Companies' Cash-Like Holdings Pose Risks

deltawatch

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Aug 20, 2002
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Companies' Cash-Like Holdings Pose Risks (AP)
As Corporate Losses Mount From Higher-Yielding Bonds, Investors Struggle to Identify Risks

As corporate losses mount from investments that until recently seemed as safe as cash, shareholders are in a pickle: They don't know the severity of the problem or which companies are affected.

So far, Bristol-Myers Squibb Co., US Airways Group Inc., Qwest Communications and others have disclosed multimillion-dollar losses on a common type of higher-yielding bonds marketed as short-term and low-risk.

Such descriptions for these investments, known as auction-rate securities, were at best wishful thinking in the era of easy credit that helped fuel the housing boom. But as credit tightens on Wall Street and around the globe, it has become extremely difficult for companies and wealthy individuals to sell these securities, which are backed by mortgages, student loans and municipal bonds.

"The problem is quite widespread," said Lance Pan, director of investment research at Capital Advisors Group Inc. in Newton, Mass. "There will be more confessions to be made by large corporate investors."

For years the securities were attractive to investors because they offered a slightly better return than ultra-safe investments such as Treasury bills at a time when interest rates were relatively low. Over the past week, however, there have been barely any buyers in the more than $300 billion market as investors have shied away from all but the safest places to put their money.

Since some of these investments are backed by troubled bond insurers, investors have been particularly queasy. Hundreds of auctions have failed over the past week, driving up the interest rates for securities that do get auctioned off. That makes it more expensive for municipalities to raise money through bond sales.

Investors' growing aversion to auction-rate securities doesn't mean the assets underlying them are worthless; but the companies that own the securities are increasingly under pressure to acknowledge in future financial statements that their value has dropped. Auction-rate securities can be held by mutual funds, but not money-market funds.

Wall Street's inability to attract investors for these securities is also a big problem for government agencies selling the debt, including student loan programs in Michigan and Montana, and the operator of airports, tunnels and ferries in New York and New Jersey.

After a failed auction on Tuesday, the Port Authority of New York and New Jersey has had to temporarily pay interest rates of 10 percent or more while it looks for other ways to sell bonds to avoid these high interest costs.

Jeff Glenzer, a managing director of Association for Financial Professionals, a Bethesda, Md. based trade group for corporate financial officers, said the problems in the auction-rate market reinforce a time-honored saying: If something looks too good to be true, it probably is.

Alarms were sounded about risks in the auction-rate market long before the latest flare-up. The Securities and Exchange Commission in May 2006 fined 15 Wall Street firms $13 million to settle charges that they had manipulated the market.

Still, Robert Salomon, a professor at New York University's Stern School of Business, said many executives likely were unaware of what they were buying. "I would expect to see corporate treasurers raise the question of: well, what the heck is in our portfolio?" he said.

Companies are not required to break out the details of these investments and typically only do so if they go bad. That presents a puzzle for financial analysts trying to get a handle on the problem.

Merrill Lynch analyst Tai Liani in January published a report examining 190 technology companies for their exposure to risky short-term investments, and found that 44 had invested some of their cash in riskier assets. However, Liani noted in the report that limited disclosures "make it virtually impossible for us to assess the quality of the underlying assets."

Last fall, US Airways warned in an SEC filing that $411 million of its $3.13 billion in cash and short-term investments was tied up in auction-rate securities that did not find buyers in auctions. The company warned that -- if it needed the money -- it would have to sell the debt at below-cost and estimated the securities' value at $373 million. Last month, US Airways took a $10 million charge on the securities.

LINK
 
I'm speaking as a financial novice here, so take it for what it's worth. My gut feeling, at least for now, is that our profits since the US/AW merger have all been the result of "fuzzy math" and crisis management. Might we be the "Enron" of the airline industry?
 
In the simplest of terms, here's what this means:

US Airways parked their money in bonds (debt) that were secured by mortgages banks and other financial insitutions were holding. Because of the tightening of credit, which was set off by the sub prime credit issue, that debt is now not worth what US Airways paid for it. On top of it not being worth what US Airways paid for it, it's worth, potentially, a small fraction of the $411 Million that was parked there since it's unmarketable. In other words, if US Airways needed that cash tomorrow, they can't get it.....because no one wants to buy this type of debt.

