Huron Consulting Group Analyzes Financial Reporting Matters Related to Auction Rate Securities
CHICAGO – August 21, 2008 – Huron Consulting Group (NASDAQ: HURN), a leading provider of financial and operational consulting services, today released an analysis of financial reporting by public registrants that disclosed investments in Auction Rate Securities (ARS) during the first quarter of 2008. The analysis reveals numerous matters that users of financial statements have had to struggle with arising out of the reporting of ARS.
In February 2008, the market for ARS effectively ceased when the vast majority of auctions failed and prevented holders from selling their investments. ARS are debt instruments with long-term maturities, supported by various underlying asset types. Investors generally considered ARS to be short-term, liquid investments because they could sell the securities periodically at auction.
The failed auctions and the resulting loss of liquidity caused significant financial reporting challenges as companies holding these securities were required to make judgments about complex issues related to fair value measurements, recognition of impairments, and appropriate disclosures. The illiquid market conditions intensified the focus on the quality of the underlying collateral, which may have been under additional pressure depending on the asset type.
“When an event such as the loss of liquidity in the ARS markets occurs so fast, and companies are forced to respond, it provides an opportunity to gauge how well the financial reporting world performs in producing understandable information,” said Joseph J. Floyd, vice president of Huron Consulting Group’s Financial Consulting practice. “Our purpose in studying this event, which reflects a microcosm of the broader credit crisis, was to highlight differences in disclosures and accounting treatments among registrants related to ARS.”
Huron used Form 10-Q and Form 10-K filings as well as Form 6-K filings by foreign private issuers to compile the data. This included risk and investment disclosures, changes in the fair value of the assets, if any, and the type of underlying assets as well as balance sheet classifications, if disclosed, for registrants.
It is important to note that while registrants may have properly disclosed these events in accordance with generally accepted accounting principles and the applicable U.S. Securities and Exchange Commission (SEC) rules and guidance, the registrants’ facts and circumstances and the evolving nature of the issues under consideration can result in significant diversity of information reported to the market.
The accounting rules require the use of judgment in assessing investments for impairment. Applying those rules can result in different conclusions by companies holding the same asset because of differences in circumstances affecting those companies. Where some companies determined that the securities were not impaired on an “other-than-temporary” basis and therefore recognized decreases in fair value in shareholders’ equity (for securities classified as “available-for-sale”), other companies determined the loss in value was “other-than-temporary” and recognized a charge to earnings. Companies would have considered a number of factors, including ability and intent to hold the securities until values recover and the quality of the underlying collateral, in determining the appropriate accounting for impaired securities. Substantially all of the companies in Huron’s analysis classified ARS as “available-for-sale.”
“Comprehensive and consistent disclosures, including disclosure of significant judgments regarding valuation matters and a company’s liquidity needs, are essential to delivering meaningful information to users of financial statements. Current GAAP, where the uniqueness of each registrant’s circumstances affects how companies report information and where judgment is required in determining how much information to disclose, can often make ‘apples to apples’ comparisons among registrants very difficult,” said Jeffrey H. Ellis, managing director, Huron Consulting Group.
Key findings from Huron’s analysis include:
Similar assets, dissimilar earnings impact
Of the more than 600 registrants that reported ARS investments, approximately 90 percent disclosed making fair value assessments of ARS in the first quarter:
- 53 percent reported temporary impairments that did not impact earnings;
- 10 percent reported other-than-temporary impairments as a charge against earnings;
- 5 percent reported both temporary and other-than-temporary impairments; and,
- 32 percent reported no impairment related to their ARS holdings.
At the underlying asset level, Huron’s analysis also looked at how registrants reported variability in the type of impairment for ARS backed by Collateralized Debt Obligations (CDOs), student loans, municipal obligations, and closed-end funds.
Wide ranges of fair values
Within underlying asset classes, substantial differences were observed in the impairment reported:
- For ARS backed by CDOs, impairments as high as 64 percent of fair value were reported. The average impairment percentage was 20 percent.
- For ARS backed by student loans, impairments as high as 21 percent of fair value were reported. The average impairment percentage was 6 percent.
- For ARS backed by municipal bonds, impairments as high as 19 percent of fair value were reported. The average impairment percentage was 5 percent.
- For ARS backed by closed-end funds, impairments as high as 11 percent of fair value were reported. The average impairment percentage was 7 percent.
Loss of liquidity alters current ratios
Historically, ARS were classified on the balance sheet as short-term investments. As a result of the loss in liquidity for these assets, many registrants have reclassified ARS to long-term during the period reviewed:
- 41 percent of companies reporting balance sheet classifications for ARS changed their classification from short-term to long-term during the first quarter of 2008.
- 48 percent of companies holding ARS backed by municipal bonds, 18 percent of companies holding ARS backed by student loans, 26 percent of companies holding ARS backed by CDOs, and 40 percent of companies holding ARS backed by closed-end funds classified the ARS as current assets.
Some registrants reported risks in prior periods, but not many
Many registrants’ filings for periods ending on or near December 31, 2007 acknowledged the auction failures. For this reason, Huron reviewed the immediately preceding filings of a subset of surveyed companies, which comprised nearly 70 percent of the total value of impairments reviewed. Of these companies, 58 percent disclosed holding ARS, 24 percent mentioned prior auction failures, and 15 percent actually reported impairments during the earlier period.
Copies of Huron Consulting Group's Analysis of Financial Reporting Matters Related to Auction Rate Securities are available at www.huronconsultinggroup.com.
About Huron Consulting Group
Huron Consulting Group helps clients effectively address complex challenges that arise in litigation, disputes, investigations, regulatory compliance, procurement, financial distress, and other sources of significant conflict or change. The Company also helps clients deliver superior customer and capital market performance through integrated strategic, operational, and organizational change. Huron provides services to a wide variety of both financially sound and distressed organizations, including Fortune 500 companies, medium-sized businesses, leading academic institutions, healthcare organizations, and the law firms that represent these various organizations. Learn more at www.huronconsultinggroup.com.
Jennifer Frost Hennagir, Director
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