As the dog days of summer approach, securitization market players are facing some of the biggest accounting changes in years that will require major changes in relatively short order to their balance sheets, financial disclosures and the systems to generate that information.
The Financial Accounting Standards Board (FASB), based in Norwalk, Conn., published June 12 two standards affecting securitizations: Financial Accounting Statements (FAS) No. 166, Accounting for Transfers of Financial Assets, and FAS 167, Amendments to FASB Interpretation No. 46(R). Effective for first-quarter financial statements, firms must implement new disclosures and bring most securitizations onto their balance sheets, a move market participants fear could prompt regulators to impose more intensive capital requirements.
In the works for more than a year, the new standards have already ramped up the workload of some financial services firms' operations departments, which face a bevy of other accounting and regulatory changes by year-end. "It's been a monumental task so far at some organizations, and they've devoted a significant number of full-time employees and consulting spent to just get their arms around the new requirements," said Bob Walley, principal at Deloitte Touche.
Walley added that his firm has also seen some organizations "sitting on the sidelines" waiting for the new statement to come out, hoping it would be deferred. Many of the disclosures required by FAS 166 will be familiar to publicly traded firms because they are already required by FASB Staff Position (FSP) FAS 140-4, which was issued last September and became effective for financial statements after Dec. 31. The disclosures, however, will be new for non-public companies, and the new standard has at least some new provisions that could prove challenging.
Probably far more burdensome will be FAS 167. In the long term, "It's going to drive trillions of dollars onto balance sheets that weren't there before," said Jason Kravitt, a partner at Mayer Brown and the founder of its securitization practice.
Kravitt noted that under current regulatory rules, consolidating those assets would also require firms to set aside more regulatory capital, even though that capital has been depleted as they've dealt with festering toxic assets over the last year and a half. "FASB has written a rule that will bring most special purpose entities (SPEs) onto sponsors' balance sheets," he said, adding, "Just at a time when regulated financial institutions are trying to build capital, they will need huge amounts of new capital."
Kravitt said he anticipates federal bank regulators amending current regulatory capital rules to align them more with a firm's risk rather than accounting rules, lessening the effect on bank regulatory capital.
Preparing for new accounting will be daunting, especially for firms who neither originated nor serviced the assets but simply invested in them, since they may not have all the required data to determine whether consolidation is appropriate under the new language. John Hepp, a partner in Grant Thornton's national professional standards group, said firms will have to tally up the risks and rewards of each of their transactions to determine whether they control them or not, and whether they should be consolidated. In addition, he says, firms previously performed the consolidation assessment when a deal was initiated, and then it was left on "autopilot" until an event occurred requiring re-evaluation; now, those assessments must be done at least once a quarter.
"So you're going to have to have the staff - a big one-time cost - to review all past transactions that people thought were zipped up and on autopilot, and then firms are going to have to adjust their systems to monitor the transactions regularly," Hepp said, adding that the new requirements apply to companies outside financial services as well and a wide variety of SPE transactions.
Jack Ciesielski, head of R.G. Associates, an investment research and portfolio management firm, noted that the analysis has to be started "at the ground level" and depends in part on the current state of transactions, which makes it difficult to comply with the rules before publication. "It's driven by the document terms and the circumstances of the transactions out there. These guys are going to be busy," Ciesielski said.
Very large companies may have multiple business units engaged in securitization activity or otherwise using SPEs, and each of those units may currently have different operations and policies and procedures to handle those transactions. They will have to adjust the systems in each unit and likely also build a "dashboard" enabling the firm to manage the whole process. "The dashboard would sit on top of a mechanism to monitor transactions across units to determine which ones have reconsideration events, which must be consolidated and whether they've been consolidated," Walley said.
Peter Wilm, a director at Deloitte, noted that companies consolidating securitization SPEs must now account for the SPE's loans and debt securities in their financial statements. "Before, SPEs never had to comply with loan accounting. Now those loans are coming back onto the balance sheet," Wilm said, adding that this will result in consideration of loan loss reserves for many firms.
Although the task of reassessing potentially thousands of existing transactions in less than six months - to give time for test runs to make sure the new systems are up to snuff - may seem overwhelming, Wilm said certain transactions will be standard enough to place in buckets where they can be treated uniformly.
Hepp said that although the new disclosures will be new to private companies, most of these firms do not have sufficiently large capital bases to participate actively in the securitization market. Even for public companies, however, many of the disclosures ask for qualitative explanations about, for example, a firm's involvement with a variable interest entity - in which a firm holds a controlling interest that's unrelated to voting rights and often takes the form of an SPE- - and its continuing involvements with transferred financial assets. Those explanations can't be automated and require more costly human input.
Hepp noted two new disclosures in FAS 166. One requires disclosing the maximum exposure to loss from a transferred asset, and the other requires classifying transferred assets with which the firm remains involved in the fair-value hierarchy described in FAS 157, which was published in September 2006. Hepp noted that firms will have to implement the new standards' requirements while dealing with as many as 22 other new accounting rules, and perhaps two more pending ones on liabilities and alternative investments, by year-end.
In addition, as of June 1, FASB initiated its project to codify standards. It levels what has been the hierarchy among different types of accounting rules - ranging from the most important financial accounting standards to the lowly statements of position from the American Institute of Certified Public Accountants - and will require an adjustment period.
Furthermore, the current economic recession has done little to bolster financial firms' capital and income, and resources to support these changes remain scarce.
"Even though I view the impact of these statements as good accounting and the further rationalization of GAAP, I would have deferred them to the end of calendar year 2011," said Michael Youngblood, a principal at Five Bridges Capital, an asset manager specializing in structured debt.
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