PG&E Has Accounting Problem With Synthetic Lease

Updated from 12:04 p.m. EST

Shares of PG&E ( PCG) were lower Thursday after the company delayed the release of its fourth quarter earnings to review its lease accounting. The company also said it might have to restate earnings going back as far as 1999 following the review.

The company's fourth quarter earnings were originally scheduled for release Thursday, and trading of the stock on the New York Stock Exchange was halted shortly after the announcement at 9:52 a.m. EST. Trading resumed at 10:05 a.m. Shares were lately down 44 cents to $20.15.

In a statement, PG&E, the parent company of bankrupt California utility Pacific Gas & Electric, said it might have to adjust the off-balance sheet status of four so-called synthetic leases it holds for power plants.

Such leases allow a company to control real estate without showing the property's assets and liabilities on its balance sheet, but require independent third-parties to hold at least 3% ownership in the projects. The company recently found that outside ownership had fallen below 3%, which "would require reclassification of these financings from off balance sheet to on balance sheet," the company wrote.

While synthetic leases are a fairly common strategy for reducing liabilities, investors are very sensitive to accounting problems involving off-balance sheet financing in the wake of Enron's collapse.

In PG&E's case, the relevant power plants are under construction, which means they are incurring financing costs without generating any income. If moved onto the balance sheet, PG&E's leases would increase total assets and liabilities by about $1 billion, the company said.

Following its review, PG&E said it might have to amend financial statements as far back as 1999, when the first synthetic lease transaction was made. Still, any changes are unlikely to materially affect its income, equity, or debt covenants, the company said.

One analyst agreed. Because of the way a synthetic lease is structured, if the company brought the lease on balance sheet, it would remain capitalized and wouldn't flow through to earnings, said Carol Coale of Prudential Securities. "It's just simple GAAP accounting," she said. Meanwhile, ratings agencies always treat such leases as debt, so moving these properties on or off balance sheet would not have an impact on the company's credit rating.

Earnings could be impacted, however, when construction on the plants is completed, something that should happen in the next few months, according to one analyst who preferred to speak off the record. At that time, unless the company exchanges the synthetic lease for an operating lease, which would require new financing, additional depreciation would have to be written off. According to the analyst, depreciation over 30 years of the $1 billion represented by the relevant properties could cut 5 cents a share out of earnings in 2002 and 2003.

One impediment to replacing the synthetic lease with an operating lease is that financing for the latter is tight, the analyst said. Still, he called it a worst-case scenario.

PG&E shares have been falling since Feb. 7, when a bankruptcy judge rejected the restructuring plan put together by its subsidiary Pacific Gas & Electric. Pacific Gas & Electric filed for Chapter 11 bankruptcy protection in April 2001 after running up billions of dollars of debt buying power for its customers at soaring prices in the wholesale market.

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