Anderson defines failure more broadly, as the point when a dearth of bidders forces a dealer to “buy the last piece.” There’s no guarantee that dealers will rescue the auction, and Anderson reckons that there may come a day when the dealers will bow out, deciding that they were investing too much capital in the process and receiving too low a return.
To be sure, auction failures are rare. The last one occurred in 2002 after an ARS issue suffered a credit downgrade. Still, the ARS market has never weathered the kind of pressure it currently faces. In fact, corporate portfolio managers such as SVB and CAG are warning clients to think about liquidating their positions and avoiding investment in new ARS in the near term, at least until the effects of the SEC investigation and the accounting adjustment are understood.
Further, some CFOs might not like the look of their employers’ balance sheets after making the accounting change because the alteration reduces cash holdings. Pan speculates that the shift away from cash and cash equivalents may cause some companies to unintentionally break debt covenants tied to cash ratios.
As a result of the cut in cash balances caused by the bookkeeping adjustment, cash totals could drop below a debt covenant’s threshold. If that happened, the company would fall into technical default. Pan says that most lenders would rather help a healthy company work through a technical default than abandon them. Nonetheless, a broken covenant could be worrisome for marginal companies or ones in financial distress.
In any case, the accounting change is just “splitting hairs,” asserts Jack Ciesielski, the publisher of The Analyst’s Accounting Observer, a newsletter for the securities industry. “Any company that defaults over [the ARS accounting issue] is probably already in trouble,” adds Ciesielski.
Undaunted, So Far
Despite the ARS market’s troubles, however, corporate bond investors don’t appear ready to exit it just yet.
For example, with more than $1 billion currently invested in ARS, Comverse Technology is still bullish on them. In January, Comverse reclassified three years’ worth of the securities, with a value of $1.87 billion, as short-term investments. Despite the accounting change, the securities meet the company’s cash-management criteria in terms of liquidity, yield, and risk profile, according to company spokesperson Paul Baker. A balance-sheet reclassification “doesn’t change that,” he says.
Similarly, Edward Wilhelm, CFO of Borders, says that “given our short-term investment policy, ARS provided the best alternative [in terms of] risk/return for us over the last two years.”
Wilhelm hasn’t decided whether Borders will invest in ARS going forward. He says his team is evaluating cash-management strategies now, as the company’s need for short-term investments is seasonal and applies to the first calendar quarter of each year.
Small companies are weighing their ARS options, too. Steve Steinberg, CFO of GuruNet, which has a market capitalization of $12 million, likes ARS because they deliver “small increases in yields” relative to commercial paper. But Steinberg, who has most of the company’s $1 million of short-term investments tied up in ARS, says he hasn’t yet decided whether he will buy new bonds this year.
When executives do get around to making their choices over the next few months, however, the market and regulatory pressures being placed on the ARS industry will likely figure into the cash-management decisions they make. While no one’s predicting a run on the ARS market, smart corporate treasury managers that consider liquidity a prime investment directive will be careful not get stuck holding the bag — especially one that doesn’t mature for the next 30 years.