In 2003, there has been nary a dull week in securitization accounting, as just about every Wednesday the Financial Accounting Standards Board grinds out a new set of ideas, often in opposition to deliberations the week prior.
Over the past three weeks, it appears the board is trying to offer some breathing room - postponing the effective date of FIN 46 and deciding to completely re-expose a draft of the controversial amendment to FAS 140 - both of which extend various deadlines, though how practical the extensions are, particularly with regard to FIN 46, remains to be seen. For the amendment to FAS 140, it appears the draft is next year's business, complete with a 45-day comment period, a new set of deliberations, and all sorts of other bells and whistles such as "elaborate grandfathering provisions for existing QSPEs," writes Marty Rosenblatt of Deloitte & Touche in an informal commentary circulated shortly after the board met last week.
Of course, no really knows what the final drafts will look like, so the uncertainty factor is still at play. Some, for example, are simply blowing off the FIN 46 postponement, with a too-little-too-late attitude. What's interesting, however, is that in most cases, FIN 46 consolidations are receiving special treatment on the balance sheet - at least a special discussion in the notes - since they seem to demand some level of explanation outside the asset/liability presentation.
In its earnings release last week, BlackRock, Inc. stated that it is applying FIN 46 "notwithstanding the decision of the FASB to defer implementation to the fourth quarter of 2003."
The company adds, "In order to provide some measure of transparency to shareholders, BlackRock's consolidated operating results will be segmented by Asset Management' (previous reporting) and Consolidated Special Purpose Entities.'"
According to BlackRock, it was deemed the primary beneficiary in the six CDOs it manages primarily as a result of the market-based fees it collects. BlackRock's fees were about $3.4 million for the three months ended Sept. 30, associated with the $2.6 billion it will consolidate. The company stated that its maximum loss exposure to these CDOs is its vested $14.3 million.
BlackRock expects to incur an expense of about $1 million associated with complying with FIN 46 this quarter, and anticipates that annual costs for future periods will be "substantially higher" due to increased staff resources required.
Meanwhile, PNC Financial Services, which owns approximately 70% of BlackRock, and as such consolidates BlackRock on its financial statements, also chose early adoption of FIN 46. In PNC's statement, the company noted that BlackRock was deemed primary beneficiary in its CDOs, and listed additional VIEs that PNC will be consolidating. PNC will take the assets of Market Street Funding, a PNC-sponsored multi-seller ABCP conduit, onto its balance sheet, along with PNC Real Estate Finance, which invests equity in limited partnerships sponsoring real estate developments, and PNC Advisors, which runs a line of private investment funds. In total, PNC consolidated an additional $6.5 billion.
(Separately, Wachovia Corp. stated in an 8-K that it consolidated about $4.7 billion in conduit assets associated with FIN 46, which had an impact on its net interest margin and leverage ratios.)
Ernst & Young's assessment
Shortly after FASB decided to defer FIN 46, Ernst & Young, through its On Call Advisory Services Accounting Alert, circulated a brief summary of some of the tentative changes the board agreed to on Oct. 8 that will likely be incorporated into FASB's amendment to FIN 46, which is due out sometime this year. Click FIN 46 for E&Y's full writeup.
According to E&Y's comments, the board intends to expand the scope exemption for situations in which the primary beneficiary does not have enough information, or access to information, to properly consolidate the VIE under, for example, FAS 94, Consolidation of All Majority-Owned Subsidiaries, which is a control-based model generally applied when the parent has a controlling financial interest, usually meaning that company has a majority of the voting interest. Accountants have been heard calling this FIN 46 exemption the "information out."
"The consolidation literature that applies if you don't have the information necessary to apply FIN 46 is an open question," said E&Y's David Thrope.
Also, it is anticipated that paragraph 5(a), which defines a VIE as an entity without sufficient equity to support its operations (or absorb expected loss), will be clarified. Currently, the paragraph states that support to the SPE's equity cannot come from "other parties" through subordination. According to E&Y, the paragraph may be modified such that it's clear that the entity is a VIE even if the added support comes from the "risk equity group."
Further in paragraph 5(b), the board plans to clarify that, to be included in the analysis of the "controlling financial interest," the voting interests in the equity group need to stem solely from the equity owned and not from some other contractual arrangement. For example, if a CDO collateral manager is also an equity holder, only its powers as an equity holder should be used in determining whether or not the entire equity satisfies the three characteristics of a controlling financial interest.
The board is also going to broaden its "anti-abuse" clause - as E&Y coins it - such that all variable interests in any legal form (including, for example, subordinated debt) will be included in the analysis of whether not a party's variable interests are disproportionate to its voting interests (which would cause the SPE to fail 5(b)1 and be deemed a VIE).
E&Y also describes a change to paragraph 15, such that all variable interest holders should reconsider whether or not they are the primary beneficiary whenever an event occurs that would cause the existing primary beneficiary to reconsider.
In calculating ERRs
Meanwhile, according to another brief circulated by Deloitte's Rosenblatt, at last week's board meeting, FASB agreed to cautiously "move to a possible relaxation" of the provision in paragraph 8(c) that requires fees paid to a decision maker to be considered in the expected residual return analysis, if the decision maker can be "kicked-out" by the equity holders. Similarly, the board will consider allowing other circumstances - such as fixed fees to a decision maker not based on performance of the VIE - to be excluded from the ERR analysis. Both may appear in a final form of FSP FIN 46-c.
Other modifications are expected to emerge as the board continues redeliberations.