US regulatory authorities are to consult financial institutions over impending changes to accounting principles that could bring billions of dollars in off-balance-sheet conduits and other vehicles back onto bank balance sheets, ramping up firms' capital requirements.
In a Federal Deposit Insurance Corporation (FDIC) board meeting in Washington, DC on August 26, regulators agreed to issue a notice of proposed rulemaking (NPR) asking for industry feedback on changes to the Financial Accounting Standards Board's (FASB) Generally Accepted Accounting Principles (Gaap).
Representatives from the FDIC, Federal Reserve, Securities and Exchange Commission, Office of Thrift Supervision and Office of the Comptroller of the Currency (OCC) are seeking comment ahead of the implementation of two new Financial Accounting Standards, FAS 166 and 167, that will come into force on November 15, to gauge whether changes to the treatment of off-balance-sheet vehicles could create sudden and sizable capital burdens for US institutions.
FAS 166 will supersede the existing FAS 140 rule by removing the concept of qualifying special purpose entities (QSPE) from Gaap. Under the old rules, any institution that transferred assets to a vehicle that met the definition of a QSPE could treat that transfer as a sale and remove those assets from the balance sheet altogether.
A second existing accounting standard, FASB Interpretation 46R (Fin 46R), exempted QSPEs from being consolidated on the balance sheet like other special purpose entities – such as variable interest entities (VIEs) – ensuring no capital had to be held against assets in QSPEs. Fin 46R will be replaced by FAS 167, which sets out a qualitative assessment for determining whether a specific company has a controlling financial interest in a VIE and, if so, whether that company is required to consolidate the entity onto its balance sheet.
The changes mean that, from 2010, many banks will be required to assume onto their balance sheets many QSPEs and other VIEs that are not consolidated under current accounting standards, adding billions in additional assets and liabilities. Among the transactions that are expected to be brought back onto balance sheets are asset-backed commercial paper conduits; revolving securitisations, including credit card securitisations and home equity lines of credit; and term-loan securitisations in which a bank retains a residual interest and servicing rights, such as private label mortgage, student loan and auto loan securitisations.
The NPR will ask market participants for information on which assets will probably be consolidated and which may be restructured to avoid consolidation, the impact of FAS 166 and FAS 167 on lending and securitisation activity, and whether a phase-in period that allows institutions to adjust capital levels over four quarters is appropriate. It will seek industry views on proposals that require securitisers to retain a portion of the credit risk on any asset that is transferred or sold through a securitisation.
"The preliminary analysis indicates that the implementation of FAS 166 and FAS 167 will increase the amount of assets and liabilities recorded on some bank balance sheets and for some banks result in significantly higher capital requirements," said James Weinberger, senior policy analyst at the FDIC in Washington, DC. "It is believed the accounting consolidation requirements will result in a regulatory capital treatment that more appropriately reflects the risks to which banks are exposed."
Regulators voted unanimously in favour of issuing the NPR, and set the consultation period at 30 days in duration. The OCC and the FDIC agreed that the critical issue facing regulators around the issue was striking the right balance between closing a significant accounting loophole while not stunting the nascent recovery in securitisation markets.
"It is a critically important issue for us as we try to assure that our regulatory capital requirements appropriately address the risks faced by banks because accounting changes don't always go by risk. In light of recent experience it is clear we did not have the risk reflected accurately on our own capital requirements," said John Dugan, US comptroller of the currency. "I recognise that these proposals in some cases will result in significant increases in regulatory capital required for institutions and will do so quite suddenly and I think it is very appropriate that we should ask the question whether we should phase this in over time."
Dugan's sentiments were echoed by FDIC chairman Sheila Bair. "Over recent years securitisation had become driven more by short-term gains and related accounting and capital benefits than the economics of the transaction and we paid a price for that. This accounting change closes loopholes that gave rise to things like structured investment vehicles and collateralised debt obligations that were at the heart of the financial disruption that shut down large swathes of the capital markets," Bair said.
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