Securitization Accounting: Later Than Sooner?

by: Belvedere

On Wednesday, the FASB will take another look at the effective date to be inserted into the exposure draft of the forthcoming amendments to Statement 140 and Interpretation 46R. These amendments, covered before in the May Accounting Observer and in subsequent posts, will make full consolidation of the vehicles used in securitizations much more likely.

In other words, after these amendments go into effect, firms might still securitize loans - but the loans will still exist on their balance sheets and a liability shown for the amount of the "pass-through" security created in the securitization. The traditional "sale treatment," where the assets are derecognized and the pass-through liability instrument isn't shown on the securitizer's balance sheet, would likely be a much rarer find.

The likelihood of these amendments being in place by year-end is getting pretty slim. It's now the end of July, and there's no exposure draft; indeed, the topic on Wednesday is directly related to the tardiness in completing a draft. There needs to be at least a 45-day comment period for the proposal, if not a longer 60-day comment period. If the draft was complete two months ago, there would not be debate now about the effective date.

The effective date, considered this far, works like this: new securitizations would have to be evaluated under the new rules, potentially putting the full-strength transaction on the balance sheet of the sponsor, for transactions occurring in the first fiscal year and interim periods beginning after November 15, 2008. A bank with a calendar year end making a securitization in the first week of January would then have to evaluate such a transaction under the revised rules: a bulkier balance sheet would probably result, when the first balance sheet is reported on March 31, 2009. For existing securitizations at the 11/15/08 effective date, the same principles would be applied - but there would be a full year grace period. Those old securitizations might not pop onto the bank's balance sheet until March 31, 2010. (Assuming that they would have to be consolidated.)

As reported before, banks don't like this (like Citigroup (NYSE:C)); trade groups don't like this (like the American Securitization Forum). Now there are others getting into the act, pressuring the FASB to delay. Last week, Ranking Member of the House Committee on Financial Services Spencer Bachus wrote to FASB Chairman Bob Herz and SEC Chairman Christopher Cox, asking them to - what else? Slow down the process on amending Statement 140 and Interpretation 46R for an additional year:

"Changes to securitization accounting could have a dramatic impact on the economy, the capital markets and consumers seeking credit. With capital and liquidity at a premium, the effect of these changes could be to prolong market dislocation."

Those concerns are rather patronizing of investors, in several ways. There's a presumption that investors are better off right now with crummy information about risks and leverage being taken on by firms when they engage in securitizations. Don't fix the accounting right away, because the market has been dislocated. So - keeping investors in the dark longer would be better? Or does that mean that a certain level of securitizations have to be floated to get the lenders back in the game, over the course of the next year? Then it will be okay to fix the accounting?

Of course. Fix the accounting after investors in securitization-sponsoring firms have been kept in the dark about the level of risk and liability being undertaken by the firms in which they've invested. That's a sure-fire confidence-builder, a really good way to engender trust in the markets.

Extensions of deadlines beget more extensions of deadlines. If the delay doesn't work and the markets are still in deep trouble, the delay will be extended again at the request of some other Senator or Congressman. And if there is a recovery, the banks and their ilk will not welcome changes that make them look more leveraged; they'll cite the success of a recovery without the revised rules and resist them. The more time that elapses before a standard becomes effective, the greater the opportunity for its foes to find a way to delay the standard once again.

It would be better for the FASB to stick with their existing plan for the two-tiered approach to implementation of the new rules:

♦ The firms that are likely to be affected by this - the major banks - have not been caught flat-footed by these proposals. They have long known what would likely be required.

♦ The existing plans would affect only new securitizations immediately. Not everyone must do securitizations; and some might choose to pass, anyway. The securitization market isn't what it used to be, nor is it likely to be again.

♦ Investors will be better served by not having solid recognition principles in place for such leveraged creations sooner? In recent weeks, the market has gotten hot and messy over estimated amounts of additional leverage that have been pitched by analysts. Might the markets not be more confident if more reliable, factual numbers were added to balance sheets based on genuine accounting standards, instead of educated speculation?

♦ Firms applying the new accounting to new transactions would be able to hone their skills over the coming year in restating the old transactions.

The changes the FASB is proposing are not new, and not particularly revolutionary. Firms that would be affected should be able to handle them without further "market dislocation." Investors should have the benefit of seeing what risks they've entrusted managements to handle for them.

FASB should proceed as planned. Their mission is "serving the investing public through transparent information resulting from high-quality financial reporting standards, developed in an independent, private-sector, open due process." They can achieve this by keeping on the path they've started.

If the SEC wants to delay it - and they shouldn't, because they asked the FASB to get this done by the end of 2008 in the first place - they can change the effective date themselves. They've done this before: the chief accountant delayed the implementation of Statement 123R on stock compensation accounting after the FASB wouldn't be persuaded to halt its introduction.
We'll see if there's a cave-in on Wednesday.