The EITF 99-20 phenomenon, which continues to cause sizeable write-downs associated with reevaluations of credit-sensitive securitized assets (residuals), has brought the elusive first-loss piece to the media front line recently.
According to published reports, companies like Bank One Corp., Lincoln National Corp., Liberty Financial and others have all reported write-downs associated with EITF 99-20. Garnering the most attention, perhaps, Citigroup reported a $116 million charge associated with the accounting change.
And as it turns out, some of the much-hyped loss that American Express suffered from its exposure to CDOs was attributable EITF 99-20 write-downs, an analyst said.
"I think the reason why we're seeing a lot of this now is because everyone is playing follow the leader," an analyst said. "You might as well take the write down now when everyone else is, rather than a year from now, when it will stand out."
Although not related to the accounting revisions, the troubles causing the failure of Superior Bank are also associated with residual valuation discrepancies. The seizure of the by the Federal Deposit Insurance Corp. (FDIC) happened when the bailout investors, primarily the Pritzker family, pulled out of the deal because the FDIC rejected the family's plan to pump in an additional $210 million, according to published reports.
Chase Manhattan Mortgage Corp.'s lawsuit against Advanta Corp. (see story next page) also involves a discrepancy in the value of the residual assets in Advanta's securitized portfolio of subprime mortgage loans.
As previously reported (see ASR 10/16/00), EITF 99-20 is related to two areas of residual accounting, interest recognition for residual accounting, in addition to an impairment accounting clause, which determines how to recognize a non-temporary decline in fair (or market) value on a residual asset.
For the interest recognition piece, under prior guidance, EITF 89-4, interest income was accounted for using a retrospective method. The retrospective method recognizes interest income on a cash basis, where any variance from an expected residual cash flow is recognized as an income gain or loss.
Under EITF 99-20, any variance on residual returns from the estimated returns will be accounted for on a prospective manner, meaning that a change in cash flow is accounted for over the remaining life of the instrument, to capture the variance in future projections.
As for the impairment clause, under the previous guidance, an asset is considered impaired when the internal rate of return calculated is less than the risk-free rate, or the rate paid on a comparable Treasury.
However, with EITF 99-20, the concept of "other-than-temporary" decline in value was incorporated into the accounting mechanism. Prepayment risk, which is considered non-temporary decline in value on senior bonds (which pay out first in a prepayment event), needs to be taken into account for valuation of the instrument.
EITF is an acronym for Emerging Issues Task Force, which is the accounting team that deals with all the "pressing" industry issues. The group meets regularly, usually with five to ten issues on the agenda for discussion.