance, held auction-rate securities worth $411million at par value was advised that the fair value was only $353 million, a decline of $58 million, according to the 10-K filed today. With the help of outside financial advisors, they determined that most of this was only a temporary impairment. The only portion of the write-down that seemed lasting was $10 million from auction-rate securities linked to subprime.
But in late January, the commercial banks managing US Airways auction-rate securities warned them that the fair value was likely to decline. According to the banks, the fair market value decline was closer to $70 million. US Airways concluded, however, that most of this was also just a temporary impairment, and decided to hold onto its investments unless the market deteriorates further. In the coming weeks, of course, the auction failures became even more wide-spread. US Airways has not disclosed whether it has re-evaluated its position.
Others corporations were spooked by the credit market deterioration and early auction troubles. Often they were tipped off by the banks managing their accounts that the auctions were failing or very close to it. When they ran for the exits, the auctions failed dramatically, with sellers vastly outnumbering buyers for the securities. For a time, the banks stepped in to support the market but withdrew their support when the balance sheet strain become too much.
Some corporations and individual investors were left holding the bag, so to speak. This morning, Continental Airlines revealed in an SEC filing that it got stuck holding $314 million in auction rate securities. Apparently all of the auctions for the ARS held by Continental were successful in January, but in February auctions involving $128 million failed. Continental seems to have a slightly less active risk management policy and less attentive bankers. Unlike US Airways, it does not record any impairment to these investments on its 10-K and was apparently not warned by its bankers that the fair market value of these investments had declined. Continental continues to account for about a quarter of its auction rate securities as “restricted cash.”
As additional companies report earnings, we should learn even more about who got out early and who got stuck holding the auction-rate securities.