FASB Releases Proposed Changes to FAS 140, FIN 46R, on QSPEs, More; Banking Agencies Look at Proposal; FAS 157 and Lehman

Earlier this afternoon (Sept. 15) FASB issued a press release announcing the release of three Exposure Drafts (EDs) that would amend the accounting and related disclosures for transfers of assets including securitizations, and consolidation of certain off-balance sheet entities (commonly called Special Purpose Entities (SPEs), Qualified Special Purpose Entities (QSPEs) and Variable Interest Entities (VIEs).

As noted in FASB’s September 3rd media advisory issued in advance of today’s release, “The proposed Statement to amend Statement 140, would, among other things, remove the concept of a qualifying special-purpose entity (SPE) and would remove the exception from applying Interpretation 46(R) to qualifying special-purpose entities (SPEs).” Additionally, “The proposed Statement to amend Interpretation 46(R) would amend the guidance for determining whether an enterprise must consolidate a SPE, including those previously considered qualifying SPEs.”

There is a 30 day comment period (ending Oct. 15) on the proposed FSP containing disclosures only; and there is a 60 day comment period (ending Nov. 14), on the other two EDs.

Reaction of the Banking AgenciesUpon issuance of FASB’s proposals, the federal banking agencies issued a statement, saying: “The Federal Reserve Board, Federal Deposit Insurance Corporation, Office of the Comptroller of the Currency, and Office of Thrift Supervision are evaluating the potential impact that these proposals could have on banking organizations' financial statements, regulatory capital, and other regulatory requirements. The agencies expect to engage in discussions with banks, savings associations, and bank holding companies to review and understand fully the implications of the proposed amendments.”
In other words, banks and other financial institutions could find their balance sheets ballooning when FASB’s proposals become finalized, thereby potentially threatening their compliance with bank and other regulatory capital requirements as currently established. The capital shortfall could occur, e.g., if those institutions are required (as proposed) to return to their balance sheets billions of dollars of mortgages and other financial assets previously treated as ‘off balance sheet’ under the original rules for FAS 140 and FIN 46R, including but not limited to use of QSPEs, a concept that is being ‘removed’ from the accounting literature. It remains to be seen if the regulatory agencies will adjust their capital requirements in light of changes to the accounting standards, if some kind of transitional capital requirements will be put in place for some period of time, or if any other particular action would be taken by the regulators.

Links to Proposals, Effective Date(s); Reference to Earlier SEC Guidance

Proposed Statement of Financial Accounting Standards: Accounting for Transfers of Financial Assets – an amendment of FAS 140 [Revision of Exposure Draft issued Aug. 11, 2005]
Effective date and transition: “This proposed Statement would be effective as of the beginning of a reporting entity’s first fiscal year that begins after November 15, 2009. Earlier application would be prohibited. Additionally, on the effective date, the concept of a qualifying SPE would no longer be relevant for accounting purposes. Therefore, formerly qualifying SPEs (as defined under previous accounting standards) would be evaluated for consolidation by all reporting entities on the effective date in accordance with the applicable consolidation guidance. If the evaluation results in consolidation, the reporting entity would apply the transition guidance provided in the pronouncement that requires consolidation.”

Proposed Statement of Financial Accounting Standards - Amendments to FASB Interpretation No. 46(R) [Consolidation of Variable Interest Entities].
Effective date and transition: “This proposed Statement would be effective as of the beginning of each reporting entity’s first fiscal year that begins after November 15, 2009. Earlier application would be prohibited. If an enterprise is required to consolidate an entity upon the implementation of this proposed Statement, the enterprise would recognize and measure all assets and liabilities pursuant to paragraphs 18–21 of Interpretation 46(R) as of the date the requirements of this proposed Statement would be applicable, except that any amounts that were ordinarily recognized as goodwill or a gain or loss would be recognized as a cumulative effect adjustment to retained earnings.”

