[PEN-L:30027] Re: sale and leaseback

[Nomiprins@xxxxxxx]

In a message dated 9/3/2002 9:18:41 PM Eastern Daylight Time, sdiamond@xxxxxxx writes:


> After all the investors in these securities are not stupid - most are large institutions (they usually have to meet certain requirements to access such instruments) - and in part that is the shoe that has yet to drop in the Enron scandal:  who were all the investors in the off balance sheet partnerships?  Did they serve as "enablers" of this giant fraud?


Mostly yes. Investors in these securities have to be QIB's, qualified investors, usually institutions, or individuals with more than $1mln per year of income. In Enron's case, the situation is much murkier than with simple SPEs. Enron created almost 3000 off shore SPE's, many of them were backed by each other, by layers of each other, or by Enron stock or loans backed by Enron stock. Enron's creativity in camouflaging everything with SPEs was pretty impressive. The bankruptcy remoteness, an important aspect as sdiamond mentioned (sorry, I don't know your first name), of these entities is predicated on at least 3% of the first loss risk (or equity capital risk) in them being owned by an independent party (such as an outside investor).

However, in Enron's case, that 3% rule was violated, because a) SPEs owned part of that 3% in each other and b) Andrew Fastow, former CFO, vouched for that 3% with his own personal loans, that were in turn backed by shares of Enron stock. So, even though the banks have exposure to those personal loans and other much larger loans, the SPE's themselves are suspect. That was one of the first things that Arthur Andersen had to alert Enron to last October, which was a factor in its subsequent unraveling, cause all sorts of losses started to come to the surface. 

Merrill Lynch was a big investor in these, as were their customers without knowing all the pitfalls.

The FASB (Financial Accounting Standards Board) wants to increase the third party ownership in an SPE to 10% from 3% as a solution to problems with SPEs, but given other possible tricks, that will not really solve anything.

Where the banks have huge exposure is that they gave large loans to Enron and other companies by virtue of balance sheets appearing like they had less debt than they actually had. Companies were over leveraging because they were hiding stuff. And banks were arguably looking the other way. This is where the major bank risk still lies, in the loans and credit facilities they offered. 

There are other major collusions in question that are variations of the sale / leaseback strategy, in that long term debt was swapped away, that may be helpful for Sabri's query - 

a) long term natural gas swaps disguised as loans - these 'prepaid swaps' are a noose around JPMChase's neck. Enron and other energy companies would agree to pay an SPEs of JPMC a certain amount of natural gas at a certain price on a date 5 years out. For example, $394mln worth. They would engage in an identical trade where they would receive from JPMC $330mln worth. No gas actually changed hands in this swap. The numbers back into a 6% loan, but Enron books it as $330mln upfront, and $79mln paid each year for 5 years. $5bln of this disguised loan was done w/Enron. In bankruptcy, Enron isn't paying the money back. So, JPMC is screwed. Enron's not the only case.

b) long term capacity swaps - most of the now extinct carrier telecom companies like Global Crossing, sold rights to use capacity on their networks to other carriers for a 20-25 year period, but booked the cash up front, making their balance sheets appear more cash rich, allowing them to borrow more from banks at a lower rate due to this perceived credit worthiness. Banks played along.

I define the corporate / bank relationship along two simple, perhaps cynical axioms: 
1) For corporations: Raise as much debt as you can, as cheaply and quickly as possible (for growth, acquisitions, inflating share value, etc.)
2) For banks: Book as many fees as possible (doing #1), then worry about risk.

I think a good place to look for data might be the FASB itself. Alternatively, for airlines, SPEs and lease programs are listed in their SEC filings, even if they don't explicitly list the debt reductions. Unfortunately, these long term for short term swaps fall under the category of bad transparency.

Nomi