Remember, on a balance sheet, one person's liability is another person's asset. So, if I have a mortgage for $250,000...I have debt for $250K and a bank has an asset, something that has cash value, of $250K PLUS the reasonable amount of interest they hope to collect.

Banks can sell those assets (my mortgage) to other people or companies, like US Airways.

If suddenly, (a.) people stop paying their mortgages in mass and (b.) banks tighten credit and lending, that asset becomes SIGNIFICANTLY undervalued.

Translation: The cuts on glassware and FF programs may well not be due to fuel, but instead may be tied to this mess (and LOTS of companies have this mess) as well as management ineffeciencies....like Envoy seats that added 200 lbs per seat to the envoy cabin....or part that have to be air taxied into PHL from DTW because US doesn't have a good replacement parts system.

All of this stuff is cumulatively not good....and then it's the employees and pax the company decides to leverage off.
 
In the simplest of terms, here's what this means:

US Airways parked their money in bonds (debt) that were secured by mortgages banks and other financial insitutions were holding. Because of the tightening of credit, which was set off by the sub prime credit issue, that debt is now not worth what US Airways paid for it. On top of it not being worth what US Airways paid for it, it's worth, potentially, a small fraction of the $411 Million that was parked there since it's unmarketable. In other words, if US Airways needed that cash tomorrow, they can't get it.....because no one wants to buy this type of debt.

Remember, on a balance sheet, one person's liability is another person's asset. So, if I have a mortgage for $250,000...I have debt for $250K and a bank has an asset, something that has cash value, of $250K PLUS the reasonable amount of interest they hope to collect.

Banks can sell those assets (my mortgage) to other people or companies, like US Airways.

If suddenly, (a.) people stop paying their mortgages in mass and (b.) banks tighten credit and lending, that asset becomes SIGNIFICANTLY undervalued.

Translation: The cuts on glassware and FF programs may well not be due to fuel, but instead may be tied to this mess (and LOTS of companies have this mess) as well as management ineffeciencies....like Envoy seats that added 200 lbs per seat to the envoy cabin....or part that have to be air taxied into PHL from DTW because US doesn't have a good replacement parts system.

All of this stuff is cumulatively not good....and then it's the employees and pax the company decides to leverage off.

Good explanation.

Actually the bank owns the debt as well as the future stream of cash over time, your house payments. The banks sells this stream of cash (and debt) to someone at a discount just like those commercials on television that offer to buy your "structured settlement". The discount is figured depending on the risk, the market conditions for liquidating (re-selling), the "worth" of the cash stream. It is like musical chairs, when the music stops, as it has, we all found out there were a lot less chairs than players, exacerbating the situation.
 
The airlines are not the only investors guilty of buying into this stuff. We are just an industry that is more susceptible to problems when there is a loss of liquidity. If jet fuel shoots up in price again, we can't buy any on a "promise to pay you back next week." Over the past few years, the fuel suppliers have been royally burned by easy credit arrangements with airlines who then abrogated that debt in bk court. I'm not pointing fingers. Some not in bankruptcy forced "debt restructuring" arrangements on suppliers.

It's ok to put a pile of money that you can afford to lose into higher risk investments, but not the money that you need to run your business. A good old-fashioned savings account or a CD might be the better choice. :lol:

The thread title is more telling than perhaps the op intended. "Cash-like" is not the same as cash.
 
Well, this article finally made the entire Valentines day ugliness make some sense....and it really didn't make sense prior to this article and some other information I came across.

First off, when a company is in a "low margin" business, and EVERY AIRLINE is a "low margin business," this stuff is a real, bonified, UGLY threat. I had NO idea US Airways was leveraged in this stuff. To be fair, LOTS of businesses and companies are. At the end of the day, it's the banks that sold this crap...and then subjected comapanies like US to it.

But $411 Million in "cash" is put in....and likely done to get a better return then a CD. The company warned, then wrote off $10 Million...and I will guarantee you this, with a 110% degree of certainty, more "write down" on that cash is coming. I won't be too, too surprised it as much as $75 million is written off. Now, remember, in a good year, the profit was, what, $300 million? $75 million is a friggin chunk, I tell ya.

