The auction rate securities (ARS) market is still frozen more than a year after many public companies were stuck with illiquid holdings on balance sheets, although there are some indications that a thaw is under way. The freeing up of this market may be the true sign of an end to the financial crisis. (Read Dialing In On The Credit Crisis for a refresher on events leading to the crisis.)
Auction rate securities are instruments issued by corporations and other entities. They have a long-term maturity date, but they pay an interest rate that resets on a short-term basis, typically in less than 35 days. This type of security appealed to issuers because they could pay a lower, short-term yield and not have to worry about rollover risk.
Auctions Failed
Many investors bought these securities thinking they were the equivalent of a money market instrument, and thus highly liquid. However, during the early days of the financial crisis, when it was time to reset the yields, there weren't enough bidders and the auctions "failed". This meant that holders were stuck with the securities until conditions in the credit market returned to normal.
After the auctions started to fail, the holders were required by accounting rules to move the asset to the non-current asset segment of the balance sheet.
Companies Holding Significant ARS Amounts
Many companies still hold significant ARS amounts on balance sheets. Bed Bath and Beyond (Nasdaq:BBBY) had more than $200 million in long-term investment securities in its most recent quarter. Last year, the company reported that in the first fiscal quarter of 2009 (ended May 31, 2008), it owned $322 million of par value in these securities.
JetBlue Airways (Nasdaq:JBLU) is another company caught holding these illiquid securities. The company had $221 million worth on its balance sheet, and it took an $8 million charge against net income due to a decline in the securities' value. JetBlue was able to sell some of its holdings during the quarter and reduced the total by $29 million. This would seem to indicate an increase in liquidity in the marketplace.
At the end of the Q1, Lattice Semiconductor (Nasdaq:LSCC) had $19.6 million in long-term marketable securities, some of which were auction rate securities. A company must also write down the value of these investments if necessary, and Lattice recorded an unrealized loss of $7.9 million when the market froze up back in Q1 2008.
Banks Being Sued Over ARS
Some of the banks that sold these securities to investors have paid the price as well. Bank of America (NYSE:BAC) just settled with investors in Missouri and bought back $400 million in auction rate securities from them.
Wells Fargo (NYSE:WFC) was recently sued by California for the bank's role in the auction securities market. The state claimed that Wells sold them to customers as liquid and as safe as cash.
Final Thoughts
Market pundits spend much time deciding when and if the "financial crisis" is over. It might be illuminating for them to look at the liquidity situation in the auction rate securities market, consider it an indicator of credit conditions and incorporate it in their analysis.
