PG&E Corp. raised the specter of the Enron calamity by announcing that it may have to amend its financial statements potentially back to 1999 and place certain “leases” on its balance sheet that would increase its total assets and liabilities by $1 billion. PG&E said it discovered errors in the accounting treatment of several leases related to merchant power plant financings. Nevertheless, it said any financial revisions would have no material impact on its current income statement.

The company decided to delay the release of its quarterly and annual earnings to further examine the problem. PG&E said that as it was preparing for the simultaneous release of its earnings and 10-K on Tuesday, it identified a “technical issue” related to four “synthetic leases” tied to the financing of several power plant projects, including Lake Road in Connecticut, La Paloma near Bakersfield, CA and Harquahala in Arizona.

These types of leases, which to some may sound similar to the partnerships used by Enron to off-load debt, have been fully disclosed in previous consolidated financial statements, said PG&E.

PG&E spokesman Greg Pruett said the leases were done at the time when the power projects were being constructed. La Paloma is expected to begin operation in mid 2002. Lake Road has already begun operation, and Harquahala is being built. The “leases” or “trusts” required that independent third party lessors hold a minimum of 3% ownership in them, but PG&E said after recent routine monthly dispersals to the third parties, their ownership somehow fell below the 3% minimum threshold. Such a decrease in equity ownership requires reclassification of these financings from off balance sheet to on balance sheet, PG&E said.

“These entities are trusts in which the trustee goes out and obtains 97% financing for a project along with the 3% equity from various entities that have invested,” Pruett added. “What we have found is that payments were inadvertently made to these independent third party owners. They should not have received payment. Their return on investment should have been accrued, but when they were paid instead, it took their equity stake below 3% and takes this from an off-the-balance-sheet enterprise to one that it is on the balance sheet. PG&E is the trustee in all these leases,” he said, adding that 40% of the financing in these entities was non-recourse debt.

The company stated that it expects this finding will have no material impact on net income. The spokesman also wanted to clearly distinguish PG&E’s activities from the shady partnership deals that helped trigger Enron’s fall to bankruptcy.

“There are three key differences between [these leases and Enron’s partnerships],” said Pruett. “They were not designed to either inflate earnings or hide debt. And No. 3, these have been reported numerous times in previous financial statements. On page 22 of our third quarter 10-Q, we have several paragraphs that talk about these leases and what projects they involved and other details about them.”

PG&E said these leases have been fully discussed with rating agencies, lenders and the financial community. The company said it expects this change will have no material impact on earnings, equity, or debt covenants.

“One of the biggest differences between [what Enron did and what PG&E has done with these financing entities] is that our partnerships were specifically created to finance a real live bricks-and-mortar, electron-producing power plant,” said Pruett. He said the company wouldn’t release its earnings until it completes an investigation into what happened and why it happened.

The announcement triggered only a slight decline in PG&E share prices, which have rebounded significantly since its utility subsidiary filed for bankruptcy last spring (see Daily GPI, April 9, 2001). Its stock lost about 2.28% in trading Thursday to $20.12 and was slipping in early Friday trade.

Merrill Lynch analyst Steven I. Fleishman noted the bad timing of this announcement “given the current market focus on accounting issues in general and special purpose entities in particular.” However, he downplayed the announcement as relatively insignificant, but did warn investors to keep a close watch on the reaction of ratings agencies.

The transfer of debt and assets would raise PG&E National Energy Group’s (NEG) debt:capital ratio to the mid-60% level from about 55%, but is not expected to activate automatic ratings triggers or debt covenants. Current NEG ratings are A- for the pipeline business, BBB+ for trading and BBB for other activities.

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