GE Capital Loses $1.2 Bln on Derivatives; IBM Has $507 Mln Gain
By Tom Kohn
Washington, May 25 (Bloomberg) -- General Electric Co.'s finance subsidiary lost $1.2 billion in the derivative markets in the first quarter, while Citigroup Inc. gained $992 million and International Business Machines Corp. earned $507 million.
The world's three biggest companies disclosed the figures for the first time in Securities and Exchange Commission filings because of a new accounting rule. Regulators penned the rule, known as FAS-133, to boost disclosure in the $109 trillion derivatives market.
``This change will be beneficial,'' said William Rubin, who helps oversee $250 million in stocks at Keefe Managers Inc. in New York. ``Astute investors will determine who wins and who loses.''
The rule requires public U.S. companies to tell investors the market value of their derivatives in quarterly SEC filings, bringing more transparency to how companies use these financial contracts to hedge risks and take leveraged bets. It's a market where firms such as Long Term Capital Management made and lost billions of dollars, and wrong-way bets wrecked Barings Plc.
The Financial Accounting Standards Board, which sets U.S. bookkeeping regulations, decided companies should put derivatives on their balance sheets so shareholders can avoid being surprised by losses. Derivatives are securities whose value is based on the price of an underlying asset, such as a stock or bond.
``It's a very significant amount of disclosure,'' said Kevin Wrenn, a risk strategist at Deutsche Bank AG in New York, who specializes in accounting treatment of derivatives. ``It prevents the blow-ups you've heard about in the past. If there's anything inappropriate, it can't really build up. Everything's right there.''
Insurance
Most companies use derivatives to shield themselves from potentially bigger losses from swings in currencies, commodities and interest rates. Companies treat them like insurance, paying a premium to stop unexpected market movements disrupting income.
IBM, for example, operates in 40 currencies and reports earnings in dollars, so needs to hedge foreign exchange rate risk. IBM said it will set aside $421 million of its $507 million gain in the first quarter to include in its income over the next 12 months to offset possible losses. The company's net income rose 15 percent to $1.75 billion in the quarter, from a year earlier.
IBM ``does not use derivatives for trading or speculative purposes,'' the company said in its SEC filing.
While companies must state on their balance sheets the change in value of all derivatives, if they can prove the securities are hedges rather than speculation they don't have to count them in income statements until the underlying asset is counted.
GE, Microsoft Losses
GE Capital said it expects its $1.2 billion loss will be offset mainly by changes in floating-rate interest expenses. About $352 million of that amount will be included in its income in the year ending March 31, 2002, the company said.
Microsoft Corp., the largest software maker, lost $90 million in the value of its derivatives in the first quarter, and lost $516 million on derivatives in the nine months ended March 31.
Exxon Mobil Corp. said it didn't use derivatives, and lost $149 million in the first quarter from exchange rate movements.
Securities firms, by contrast, typically use derivatives to make bets on the direction of price movements. At Citigroup, the largest financial services provider, the $992 million gain came from $248 million through hedging between January and March 2001, and $744 million from the value of its traded derivatives rising.
American International Group Inc., the second-largest financial services firm, made $861 million from trading derivatives in the quarter.
``There will be greater income volatility,'' said Ira Kawaller, a derivatives and accounting consultant at Kawaller & Co. LLC in Brooklyn, NY. ``The reality is that if you use derivatives, especially long dated, (FAS 133) could have a very profound effect.''
Derivatives traded outside exchanges had a face value of $95 trillion Dec. 31, 2000, according to the Bank for International Settlements. Exchange-traded derivatives' face value totaled $14.1 trillion at the end of 2000, BIS figures show.
Leverage
Historically the derivatives market let firms reap big rewards as it lets traders leverage their positions, or control a large amount of money with a smaller quantity of money to place bets on market movements. Because companies didn't have to report the value of derivatives, they could keep them off their balance sheets, allowing risks to build unnoticed.
In the past ``if your hedges started to make money the temptation to go on and do more of them was quite strong, because they were completely off balance-sheet,'' said Neil Taylor, director of client services at Principia Partners LLC in London, which makes software to help users comply with FAS-133. ``What the rules do is force them to report those to the outside world.''
In 1993, Bankers Trust New York Corp. earned 31 percent of total profit, or $336 million, from derivatives. They accounted for 45 percent of the bank's profit in the first nine months of 1994. That reward doesn't come without risk.
Billions Lost
Procter & Gamble Co. lost $200 million on derivatives it bought from Bankers Trust in 1994, and sued the bank, later settling for $35 million. U.S. regulators investigated Bankers Trust for fraud after a string of other companies lost money on derivatives it sold them.
Long Term Capital Management lost $4 billion in 1998, mainly from bets on differences between bond and futures prices, prompting the Federal Reserve to organize a bailout by banks. One of its losing trades was on Danish mortgage-backed bonds hedged with options on German interest-rate swaps.
Barings, Britain's oldest merchant bank, folded in 1995 after Singapore-based trader Nick Leeson lost more than $1.4 billion on Japanese stock-index futures.
Regulators are seeking to prevent similar events. FAS-133 is an effort by the Financial Accounting Standards Board to stop more risk building than a company can handle, and make companies more accountable.
``FAS-133 is proving useful information not just for people outside of companies but also for people inside of companies,'' said Tim Lucas, FASB's director of research and technical activities in Norwalk, Connecticut.
Company Ranked Gain/Loss from derivatives in by Market Value 1st Qtr 2001 ($ millions)
General Electric's GE Capital -1,200 Microsoft -90 Exxon 0 Citigroup 992 IBM 507 |
