Griep: But we would make adjustments. So wherever there is risk retained or some obligation retained...
Willens: But if there's risk retained, it's supposed to be consolidated.
Jenkins: No, not necessarily. To the extent that the transferor or sponsor continues to have exposure to risk, that is either supposed to be recognized on the financial statements or disclosed. For securitized assets in an SPE, SFAS 140 specifically requires disclosures about those assets.
I think one difference is — and this is an issue for financial reporting — S&P is supposed to be forward-looking. Financial statements are point-in-time. That's at least one reason why you make adjustments. What we try to do, and what I think we'll be doing more of, is put into footnotes information that helps on the forward-looking portion of the whole scheme.
Griep: We're constantly making adjustments to the financials, but they have to be value oriented or adjusting cash flow in some way. We're looking at the quality of earnings and adjusting cash flow or reported earnings based on what we believe to be the quality.
Willens: But doesn't that bother you a little, that you have to make substantial adjustments from reported numbers?
Griep: No, I think it's part of fundamental analysis, and I do think it's a part of looking forward.
Defining Earnings
Willens: I guess I'm looking for something that maybe doesn't exist. What I would like to see, and what a lot of people I speak to would like to see, would be one operating-earnings number that would have been created and blessed and certified by FASB. The components of it would be something that everyone would agree belonged in the computation of this ultimate number. I understand that that may be an impossible goal.
Jenkins: We are working right now on a project on financial performance reporting. Its purpose is to look at not only how the income statement is structured and the way it displays information, but also at certain cash flows and, to some extent, the balance sheet — to see if there's a better way to display or aggregate or disaggregate the information, so that investors can have the opportunity to come to their own conclusions about what set of earnings is likely to be replicable in the future.
Willens: But people want to be guided here. I think they want more than just a framework.
Jenkins: We keep talking about how complex business is today, how complex the transactions are. I don't think it's possible to distill all that into one per-share number.
Hill: I think FASB could do some things that would get us a little closer, but you're never going to have a standardized number that everyone is going to accept.
I think everyone would agree that there are times when it's not only legitimate to adjust GAAP earnings, but desirable. The problem is that you use earnings for different things.
The SEC's cautionary advice [on the use of pro forma financial information in earnings releases] that came out recently was a big step forward on this issue. The advisory said you had to provide some sort of trail from how you got from GAAP to the pro forma earnings.
Willens: But doesn't that bother you, the fact that virtually no one is using GAAP net income for analytical purposes? That everyone is using their own formulas?
Hill: That's what analysis is all about.
Griep: This is a very big issue on the equity-analytic side of our business, and with the index business as well. I know they've proposed a definition of operating earnings to try to bring standardization to that aspect, and it's the one that we would use internally for valuation purposes.
Hill: But you can't do that. The problem is, everyone agrees that the extraordinary items as defined by FASB should be excluded from the GAAP net earnings. But the sticky wickets are the footnotes, the restructuring charges, the asset-sale gains and losses, the acquisition charges, litigation, inventory write-downs. All these kinds of things can come in a lot of different shapes and flavors.
Rethinking Rating Triggers
Let's turn to another post-Enron issue: rating triggers. The rating agencies are going to take a closer look at those, but S&P seemed to suggest that a lot of change wasn't necessary.
Griep: Enron was a catalyst for us to undertake a review of what the actual exposure was of, in particular, lower-investment-grade companies — those rated in the triple-B, single-A range — to contingent commitments that involved significant debt repayment or collateral pledge. While it's been played up in the media as a focus on credit-rating triggers, the questionnaire we put together actually focuses on rating, equity-price, and other kinds of operating-performance triggers that are built into borrowing arrangements and counterparty arrangements. The problem of how to factor these triggers into the rating process is a challenging one, and one that we're still reviewing.
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