S&P Weighs in on Operating Earnings

In: stock options as expenses. Out: pension plan gains as earnings. Also: Fed says banks loosening up, The Stanley Works to stay put, and is hiring on the increase?


So, what’s the definition of operating earnings?

That depends — upon what a company’s management decides to throw in and leave out of its pro forma earnings results. This practice has led to widespread criticism, and a call for a standard way for companies to report their results.

Enter Standard & Poor’s, the credit rating agency. Reportedly, S&P is expected on Tuesday to trot out new standards for calculating operating earnings figures.

Bear in mind that companies aren’t required to act on S&P’s proposals. These would merely be guidelines.

Nonetheless, S&P’s indexes of stocks are widely used as benchmarks for valuing equities, as well as investor and corporate performance. Hence, S&P’s proposals will likely have an impact on markets.

The most controversial of S&P’s new standards would treat employee stock options as a quarterly expense against earnings. That would particularly hurt tech companies, which typically issue stock options to its rank and file.

Indeed, the stock options change alone would cut 2002 estimated earnings for companies in the S&P 500 index by an average of 10 percent, according to Dow Jones, citing S&P officials.

Among the items S&P believes should be included in operating earnings: Restructuring charges, write-downs of assets which are depreciable and the cost of buying outside research-and-development services.

Items S&P thinks should be excluded from core earnings: pension-plan investment gains, unrealized gains and losses from hedging activities and merger-and-acquisition related expenses.

Wooing Andersen’s Partners

As CFO.com predicted in January, second-tier accountancies are benefiting from the troubles at Big Five firm Arthur Andersen. Smaller accounting firms like BDO Seidman, Grant Thornton and RSM McGladrey have picked up a number of Andersen’s middle-market accounts over the past few months.

Now this: on Saturday, the New York Times

reported that those three firms are bent on coaxing Andersen employees to join their companies before a verdict is delivered in Andersen’s trial for obstruction of justice. In fact, BDO Seidman reportedly sent a mass e-mail memo to about 600 AA Partners on Friday, criticizing a competing firm’s offer and laying out the terms for Andersen partners to join BDO.

“Andersen is going to be signing agreements over the next two weeks — they would basically have to have all their agreements signed before the end of May,” Howard Allenberg, vice chairman and chief information officer at BDO, told The Times. Because the formal negotiation process is not moving quickly, ‘we wanted to go straight to the partners,” he added.

Andersen’s middle-market practice is defined as private and publicly held companies with revenue between $50 million and $1 billion.

According to the paper, Andersen’s administrative board may not release individual partners from their noncompete clause, which forbids Andersen partners from joining rival firms. In fact, BDO’s e-mail reportedly said that “if a partner does not go with a `group deal,’ the administrative board will not release the partner from his or her notice and noncompete requirements without adequate consideration,” according to the story in the Times. “BDO is prepared to make the required payment on your behalf.”

Andersen partners were also told they can bring 10 other nonpartner professionals with them.

In other Andersen-related news: KPMG LLP has reached a deal whereby roughly 400 Andersen partners and employees in the northwest will join KPMG. Under the deal, 123 former Andersen partners and employees in Portland, Ore. will join KPMG, effective immediately. In Salt Lake City, 52 ex-Andersen partners and employees will join KPMG. Also, 206 former Andersen employees and partners in Seattle will join KPMG.

Fewer Banks Tightening Lending Standards

It appears it’s getting easier for companies to borrow money from banks.

The percentage of domestic and foreign banking institutions that tightened standards and terms on commercial and industrial (C&I) loans over the past three months fell to 25 percent, according to the Federal Reserve Board’s most recent survey, conducted in April. In the prior quarter, the number of banks tightening loan provisions was 45 percent.

What’s more, the percentage of banks tightening standards on business loans to small companies declined even more, from more than 40 percent in the Fed’s previous survey, to about 15 percent in April.

At the same time, banks continued to report a weakening of demand for C&I and commercial real estate loans, but at a lesser rate than in January. In addition, the share of U.S. branches and agencies of foreign banks that tightened standards for customers seeking C&I loans or credit lines fell from 70 percent in January to about 40 percent in the April survey.

Further, fewer domestic banks reported tightening their lending terms for large and middle-market borrowers. About 45 percent of domestic banks, however, increased premiums charged on riskier loans to large and middle-market firms, in line with the January survey.

Other findings in the April survey:

  • The net fraction of domestic banks that tightened covenants on loans to small businesses fell from 40 percent in January to only 12 percent.
  • The net percentage of banks that increased spreads of loan rates over their cost of funds dropped from 37 percent to 13 percent over the same period.
  • The net fraction of banks that reported increasing premiums charged on riskier loans to small firms over the past three months fell from 40 percent in January to 34 percent in April.
  • The percentage of foreign institutions that raised premiums on riskier loans decreased from 75 percent in January to 52 percent.
  • The percentage of foreign banks that strengthened loan covenants declined from 52 percent in January to 43 percent.

“The one exception was the percentage of foreign institutions that increased the costs of credit lines, which moved up noticeably from 35 percent in the previous survey to 57 percent in April,” the Fed noted in its survey.

“A significant percentage of banks that tightened standards or terms on C&I loans over the past three months pointed to a reduced tolerance for risk as a reason for doing so and continued to voice concerns about the economic outlook,” the Fed added.

In the current survey, 75 percent of domestic and foreign bank respondents cited reduced tolerance for risk as a reason for tightening their lending policies. About 70 percent of domestic banks also indicated that a less favorable or more uncertain economic outlook was a reason for changing their standards and terms over the past three months.

About one-third of domestic banks, on net, reported weaker demand for C&I loans from both large and small firms over the past three months, down from roughly one-half in the January survey. “Every domestic bank that experienced weaker demand reported that a decline in customers’ needs for bank loans to finance capital expenditures was at least a somewhat important reason for the weakness in demand, and more than one-third of respondents indicated that this reason was very important,” stated the Fed.

Banks also reported weaker demand for loans to finance mergers and acquisitions, inventories, and accounts receivable.

Short Takes

>>Reliant Resources on Friday cancelled its planned $500 million, 10-year bond offering that had been priced Thursday. The reason? The company cited an internal review of possibly questionable power-trading transactions. The issue was priced at 425 basis points over comparable Treasurys.

>> Stop the presses. UBS Warburg analyst Samuel Buttrick last Tuesday started coverage of JetBlue Airways Corp. with a “reduce” rating, meaning holders should sell. The significance: UBS helped to underwrite the discount airline’s IPO last month. Buttrick’s move comes in the wake of New York State Attorney General’s Eliot Spitzer’s investigation into conflicts of interests between investment banks and their sell-side analysts. (For a related story, read “Near the Corner of Church and State.”)

>> Staffing specialist Manpower is expected to report Monday that 27 percent of companies in an employment survey said they plan to add jobs in the third quarter. Only eight percent of the corporate respondents expect to cut their staff. The rest of the companies reported they either expected to maintain their staffing levels or were uncertain about hiring activities.

>> Management at The Stanley Works decided to reverse course and not reincorporate in Bermuda. “Although the company believes that the shareowner vote was fair and appropriate, it acknowledges concerns raised at yesterday’s shareowners meeting that some people may have been confused about 401 (K) plan voting procedures,” the toolmaker’s management said in a statement.

>> A number of IPOs are expected to come to market this week.

On Tuesday, reinsurer Global Preferred Holdings Inc. is expected to price.

Look for three companies to price on Wednesday: Retailer Aeropostale Inc.; surveillance software maker Verint Systems Inc.; and Kyphon Inc., which makes medical instruments for spinal care.

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