Proposed FSP FAS 140-e and FIN 46(R)-e, Disclosures about Transfers of Financial Assets and Interests in Variable Interest Entities . Scope: this proposed FSP applies to public entities.
Effective date and transition: “This FSP shall be effective for reporting periods (interim and annual) beginning with the first reporting period that ends after the FSP is issued.” Additionally, “An entity (enterprise) is encouraged, but not required, to disclose comparative information in periods earlier than the effective date for disclosures that were not.” FASB explains the urgent need for the proposed disclosures contained in this FSP to be provided as soon as practicable, “given the current market environment.” They concluded an early effective date is practicable “because many of the proposed disclosures required by this FSP are similar to those the SEC’s Division of Corporation Finance suggested public entities (enterprises) consider in its December 2007 Sample Letter Sent to Public Companies That Have Identified Investments in Structured Investment Vehicles, Conduits or Collateralized Debt Obligations (Offbalance Sheet Entities). However, this proposed FSP would require certain of those disclosures to be applied more broadly to public entities (enterprises) not subject to the SEC letter. It also would require additional disclosures not included in that letter.”

Will Proposed Changes to FAS 140, FIN 46R Impact Appetite to Modify Mortgages?
An interesting question now that the proposed changes to FAS 140 and FIN 46R are out, is whether they will encourage, discourage, or have no effect on the desire of financial institutions and servicers of their loans to modify the terms of mortgages for those at risk of default, particularly subprime mortgages. I will add links to related commentary on this point or feel free to post such links in comments.

FAS 157 and Lehman?
We (and many others) reported earlier today on the major changes taking place in the markets preceding and following today’s announcements of Lehman Brothers declaring bankruptcy, Merrill Lynch being bought by Bank of America, and AIG reportedly seeking a cash infusion. (This afternoon, the NYT reported: “New York State Throws Big Insurer [AIG] a Lifeline.”)

CNBC posted a Guest Blog today (Sept. 15) “Bowyer: Debunking Laissez Faire Lehman,” by Jerry Bowyer, Chief Economist, Benchmark Financial Network, (who began his career with Arthur Andersen). He criticizes earlier remarks of Governor (and former Senator and Goldman Sachs Chair) Jon Corzine, who, according to Bowyer, “blamed the current crises in the market on what he called the "laissez faire" mood of regulation which we have seen "over the past decade.”

Bowyer does not believe the last decade has been ‘laissez faire,” and has some strong words about post-Sarbox regulation, adding: “It’s not just Sarbox, and Spitzer; it’s stuff like FASB 157, which forces firms to "mark to market" even when the market has collapsed.” He continues, “Under political pressure the financial accounting system now takes localized panic pricing and imposes it on the whole system. These companies built their balance sheets over many decades under what were then the Generally Accepted Accounting Principles. Did we think that changing those rules in a flurry of legislative retribution would not have tremendously disruptive effects on those balance sheets? Did our legislators think about the effects at all? Apparently not.”

Clearly Bowyer has some fairly strongly held views; a more moderate take may be, as some have suggested, that the timing of the effective date of FAS 157, requiring a new methodology for Fair Value Measurement to be done with emphasis on a ‘market participants’ model, was one element that, when combined with the subprime crisis and suddenly illiquid markets, appears to have been caught up in a ‘perfect storm’ of sorts. And, economic downturns of historic proportions cannot always be anticipated in advance. However, urged to action by the Presidents Working Group, the Financial Stability Forum, the IMF and others, FASB, the IASB and the SEC have tried to reach out through various roundtables, working groups, and other forums gather feedback on the issue of valuation, as well as issues relating to securitization, consolidation and off-balance sheet entities addressed in the EDs issued today.

And, as we previously reported, at the conclusion of an SEC roundtable on fair value reporting earlier this summer, (July 9) SEC Chairman Christopher Cox stated: “The Commission and staff will meet with FASB and PCAOB to consider next steps, making certain Fair Value accounting truly serves the interest of investors and all users of financial statements.” More recently, we told you that FASB plans to hold a webcast on Application of FAS 157, Fair Value Measurement, on Sept. 29 at 11am EDT. If you received this blog post from ‘a friend’ and you’d like to get our blog by email, enter your email address here.

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