Risk & Compliance

Question Mark to Market: Energy Accounting Scrutinized

Also: Enron arranges $1.5 billion in DIP financing, then cans half its Houston workforce. Elsewhere: HP raises a billion, and automaker financings ...
Stephen TaubDecember 4, 2001

The remarkable collapse of Enron Corp. is drawing attention to the accounting practices of other energy companies.

The big concern seems to be “mark to market” accounting, which allows companies to count as current earnings profits they expect to earn in the future from energy-related contracts.

These types of gains accounted for a little more than half of Enron’s originally reported pretax earnings for 2000 and a third of its profits in 1999, according to the Wall Street Journal.

Other high-profile companies have also aggressively taken advantage of this accounting technique, however. Dynegy’s unrealized gains, for instance, accounted for about half of that company’s 2000 and 1999 pretax profits, according to the paper.

Other energy traders that have pushed up their earnings from mark-to-market accounting include American Electric Power, Duke Energy, El Paso, Entergy, Mirant, Pinnacle West Capital, and Williams Cos., according to the Journal.

Mark-to-market accounting, which has FASB’s blessing, comes into play at the end of each quarter. That’s the time when companies typically have outstanding energy-related contracts on their balance sheets, either as assets or liabilities. CFOs then estimate the fair value of the contracts, based in part on their forecasts for market conditions. These quarterly changes in noncash values subsequently show up on income statements.

It seems that corporate managers have wide discretion in how they can interpret this rule. According to the Journal, FASB debated this technique for the past three years, but ultimately decided to leave the interpretation to the individual companies.

“There’s no one way to do it,” Tim Lucas, chairman of FASB’s Emerging Issues Task Force, told the Journal.

Meanwhile, Back at the Ranch

Enron Corp. announced it arranged up to $1.5 billion of debtor-in-possession (DIP) financing. The funding will enable the company to operate while under bankruptcy protection.

The financing, arranged by Citigroup and JP Morgan Chase, will be syndicated and is secured by substantially all of the company’s assets.

“With this financing in place, Enron can continue to do business and move forward to implement the first steps of its reorganization. We appreciate the support of our lenders and are fully committed to meeting our obligations to our creditors as best we can,” said Kenneth L. Lay, Enron chairman and CEO, in a statement.

The company said it expects to receive $250 million to supplement its existing capital and help the company fulfill obligations associated with operating its business, including its employee payroll and payments to vendors for goods and services provided on or after Sunday’s bankruptcy filing. Another $250 million will be made available to Enron as soon as the company provides the lenders with a satisfactory business plan.

The $1 billion balance will be available to the company upon the satisfaction of certain conditions, including the entry of a final order and the successful completion of syndication. The remaining $1 billion balance of the facility will be used in part to repay $550 million of existing indebtedness of Transwestern Pipeline.

The announcement came the same day that Enron management said it will lay off 4,000 employees, or 20 percent of its workforce. After the press statement, Enron sent the rest of its staff at its Houston headquarters home for the day. Most of the laid-off employees worked at that facility. Another 3,500 still have theirs jobs — for now.

Financing News

Two car companies on Monday raised large sums of money in the asset-backed securities (ABS) market. This is not overly surprising, as carmakers tend to know a lot about ABS.

DaimlerChrysler AG priced $1 billion of asset-backed securities, supported by cash flows from its car dealerships’ inventory, called a Carcol 2001-A transaction. The funding was arranged by Salomon Smith Barney. The coupon was priced at the one-month Libor plus 6.5 basis points. It was rated Aaa by Moody’s and AAA by S&P.

And General Motors Acceptance Corp.’s Residential Funding Corp. plans to issue the remaining part of $1.2 billion of asset-backed securities, supported by subprime home equity loans, according to published reports. The company had already sold half of the two-part offering. The average life was pegged at 2.62 years and was priced at one-month Libor plus 32 basis points.

In other financing news:

  • Hewlett-Packard Co., which is attempting to complete its merger with Compaq Computer, issued $1 billion in 5-year global notes. HP management had planned to raise $750 million. Led by Salomon Smith Barney and Credit Suisse First Boston, the notes were priced to yield 5.874 percent, or 184 basis points over comparable Treasurys. The MTNs were rated A2 by Moody’s and AA-minus by S&P.
  • Cingular Wireless LLC, the wireless telephone joint venture between BellSouth Corp. and SBC Communications Inc., is expected to raise $2 billion from a private placement of debt, according to published reports. When completed, the private placement will be Cingular’s first debt offering ever. The paper is expected to consist of 5-, 10-, and 30-year debt. On Monday, S&P rated the debt A-plus. On Friday, Moody’s cut Cingular’s long-term debt rating to A3. It will be led by Goldman Sachs & Co., J.P. Morgan, and Lehman Brothers Inc.
  • LaSalle Funding LLC, a unit of ABN AMRO NV, filed a shelf registration to borrow up to $2.5 billion in the debt market.
  • Moody’s upgraded the ratings of American General Corp.’s senior unsecured debt to Aaa from Aa2 in connection with an unconditional and irrevocable guarantee provided by American International Group, Inc., its new parent company.
  • Standard & Poor’s lowered its ratings on Sea Containers Ltd. and removed them from CreditWatch, where they were placed with negative implications on May 5, 2000. The current outlook is negative. “The downgrade results from the company’s weakened credit ratios that are due to reduced earnings and cash flow that are not expected to improve materially for the foreseeable future,” according to S&P.