At the heart of last week's headline-grabbing controversy surrounding Enron Corp.'s plunging share prices and suspicious CFO replacement - instigated by a Securities and Exchange Commission probe into several questionable transactions - lies a batch of "highly structured" deals directly tied to Enron assets.

When speaking to the press, the embattled Houston-based energy company, which recently shrank its shareholder equity by $1.2 billion and took a $1 billion charge for the third quarter connected with the writedown of bad investments, has been alluding to "certain structured finance deals" that went sour and may unwind. The deals were undertaken by partnerships that had been controlled by Andrew S. Fastow, who was relieved of his position as CFO last week amid negative headlines and investor trepidation.

"These transactions have elements of both corporate finance and structured finance," said Todd Shipman of Standard & Poor's, referring to the deals at the center of the SEC's investigation, which were conducted two years ago. "The whole intent of the structures was to keep the financial effects [of credit concerns] off-balance-sheet. But there isn't bankruptcy remoteness involved, though Enron support is involved in the deals."

As a result of the recent damaging headlines, Fitch placed Enron securities on Rating Watch Negative last week due to "the loss of investor and counterparty confidence." Moody's Investors Service also has the company on watch for downgrade.

Complex transactions

According to Fitch analysts, certain debt transactions being looked at, such as Marlin Water Trust II and Osprey - backed by a variety of illiquid assets held by certain Enron-owned concerns overseas, including Wessex Water Services Ltd., a U.K. water and sewage utility - are at risk of unwinding.

Primary credit support for these transactions is derived from the Enron obligation to issue convertible preferred stock should repayment to bondholders be necessary. "If Enron cannot or does not deliver on its obligation, then the amount of the deficiency becomes a payment obligation of Enron, representing a general, unsecured claim," a Fitch report said.

Most importantly, Enron has not verified that the underlying assets have adequate market value to fully pay down the associated debt.

"Enron supposedly has assets sold to pay down any debt," said a Fitch analyst. "The company had certain investments with broadband and technology related to some of their residential retail investments, including NewPower Holdings."

NewPower, a national power marketer created by Enron, has recently stated that it intends to pursue asset-backed financing early next year, and has already received a preliminary commitment for a receivables-financing program.

"Investors share risks and rewards," the analyst said. "Enron had a contingent obligation to issue shares of stock if a transaction had a problem."

Sixty million shares of common stock have been issued related to the Marlin transaction. When some of the deals were unwound, however, Enron withdrew that obligation.

"The big issue for investors is this commitment on the part of Enron to support the debt with equity," said Standard & Poor's Shipman.

Other deals affected?

The aforementioned deals do not constitute the only times Enron tapped the structured markets in an attempt to free up its bank lines. As its liquidity dried up over the last few years, the company issued a few large credit-linked synthetic ABS deals (see ASR 5/21 p. 3) involving credit swaps referencing Enron as a corporate obligor.

"Any other credit problems for Enron should not affect the [credit-linked] deals, as far as we know," said Terry McCarthy, an analyst at S&P that looked at the synthetic deals. "But the return to investors will be dependent on what's done with Enron's corporate rating, and that has not been determined yet."

According to McCarthy, Enron was not directly involved per se in the credit-linked transactions; if Enron experiences bankruptcy or failure to pay, other elements of the swap engage.

"There have been at least four of these synthetic deals over the last two years," McCarthy said. "We have to examine what the incentives of the other parties involved in the transactions are."

For a $1 billion credit-linked note done in May, Citibank served as swap counterparty, and trust investments were the source of repayment of principal. The SPV for the deal was created by Salomon Smith Barney, and the structure involved a credit swap that took place between the trust and Citibank.

"The current controversy should not affect the returns on these certificates," S&P's McCarthy said. "But we are in close contact with our corporate group regarding changes in the ratings of Enron debt."

Still, the SEC is busy investigating "all kinds of collateral issues" related to the company, added the Fitch analyst.

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