Corporate Governance

FASB Proposes Rules Changes: Putting Securitized Assets Back on Banks? Balance Sheets

By Carol Straw

During the past weeks, we have provided ongoing reporting on congressional and other efforts to reform the market for securitized assets.  The FASB has joined the dialogue. According to CFO.com, it has proposed changes to two accounting rules requiring more disclosure around securitization transactions and ownership, and who benefits from the ownership.

Under the current FAS 140, banks are able to keep securitized assets off the balance sheets through the employment of a qualified special purpose entity. A change to this rule would eliminate that advantage the effect of which would require banks to absorb the hidden losses associated with these assets. Changes to the second rule, FIN 46(R), would provide new, more stringent criteria for when banks are allowed to transfer ownership of securitized assets and liabilities.

The proposed changes could cost banks as much as $60 billion a year as bigger balance sheets would require banks to hold more in capital reserves in order to borrow. Critics of the board?s proposals argue that this effect could further exacerbate a tightened credit market because banks rely on securitization as a form of financing. As we reported in our October 17 blog, securitization will survive the current market crisis, according to Adair Turner, the new chair of the UK Financial Services Association. Unlike the FASB however, Turner thinks that on balance sheet lending is not necessary if banks return to the original model for securitizing assets but with increased regulatory oversight via higher capital ratios for banks and more effective steps to prevent highly leveraged shadow banking entities escaping capital regimes. In this model, banks take accumulating credit assets off bank balance sheets and distribute them directly to end investors who can select desired risk return combinations and thereby reduce the concentration of risks on particular intermediary balance sheets.

Both reforms promote soundness in the market for securitized assets. The FASB?s proposals would effect a return to on balance sheet lending in which banks would load back securitized assets and liabilities on its? balance sheet but hold more in capital reserves. Turner?s proposal would effect a continuation the present regime of off balance sheet lending in which banks are able to keep securitized assets off its? balance sheets through the use of a qualified special purpose entity but with higher capital ratios for banks and the elimination of shadow banking entities which are able to escape regulatory oversight. Investors should encourage this ongoing dialogue.

See CFO.com?s article - Securitization's Last Throes?

Full post as published by PomTalk on October 28, 2008 (boomark / email).