First Union's Handling of 3Q Earnings Strikes New Blow to Investor Confidence

First Union Corp.'s stock and its credibility were dealt a new blow after news that management had taken what analysts called some questionable steps to meet expectations for third-quarter earnings.

After missing Wall Street estimates in the second quarter, Charlotte, N.C.-based First Union managed to reach analysts' forecasts in the third quarter. However, as analysts learned Monday, that achievement was clouded by a pretax, $23 million nonrecurring gain that went unmentioned in the company's earnings announcement. The gain contributed 2 cents to earnings per share, enabling First Union to avoid a repeat of its second-quarter disappointment.

Analysts said the move was symptomatic of the intense pressure on the industry to meet expectations on Wall Street, an issue that has led some to question how healthy the overall corporate profit picture really is.

"We think that lower-quality earnings is endemic to the industry," said Michael L. Mayo, a bank analyst with Credit Suisse First Boston. "As we get later in the business cycle, more banks will need to do fancy footwork to meet their numbers. First Union is not an isolated incident."

Not all saw the development as a major issue.

Stephen Berman, a buy-side analyst with Stein Roe & Farnhan Inc., said: "I don't think this helps First Union's credibility; they needed to be forthright and tell us as much as possible. But every large company, not only banks, does this.

"I don't disagree with the view that their operating earnings may have been lighter" than they reported, Mr. Berman added. "But it was only 2 cents. Who gives a damn? I don't."

First Union, which disclosed the gain in its 10Q filed with the Securities and Exchange Commission on Nov. 15, defended its actions, which were first reported Monday morning by The Wall Street Journal.

First Union spokesman Virginia Mackin said that the $23 million gain created by its sale of branches to Sun Bancorp was offset by the chargeoff of two nonperforming loans and other sundry items.

"It is immaterial," Ms. Mackin said. "We absolutely stand by the way we disclosed the information. We achieved our earnings for the third quarter, and we intend to make consensus for the fourth."

Shares of First Union dropped almost 3% in early-morning trading, before recovering later in the day. The stock closed at $39.625, down 68.75 cents, or 1.71%. That compared with a 1.5% decline in the American Banker index of the nation's 50 largest banks and a 2.12% drop in the American Banker 225.

Andrew B. Collins, a bank analyst at ING Barings, said investor confidence in banks that, like First Union, that have undergone major mergers in the last couple of years has taken a particularly serious blow.

"This really is not an issue with banks that have not done large mergers," Mr. Collins said. "Banks that have done large acquisitions - other than Wells Fargo & Co. - seem much more likely to manage their earnings because of the difficulty encountered during integration."

Lawrence W. Cohn, an analyst with Ryan Beck & Co. of Livingston, N.J., said no one asked the bank whether it had had any nonrecurring gains in the quarter. He said the discrepancy is an issue of omission rather than commission.

"Did the company lie? No, it did not," Mr. Cohn said, "but it does bring into question management's integrity."

Investors have been disappointed several times by major banks in the last year. Just last week, National City Corp. of Cleveland told investors that its fourth-quarter earnings would come up short because of margin compression.

On Nov. 10, Bank One's shares tumbled after the company said it would fall short of its fourth-quarter earnings.

In July, State Street Corp.'s shares plummeted 7% in a day, because the company had not specifically highlighted a nonrecurring gain in its second-quarter earnings. After analysts subtracted the gain, it was discovered that State Street's revenue growth was slowing.

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