Next, the Envoy seats....200 lbs more in weight, per seat, then the old seats. That's 3,600 lbs in added weight flying back and forth every day, on 10 airplanes. I'm not a pilot, but I do know that will add to the fuel bill.

So the real question is, "how the hell did that happen? How do we have these larger, heavier seats...that don't fit and are already being destroyed by roller boards and service carts?

Well, as I understand it, several corporate clients said, "fix your airplanes, FAST, or we're not booking on you any longer." So, fast repairs done....and this is what you get.

Next, parts....the situation in PHL is still a mess...and a small fuel valve for an A330 jet, which would cost $8.00 is not available....where's a spare part? DTW, Northwest Airlines has one US can buy....for $8.00....but the problem is, that part isn't in PHL, it's in DTW...and the air taxi ride for it was $7,000....I wonder how many times a week that happens????

Next, winglets, at least for the B752s that are gonig to be around. It's estimated the investment into winglets, which aren't cheap, is 11 to 17 months, depending on how the aircraft is deployed.....and the company says, "we're looking at it....and think we can have it done in 5 years." :shock: Think about this: If it were done a year ago....when the company was making GOOD money, then in this "difficult 2008 environment," the company could ALREADY be saving $25 million (or more) in fuel.

And there's more....

But all of this makes me wonder: The management team is in charge of overseeing, managing and directing the big picture. And they get paid for it, well I might add. And this is what you got: A highly paid management team that has quite literally f-ed up a number of issues that can or should have at least been addressed....and they will still get their bonuses. (Unless I were on the board in charge of compensation)

On top of that, when it comes to realizing there are major problems looming...like a debt investment that could literally cost $70 million, the answer is to "go take it to the people, no raises and while you're at it, tell the bread and butter of our industry, the business traveler, they too are going to pay for our oversights."

To me, thats horse hockey....
 
Van,

Your comments are right to the point. And I refuse to give them any more of my money to give me less while they can't manage an airline of this size. I am no longer subsidizing their constant mistakes and the high cost of cheap.
 
Van,
Thanks for putting this all in layman's terms for those of us that didn't get business degrees in college. :)


After reading all this, am I the only one that gets the feeling that the elimination of glassware and the "revamping" of the dividend
miles program is just the tip of the iceberg in the way of impending cuts? Why do I get the distinct impression that there may be much
more to come? :blink:

The effects of the subprime mortgage mess will be felt by many people for a very long time I'm afraid.
 
Van,
Thanks for putting this all in layman's terms for those of us that didn't get business degrees in college. :)


After reading all this, am I the only one that gets the feeling that the elimination of glassware and the "revamping" of the dividend
miles program is just the tip of the iceberg in the way of impending cuts? Why do I get the distinct impression that there may be much
more to come? :blink:

The effects of the subprime mortgage mess will be felt by many people for a very long time I'm afraid.

Be VERY confident of two things...

First, the glassware and "enhancements" to the DM program had MUCH less to do with fuel then the management team lead on to. This was all about panic and "holy smokes, we have SERIOUS cash flow issues ahead." Again, in the really big picture, this one incident, the write down of $411 million, won't be any sort of finishing blow, but that along with the cumulation of multiple other "questionable" (at best) decisions by this management team will continue to haunt employees and customers for quite a while.

Second, the sub prime issue will be in the rear view mirror within 2 years....its a "big deal," but it's only a matter of deciding who takes the hit and then move on. Don't buy into all this media hype that "the world is coming to an end" or that we all should learn Chinese as a second language...it's not true.
 
Second, the sub prime issue will be in the rear view mirror within 2 years....its a "big deal," but it's only a matter of deciding who takes the hit and then move on. Don't buy into all this media hype that "the world is coming to an end" or that we all should learn Chinese as a second language...it's not true.
For overview and great comments about the subprime mess:

Calculate Risk

Hopefully the mess will be behind us in two years, when the last of the variables get, um, massaged, however I think that may be rather optimistic considering the economic hole we have dug over the last seven years.

For a quick and dirty look at what happened (a few eff words) a 2.6 meg. powerpoint presentation download:

Subprime mess