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AUCTION RATE SECURITIES VALUATION

Auction-rate securities (ARS) are financial instruments designed to provide a way to finance long-term obligations at short-term interest rates. ARS can be issued as either preferred securities with no maturity or long-term debt obligations with maturities typically greater than ten years. Through an auction process, interest rates adjust at predetermined periods, typically every seven, 28 or 35 days, with the frequent interest rate resets giving the security a risk-profile similar to a shorter-term security.

Liquidity versus Credit Issue. During the last year, the over $300 billion ARS market has come under considerable pressure. ARS are typically structured with a maximum interest rate that protects issuers by prohibiting auctions that would result in a rate higher than a specified level. Due to the current credit market environment and the lack of liquidity, many ARS issues have been “failing.” It is important to note that an auction failure does not denote a default in the security, but is merely indicative of a liquidity issue.

Not all ARS are alike in structure and collateral, making assessment exposure highly important. ARS have been issued in simple structures as the direct obligations of a non-profit or municipal issuer or as securities collateralized by pools of student loans. Other ARS have been issued by closed-end mutual funds as a way to enhance performance through leverage. More complex-structured ARS have been issued by captive insurance companies in order to meet statutory reserve requirements or by entities associated with monoline bond guarantors through a put right as a form of “contingent capital.” Other even more complicated structures may involve synthetic credit exposure through credit default swaps or be issued as collateral for credit derivative product companies (CDPCs).

FAS 157 stipulates that investments must be marked at the value at which an orderly transaction between market participants to sell the asset or transfer the liability at the measurement date. Due to the lack of an active market for such a transaction, there is a requirement for valuation by an independent third party. Houlihan has extensive experience valuing ARS for financial reporting purposes, arbitration & litigation, and in advisory roles. Houlihan’s approach involves a bottoms-up analysis of structure, collateral, and other risks.

Houlihan Smith has performed ARS valuations for some of the largest companies traded on the NYSE, AMEX & NASDAQ. We have most commonly seen and valued:

  • Student Loan Auction Rate Securities (“SLARS”)
  • Auction Rate Preferred Securities (collateralized by tax-exempt municipal bonds)
  • Complex Structured ARS (backed by CDO, CDO² and CDS)
  • Other

We also provide independent price verification services for our clients. Recognizing the need for quick turnaround, many of our clients rely on our verification services to validate internal valuation controls and review existing marks obtained from their broker to meet reporting deadlines.

For more information regarding our valuation and financial advisory services, please contact our ARS specialist, Karl D’Cunha at 312.499.5929 or kdcunha@houlihansmith.com