As if the past week didn’t provide enough déjà vu moments – e.g., rumors about another investment bank in distress (Lehman), trouble brewing at large commercial/retail banks (WaMu and Wachovia), monoliners on the ropes again (Ambac and MBIA), and Countrywide making the media rounds once more. As if that weren’t enough, now it seems auction-rate securities have reared their ugly heads again.

For those of you following this blog, several months ago I posted about the trouble that auction-rate securities pose to public corporations that have been holding them as short-term investments (see Where’s the Stuff Buried?).

As as a scholar who’s interested in firm strategy, I’m less interested in the fact that the auctions have been failing (and we all know that they have). Likewise, I’m not all that interested in the impact on those institutions (be they municipalities, non-profits, or other corporations) that raised funds using such variable-rate instruments. Rather, I have been interested in their impact on the investors/holders of these instruments, especially the large public corporations with which they were so popular.

Back in February, after Bristol Myers revealed that it would be forced to take a write-down of some $275M as a result of its investment in auction-rate securities, I wrote:

I do not mean to single out Bristol-Myers. Their only fault is that they just happened to be among the first firms to acknowledge the problem, thereby drawing attention. Come to think of it, maybe we should actually be applauding BMY for being proactive in recognizing the problem and writing-down those assets as quickly as possible in an effort to move past it. As such, they are likely ahead of the curve. Should that be the case, we certainly shouldn’t be surprised to see others follow in their wake…

Given what I had written back then, I was not surprised to see a recent Wall Street Journal article detailing additional stress in the auction-rate security market (see Auction-Rate Securities Give Firms Grief). In fact, according to that article:

…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.

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.

…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%…

Given the absolute seizure in that market and the level of insolvency of the underlying assets, my sense is that the average markdown will likely increase. My best estimate at this point would be for write-downs in the neighborhood of 20-30%.

Back in February, I also wrote that I thought that many corporate treasurers were not aware of the risks involved with such securities when they were purchased. Moreover, corporate finance staffs were (and are) likely ill-equipped to value them. In fact, I was quoted in an Associated Press article expressing similar sentiment:

Still, Robert Salomon, a professor at New York University’s Stern School of Business, said many executives likely were unaware of what they were buying. “I would expect to see corporate treasurers raise the question of: well, what the heck is in our portfolio?” he said.

Consistent with my view was the following nugget from the Wall Street Journal article:

“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.

Given how much further there is yet to go with the write-downs, and how many companies still have yet to recognize their losses, I still think this story has a little more to play out.

More déjà vu to come????

This entry was posted on Wednesday, June 4th, 2008 at 9:36 pm and is filed under Corporate Strategy. You can follow any responses to this entry through the RSS 2.0 feed. You can skip to the end and leave a response. Pinging is currently not allowed.