Bonds News

Lifting the Lid: Auction-rate debt tying up corporate cash

NEW YORK, Jan 24 (Reuters) - Corporate finance managers are starting to find themselves cash-strapped by one of the very financing tools they use to manage cash flows.

Auction rate securities, debt instruments once touted as a highly liquid cash management strategy, have been hit by the credit crunch and are failing to attract bidders. For companies, the result is that cash once thought to be readily accessible may be locked up indefinitely.

Auditors and regulators are also growing concerned that companies may not be telling investors properly about their exposure to the vehicles.

In the past few months, companies including, ADC Telecommunications Inc ADCT.O, 3M Co MMM.N, and STMicroelectronics STM.PASTM.N, have recorded, or said they expect to record, impairment charges ranging from $8 million to $46 million due to auction rate securities, and analysts that could become a more common scenario.

“What was intended to be a highly liquid asset now has to be treated as something more akin to plant property and equipment,” said Adam Dean, president of SVB Asset Management, which manages corporate cash accounts. “It’s not tradable , and companies are realizing they have a problem on their hands.”

Auction-rate securities are municipal bonds, corporate bonds, and preferred stocks whose rates, or dividend yields, reset through periodic “Dutch auctions.”

In the auctions, which typically happen every 7, 28, or 30 days, investors enter a blind competitive bid process to set the rate on the securities, allowing the current holders to liquidate for cash if they want to.

But as the collapse in subprime mortgages has hurt the credit markets, demand for auction-rate securities has been drying up.

“It’s truly an auction and if there aren’t buyers coming to the market the auction can fail,” Dean said. “If the auction fails, you end up holding something that is highly illiquid and it is something you will certainly lose principal with if you sell it in between auctions.”

Some 60 auctions have failed in recent months, representing about $6 billion in tied-up assets, according to Peter Crane, president and CEO of Crane Data LLC, which tracks the market for mutual fund managers.

“The ones that have failed continue to remain in limbo,” Crane said. “They just keep on failing and I haven’t heard of any auctions that have been resuscitated or where a dealer has stepped in and said we’re going to revive this structure.”


Companies typically classify auction rate securities as “highly liquid” and say as much in their regulatory filings, but investors should be wary that it may no longer be the case.

“I’ve heard CFOs say, ‘These were marketed as securities that never fail’,” Dean said. “There are auctions out there right now that have not failed, but there’s nothing implicit in those to prevent them from failing.”

Some companies have claimed they were misled about auction rate securities, or never intended their funds to be invested in them in the first place.

STMicroelectronics said a financial institution investing on its behalf placed its funds in auction rate securities without authorization. Also, wireless operator MetroPCS Communications Inc PCS.N has sued Merrill Lynch MER.N in Texas state court claiming it improperly lost money in auction rate securities.

Regardless of intent, some investors may not even be aware of companies exposure because many have misclassified the securities as cash equivalents on their balance sheets, when they should be marked as a short-term investment, or a long-term investment if it is impaired.

Officials at the U.S. Securities and Exchange Commission have begun notifying companies about improper classification of auction rate securities, according to Stephanie Hunsaker, associate chief accountant in the SEC’s Division of Corporation Finance.

“Auction rate securities are not cash or cash equivalents -- they are investments,” Hunsaker told accountants at a New York State Society of CPAs conference on Wednesday. She said impairments of the securities should make auditors give them a second look.

Deloitte & Touche [DLTE.UL], one of the Big Four accounting firms, issued an alert on its Web site this month telling its auditors that auction-rate securities “deserve particular attention,” and must be scrutinized for impairments. (Editing by Tim Dobbyn)