Credit analyst: Although cautious on economy, buy Household on weakness

By Ronda Fears

Nashville, Tenn., August 15 - Even though Household International Inc. is restating net income dating back to 1994 for total negative effect of $386 million and she has a cautious view on the U.S. economy, Gimme Credit senior bond analyst Kathy Shanley said she would still be a buyer of Household's paper on any weakness.

Last week, Household settled the put on its 0% convertible senior notes due August 2021, buying back all but $1.6 million of the issue, which carried a face value of $1.22 billion, at 81.914.

"Although we remain cautious on the overall economic outlook," Shanley said, noting data released Wednesday show bankruptcy levels at all-time highs, "we maintain our recommendation to buy Household debt on weakness, such as was evident yesterday."

While Household met the deadline for certifying its financial statements, it also said it would restate its financial statements back to 1999, resulting in a $386 million negative swing in retained earnings through the end of June.

"Although we cannot view the accounting restatements as good news, Household is pledging to move quickly to replenish its capital base," Shanley said.

"Household told equity investors yesterday that the 'story breaks down' if it can't fund itself in the debt markets. We expect it will meet its commitment to replenish capital by reducing share repurchase activity and issuing new capital securities if necessary."

All the restatements relate to Household's credit card operations. Specifically, KPMG expressed concerns about certain MasterCard/Visa co-branding and affinity credit card relationships and about a marketing agreement with an outside credit card marketing firm.

Some of the agreements date back as far as 1992 and all were approved by Arthur Andersen.

KPMG's view is that expenses related to these programs should have been expensed either immediately or over a short period of time, instead of over the economic life of the agreements.

The methods previously used by Household and approved by Andersen were somewhat more aggressive, since current earnings were higher, but based on the information the company presented in its conference call Wednesday, Shanley said it appears there was a reasonable basis for electing a longer amortization period.

Household said in its press release it would suspend unsecured debt and equity issuance pending the completion of the KPMG audit, which is expected by the end of the month.

In its conference call, however, the company said KPMG had already completed key areas of the audit, including a review of loan loss provisions and reserves, securitization accounting, and litigation and tax reserves, and had raised no material disagreements with current policies.

Household also said it does not believe the new rules proposed by federal bank regulators for credit card issuers will have a material impact on its operations.

Last December, Household effectively rebutted suggestions of accounting improprieties, unrelated to the current restatements, that were raised in the business press.

"It fought to distance itself from the problems of Tyco and other fallen angels but remains a magnet for activists targeting predatory lending," Shanley said.

"Considering the negative headlines, it is fair to expect Household to trade wide of what might theoretically be expected for a mid single-A finance company. But we give the company credit for cutting its reliance on commercial paper, increasing liquidity, adding more funding sources, and focusing on the concerns of its fixed income stakeholders."

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