Procter & Gamble Co., the consumer products giant, said Tuesday that it was badly burned by investing in two exotic financial contracts that created a $102-million after-tax charge in the third quarter.
The loss is believed to be the largest ever reported by a U.S. industrial company on swaps, a financial derivative in which two parties exchange interest payments on loans to hedge against interest rate risk.
Procter & Gamble said it often used these contracts to hedge against risk but that the swaps in question fell outside its normal investments.
P&G; said the two contracts, arranged by Bankers Trust New York Corp., were so complex that when interest rates leaped higher last month, its losses multiplied.
"Derivatives like these are dangerous, and we were badly burned," said Chairman and Chief Executive Edwin Artzt. "We won't let this happen again."
He added: "We are seriously considering our legal options relative to Bankers Trust, the financial institution that designed these swaps and brought them to us."
Bankers Trust said it fully discussed the contracts with Procter & Gamble officials and said its advice to sell them when interest rates rose was unheeded by the company.
"Bankers Trust entered into a number of leveraged derivative transactions with Procter & Gamble, several of which were profitable to that company," the bank said.
It said the contracts were based on a bullish view of U.S. and German interest rates, which instead of falling rose sharply.
Bankers Trust said it strongly and formally recommended that P&G; limit its risks by unwinding all or part of these transactions. "Senior officials rejected these recommendations," Bankers Trust said.
Derivatives such as swaps have become popular in recent years, but, like all investments, they have a downside if the market turns in the wrong direction.
The news may rattle investors today, analysts said.
"It seems to me that derivatives are like floating mines in a busy sea lane," said Alan Ackerman, strategist at Reich & Co. "When they get too close, they can do a lot of damage."
"I think that earnings disappointments can be devastating and that derivatives may surface in earnings reports among other companies as well," Ackerman added, calling the P&G; news "a shot across the bow."
P&G; said that excluding the onetime charge for the third fiscal quarter, which will be announced this month, earnings will be up about 15%.
"It is unfortunate that this onetime charge detracts from the outstanding progress expected in the company's operating earnings for the third quarter," Artzt said.