Capital Markets

Expect More Securitization Disclosure Soon

By year's end, FASB standards will require companies and banks to reveal a lot more than ever before about their off-balance-sheet transactions.
Marie LeoneNovember 24, 2008

Accounting standard setters voted to stick a Band-aid on securitization rules today as a way of addressing disclosure problems until the standards can be properly rewritten next year. As a result, public companies will be required to reveal in their financial statement footnotes additional information about off-balance-sheet arrangements related to qualified special purpose entities and variable interest entities by the end of the year.

The Financial Accounting Standards Board is currently revising two rules — FAS 140 and FIN 46(R) — and is expected to issue the reworked versions next year. The FAS 140 rewrite will eliminate the so-called Qs, the off-balance-sheet vehicles that gave banks and other companies a way to keep securitized assets off their balance sheets. Without the Qs, banks and others will have to absorb the hidden losses. Changes to FIN 46(R) will provide new, more stringent criteria for when banks are allowed to transfer ownership of securitized assets and liabilities.

Spurred by the current credit crisis and the Securities and Exchange Commission, FASB was intent on pushing out the new versions of FAS 140 and FIN 46(R) quickly, until board members realized that more work would be needed. So in September, FASB issued a draft of the disclosure patch to provide investors with some level of comfort about off-balance-sheet exposures.

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The disclosure rules were released for public comment on Sept. 15, and two months later FASB issued revised rules after making 23 key changes based on comment letters and discussions with task force groups. But, FASB refused to bend on the compliance deadline or the board’s resolve to avoid bright-line rules. “Generally the board addressed most of the comments that were the biggest concern to preparers and auditor,” said Jay Hanson, national director of accounting with McGladrey & Pullen. “But the timetable decision was not surprise,” he told, noting that he and many others knew that it was unlikely that FASB would back down on the timing. The rule is effective for reporting periods ending after Dec. 15, 2008.

FASB decided to issue the disclosure rules to fend off “the political pressure” that bubbled up when off-balance-sheet losses were fingered as one of the culprits that exacerbated the credit crisis, remarked John Hepp, a partner in Grant Thornton’s professional practice group. Indeed, by the SEC’s lights, eliminating the broken Q would require banks to bring bad assets back on to their balance sheets in full view of investors.

But the Band-aid approach “is the better decision,” opined Hepp, who told that forcing through a “full blown standard with changes to measurement [criteria]” would have been a big problem. “I thought FASB was trying very hard to respond to comment [letters],” adding that the big criticism was the tight deadline, which he reckons will cause “a lot of sleepless nights.”

Companies and banks that are involved in hundreds or thousands of off-balance-sheet arrangements lack the systems to quickly aggregate the data and craft it into an intelligible, footnoted format, say some critics of the deadline. That’s mainly because the systems used by management for internal risk containment and management of the off-balance-sheet exposure are different than the technology used to produce footnotes. In addition, company layoffs, particularly in the banking industry, have left fewer employees to work on the financial reporting aspect.

“There is a huge difference between the quality of information that goes into management reports and the information that goes into a financial statement,” added Hepp, who also said that companies probably have not yet looked into potential internal control problems related to the new disclosures. What’s more, Hepp pointed out that it would have been hard for corporations to look ahead and start planning for the new rules because the draft rules were “a moving target,” citing the almost two dozen changes FASB made to the proposal before giving the go-ahead for the final rule today.

Changes made to the draft rule included requiring different levels of disclosure for some derivatives, depending on a company’s continued level of involvement in the securitization, as well as limiting disclosures if the assets and liabilities are carried on the balance sheet — as those items are already subject to disclosure rules, explained Hanson.

But FASB would not budge on the bright-line issues. For example, the final rule will not provide a bright-line measure regarding what constitutes a “significant” variable interest in a VIE, or what defines a “sponsor.” Hanson contends that when FASB uses words like significant, material, and primary in rules, without providing guidance, application of the standards “tends to be diverse.” The reason is that every company looks at the situation from a different angle, and responds to the threat of shareholder lawsuits and regulators second-guessing their decisions differently.

FASB also decided not to include disclosure examples in the rule, because companies often will rely on illustrative examples as “de facto standards,” said Hanson. He expects FASB will get its desired result of preparers and auditors using more professional judgment than in the past to apply these particular rules.

For their part, financial-statement users favor the disclosure rules as a way of bridging the gap until the Q is exorcised from the accounting literature sometime next year. In fact, the CFA Institute, which represents investment professionals, noted that in a 2007 survey of its members, respondents rank disclosures related to off-balance-sheet assets and liabilities, and attendant risk, as having a “high” importance with respect to analysis, yet they rank the quality of information provided as “low” quality.

What’s more, Jack Ciesielski, president of R.G. Associates, an investment research firm, and publisher of the The Analyst’s Accounting Observer newsletter, doesn’t have much sympathy for companies that complain about the compliance deadline. In a comment letter, he wrote: “I would counter that the required information is not anything that should require new reporting systems. If firms are unable to draw this information without having to rethink their information technology systems, it is questionable whether they have adequate systems in the first place.”

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