Accounting & Tax

Accounting Rule Caveat May Be Relief for Real Estate

Caveat to FAS 140 will say it's okay for qualified special purpose entity to write a conditional call option.
CFO.com StaffJuly 18, 2001

A clarification to the Financial Accounting Standards Board’s Statement 140, brought on by concerns from the real estate market, will be a balm for the U.S. real estate finance industry, which viewed the rule as a threat to one of its major sources of capital, according to a Reuters report.

FAS 140 took effect on April 1. The board will issue its clarification of the rule on Thursday, according to a board staff member.

The rule without the clarification was the source of debate within the real estate finance industry because it precluded the use of a special servicing company in a commercial mortgage loan securitization.

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Lenders providing money to commercial real estate development and construction resell their loans into bonds via securitizations. The special servicer is needed to cost-effectively resell the loans into bonds because investors buying the bonds want an entity that will actively deal with troubled loans pooled into bonds.

FASB project manager Halsey Bullen told Reuters that special-purpose entities created when real estate loans are resold will not be able to actively manage loans pooled into bonds.

But, he said, “it is okay for the the QSPE (qualified special purpose entity) to write, at inception of the deal, a conditional call option.”

FASB will introduce guidance Thursday and one aspect of the guidance makes clear that such a call option would allow the special servicer to choose to buy a loan or any asset that has met some pre-arranged standard such as a default at fair value, said Bullen.

FASB has already approved it, Bullen told Reuters. It will present it to the emerging issues task force and ask it to incorporate it into accounting literature.

“The difficulty all along has been that it is clear in FAS 140 an QSPE cannot have a choice of whether it can sell an asset. It is okay for someone else to have that choice, acting for themselves and not as an agent for the QSPE,” Bullen told Reuters. He added that some new transactions backed by commercial mortgage loans will likely be designed to include this kind of call option.

According to a press release issued by The Real Estate Roundtable, an industry trade group, the “fair value” call option would “permit the sale of defaulted loans in securitization transactions, despite provisions in the April 1 accounting standard (SFAS 140) that limit a special servicer’s discretion to dispose of an impaired loan in a CMBS (commercial mortgage-backed security) pool.”