Securitization’s Last Throes?

Changes to accounting rules could put loads of assets back on banks' balance sheets.
Alan RappeportOctober 24, 2008

Tweaks to two accounting rules could bring down the market for asset-backed securitization, critics of the proposal contend.

One rule change, to FAS 140, is the proposed elimination of qualified special-purpose entities, which provide a way for banks to keep securitized assets off their balance sheets. Without that option, they will have to absorb the hidden losses.

The Financial Accounting Standards Board also is proposing more disclosure around securitization transactions and ownership, and who benefits from the ownership.

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Changes to the second rule, FIN 46(R), would provide new, more stringent criteria for when banks are allowed to transfer ownership of securitized assets and liabilities.

FASB issued a draft of the proposed rule changes last month, and they are out for public comment until year-end.

According to a report released last week by research firm TowerGroup, the changes could hit banks for more than $60 billion a year at the bottom line, which in effect would freeze the securitization market. Moreover, the firm says, the changes could make it harder for consumers to borrow at a time when credit is already hard to find.

“TowerGroup believes the FASB proposals are intended to target abuses in mortgage lending and should exclude asset-backed securities (ABS) credit card lending, which, TowerGroup believes, have adequate safeguards in place to both serve market needs and protect the ABS investor,” writes Dennis Maroney, research director at TowerGroup.

Banks and companies that use securitization as a form of financing are worried that the market may fizzle out. Last week Esther Mills, chair of the American Securitization Forum’s accounting committee, wrote in a letter to FASB that “additional disclosure requirements are overly detailed and prescriptive and may frequently result in disclosures that are confusing to users of financial statements.”

In September George Miller, director of the American Securitization Forum, argued in testimony to the Senate that FASB should not rush to produce a new standard for the sake of change or to meet an arbitrary deadline. “Undue haste to revise accounting standards applicable to securitization transactions and off-balance-sheet entities will be counterproductive,” he said.

In his testimony, FASB chairman Robert Herz countered that “hopefully even when the music is playing, the potential risks get disclosed.” He also noted that the existing rules are not “God’s gift to accounting.”

The new disclosure rules would likely take effect in January 2009. The draft rules call for information about the nature, purpose, and activities of variable-interest entities — including how an entity is financed and the terms of arrangement that could require the company to provide financial support to the VIE, such as liquidity commitments and obligations to purchase assets. (VIEs are also known as special-purpose entities or SPEs.)

Would the revised rules spell the end of securitization? Ed Trott, a former FASB member, does not think so. “I think it will have little impact,” he tells “Securitization will continue in spite of the change.”

The real concern for financial institutions, Trott says, is that the bigger balance sheets the rule would create will require them to have more capital in order to borrow. Unless regulators change how they calculate the required equity “cushion” for borrowing, firms needing credit will face greater pressure. However, he notes, since all companies will face the same rule change, the accounting should not have an impact on their economic reality.

Speaking at the New York Society of Security Analysts’s financial reporting conference last week, James Mountain, a partner at Deloitte & Touche, agreed. “If everybody recalibrates and readjusts their models and decision rules recognizing that now the data is going to look different, we hopefully will get back into a situation where economically sensible deals get a sensible capital charge and get an appropriate reception in the marketplace,” he said.

Mountain’s view sparked some debate at the conference. Patricia Donoghue, the FASB project manager for FAS 140 and FIN 46(R), agreed, saying the proposed changes do “absolutely nothing to change the economic consequences of a securitization.” But Robert Pozen, head of the Committee on Improvements to Financial Reporting, contended that companies would not have bothered with securitization if there were no economic benefits.

“Why did all these people put all of this stuff off their balance sheet?” asked Pozen, who is also chairman of MFS Investment Management. “If it had the same economics, they would not have put it off their balance sheet. They put it off because they did not want to take capital charges. They did not want it to affect their debt ratios and debt ratings.”

Marie Leone and Tim Reason contributed to this report.