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— Rules of the Road —
The Financial Accounting Standards Board last month eliminated vehicles banks use to house off-book assets known as qualifying special purpose entities, or Qs. The board also established rules for bringing the assets onto balance sheets. The changes apply both to public and privately held companies and take effect for annual reporting periods starting after Nov. 15.
Although banks in theory will be permitted to keep healthy assets off of balance sheets, the practical effect will be to greatly reduce off-book accounting because it is typically used only for poorly performing loans and securities. FASB's move "addresses the critical need for continued improvement to the accounting for arrangements that were at the epicenter of the financial crisis," says James Kroeker, acting chief accountant at the U.S. Securities and Exchange Commission. FASB Chairman Robert Herz said recently that rules letting companies keep such items as mortgages and credit-card receivables off their balance sheets "were stretched," and "abused." Two standards were changed: FAS 140 Transfers of Assets and FIN
46(R) Consolidation of Variable Interest Entities. The effort to
rewrite the rules has been watched closely by investors concerned that
financial firms will suffer more earnings cuts as they increase capital
to offset the billions of dollars in troubled assets added to their
books. Both changes add disclosures to help investors understand a
firm's Companies will also have to alter how they evaluate transfers of financial assets to other owners and determine whether they have a "controlling interest" in special-purpose entities. Currently, companies must consolidate variable interest entities, or VIEs, which most off-balance-sheet vehicles are, only when credit losses or other negative events occur. But regulators say companies do not adequately monitor changes in asset values. The new standard requires ongoing reassessments of their value. Additional revisions require a company to disclose its involvement with VIEs, as well as any significant resulting changes in risk exposure. The change to FAS 140 also adds disclosure requirements about an
institution's continuing involvement in transferred financial assets.
Companies will also be forced to continue accounting for securitized
assets, even after some tranches are sold. And companies must reveal
any continuing involvement with the assets, including guarantees There's little doubt that the nation's 19 largest banks, thanks to the stress-test findings, will have to absorb losses that have been hidden, thus cutting into their capital levels. The stress tests reportedly factored in banks' off-balance-sheet exposures, but regulators are still hashing out guidance on how banks should apply the rules, and there is debate over exactly how much capital must be added. According to a report from Fox-Pitt Kelton Cochran Caronia Waller (USA) LLC, Bank of America Corp.'s tangible common equity, or TCE, ratio would fall in the first quarter of 2010 to 3.1%, as measured against tangible assets, from a projected 3.8% once the firm consolidates its off-balance-sheet exposure. Wells Fargo & Co.'s would fall to 3.72%, from 4.41%, and J.P. Morgan Chase & Co.'s would fall to 3.95%, from 4.40%. Typically, banks have TCE ratios of 5% to 6% or more. In May, Citigroup Inc. said the rule changes could have "a significant impact" on its financial statements. Citigroup estimated it would need to recognize $165.8 billion in additional assets, including $90.5 billion in credit-card loans. Similarly, J.P. Morgan Chase estimated that consolidation of the bank's qualifying special purpose entities and VIEs could add up to $145 billion to its books. Despite such gloomy predictions, accounting experts insist not all
off-balance-sheet activity must automatically come onto balance sheets;
each transaction will need to be Donna Block covers accounting regulation for The Deal. |
Balance sheets at banks, particularly the largest ones, will be reshaped over the next year because of new accounting rules requiring them to bring billions of dollars of assets onto their books.
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