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Companies holding auction rate securities suffer

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By: Aline van Duyn | June 17, 2008

Companies across the US are expected to feel the effect of credit market turmoil on their bottom lines in the second-quarter earnings season, with experts expecting greater writedowns and losses on illiquid auction rate securities.

In an example that could be repeated elsewhere, Aventine Renewable Energy, an Illinois-based operator of ethanol plants, recently slashed $30m off the value of $127.2m of student loan auction rate securities (ARS) that it owned, selling them for $97m.

"The Aventine sale is an important marker in terms of the discounts that companies may have to take on ARS holdings," said Espen Robak, president of Pluris Valuation Advisors.

The $330bn ARS market was routinely used by companies looking to park their cash in liquid, highly rated securities that offered slightly higher yields.

The collapse of the market earlier this year as banks withdrew support from the sector amid a loss of confidence in guarantees provided by bond insurers has left companies and other investors holding illiquid securities with long-term maturity profiles.

ARS were designed to appeal to investors seeking short-term debt by resetting interest rates, in some cases weekly and in some cases monthly.

Hedge funds and other buyers of distressed assets are lining up to buy the securities but often at a large discount.

The student loan ARS sector, worth about $80bn, remains an especially problematic segment of the market and this could persist because it is difficult for the student loan providers to refinance elsewhere.

In the municipal and closed-end fund ARS segments, holders have been bought out in many cases.

Many of the student loans in the deals are backed by a US government guarantee and retain top triple A credit ratings. The loss in value reflects illiquidity.

The problems were unexpected. In February, when the ARS market first imploded, Aventine executives said they did not believe their triple A rated ARS should trade at a discount.

The company then relented and announced on June 13 that it had completed the sale at a loss.

The actions by Aventine, which has a market capitalisation of just more than $180m, are one example of a debate that is occurring in finance departments and in boardrooms across the US.

At least 400 listed companies have revealed that they own ARS, although in many cases there has been no loss taken on their value. Some companies in Europe also own the securities.

"What has happened in ARS is one of the most dramatic pauses in a widely used market that we have seen so far," said Timothy Batchelor, managing director at Duff?&?Phelps. "How this plays out will be a precursor for the valuation of other credit instruments."

Although the issue will come up in the second-quarter earnings, it is likely to persist for some time yet.

"This will continue to be an important issue for much of 2008," said Tom Deutsch, deputy executive director of the American Securitization Forum.