FASB 166

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FASB's "plain English" on FASB 166

The FASB concluded its deliberations of two proposals on May 18, 2009 which were finalized as standards on June 12, 2009. One of the proposals relates to the consolidation of variable interest entities, and one will amend existing guidance for when a company “derecognizes” transfers of financial assets. A variable interest entity (VIE) is a business structure that allows an investor to hold a controlling interest in the entity, without that interest translating into possessing enough voting privileges to result in a majority. After considering all of the feedback received on these original proposals exposed for comment in September 2008, the FASB concluded its deliberations and expects to issue final standards in June 2009.

Both new standards will require a number of new disclosures.

FIN 46(R) amends existing consolidation guidance for variable interest entities. Variable interest entities generally are thinly-capitalized entities and include many “special-purpose entities”, or “SPEs.” The primary amendment to FIN 46(R) relates to how a company determines if it must consolidate a variable interest entity. Under GAAP, a company must consolidate any entity in which it has a “controlling interest.” The new standard now requires a company to perform a qualitative analysis when determining whether it must consolidate a variable interest entity. Under the standard, if the company has an interest in a variable interest entity that provides it with control over the most significant activities of the entity (and the right to receive benefits or the obligation to absorb losses) the company must consolidate the variable interest entity. Under the new standard, the quantitative analysis often used previously is no longer, by itself, determinative. The newly-approved standard requires ongoing reassessments to determine if a company must consolidate a variable interest entity. This differs from existing guidance, which requires a company to determine if it consolidates a variable interest entity only when specific events occur. Under existing guidance, as expected credit losses increased significantly due to unpredicted market events, some companies did not reconsider whether they should consolidate a variable interest entity. The new standard requires a company to update its consolidation analysis on an ongoing basis.

The new standard requires a company to provide additional disclosures about its involvement with variable interest entities and any significant changes in risk exposure due to that involvement. A company will be required to disclose how its involvement with a variable interest entity affects the company’s financial statements. For example, if a company consolidates a variable interest entity and the assets of that consolidated entity are restricted, the company must disclose the nature of those restrictions and the carrying amount of such assets. A company will also be required to disclose any significant judgments and assumptions made in determining whether it must consolidate a variable interest entity.

The second standard now headed for finalization—Statement 140—enhances information reported to users of financial statements by providing greater transparency about transfers of financial assets and a company’s continuing involvement in transferred financial assets. It removes the concept of a qualifying “special-purpose entity” from U.S. GAAP, changes the requirements for derecognizing financial assets, and requires additional disclosures about a transferor’s continuing involvement in transferred financial assets.

A special purpose entity is a legal entity created to fulfill narrow, specific or temporary objectives. SPEs are typically used by companies to isolate the firm from financial risk. A company will transfer assets to the SPE for management or use the SPE to finance a large project—thereby achieving a narrow set of goals without putting the entire firm at risk.

Qualifying special-purpose entities (QSPEs) generally are off-balance-sheet entities that are exempt from consolidation. The new standard eliminates that exemption from consolidation. Many qualifying special-purpose entities that currently are off balance sheet will become subject to the revised consolidation guidance in the proposal on consolidations of variable interest entities.

The standard on derecognition restricts when a company may transfer a portion of a financial asset and account for the transferred portion as being sold. Existing guidance permits companies to report many transfers of portions or components of financial assets as sales. Under the new standard, a transfer of a portion of a financial asset may be reported as a sale only when that transferred portion is a pro-rata portion of an entire financial asset, no portion is subordinate to another, and other restrictive criteria are met.

This clarifies the legal isolation requirements to ensure that a company considers all of its involvements and the involvements of its consolidated entities to determine whether a transfer of financial assets may be accounted for as a sale. The newly approved standard also eliminates an exception that currently permits a company to derecognize certain transferred mortgage loans when the company has not surrendered control over those loans.

The new standard requires a company to provide additional disclosures about all of its continuing involvements with transferred financial assets. Continuing involvement can take many forms—for example, recourse or guarantee arrangements, servicing arrangements, and providing certain derivative instruments. The new standard also requires a company to provide expanded disclosures about its continuing involvement until it has no continuing involvement in the transferred financial assets. A company will also need to provide additional information about transaction gains and losses resulting from transfers of financial assets during a reporting period.

Generally, the approved standards will be effective as of the beginning of 2010 and will apply to existing entities, including existing qualifying special purpose entities. However, the amendments on how to account for transfers of financial assets will apply prospectively to transfers occurring on or after the effective date

OCC issues regs on FASB 166 and 167

The Office of the Comptroller of the Currency, the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation, and the Office of Thrift Supervision published in the Federal Register on January 28, 2010, a final rule amending risk-based capital requirements relating to the Financial Accounting Standard Board’s (FASB) adoption of Statement No. 166, Accounting for Transfers of Financial Assets - an Amendment of FASB Statement No. 140 (FAS 166) and FASB Statement No. 167, Amendments to FASB Interpretation No. 46(R) (FAS 167). This bulletin transmits and summarizes the interagency final rule.

SUMMARY

On June 12, 2009, the FASB issued FAS 166 and FAS 167, which becomes effective as of the beginning of each reporting entity’s first annual reporting period that begins after November 15, 2009. FAS 166 and 167, which FASB has codified as Accounting Standard Codification Topics 860, Transfers and Servicing, and 810, Consolidation, respectively, modify the treatment under U.S. generally accepted accounting principles (GAAP) of certain structured finance transactions involving a special purpose entity known as a variable interest entity (VIE). Under FAS 167, banks may be required to consolidate assets, liabilities, and equity in certain VIEs that were not consolidated under the standards that FAS 166 and 167 replaced.

The final rule retains GAAP as the foundation for calculating risk-based capital requirements for exposures in consolidated VIEs under the agencies’ general and advanced approaches risk-based capital frameworks (collectively, risk-based capital frameworks) and the agencies’ leverage capital rules. The final rule also eliminates provisions in the risk-based capital frameworks that permitted banks to exclude GAAP-consolidated asset-backed commercial paper (ABCP) program assets from risk-weighted assets. Finally, the rule provides a reservation of authority that permits the agencies to require banks to treat VIEs that are not consolidated under GAAP as if they are consolidated under the agencies’ risk-based capital frameworks.

In order to avoid abrupt adjustments that could undermine or complicate government actions to support the provision of credit to U.S. households and businesses in the current economic environment, the final rule provides an optional two-quarter implementation delay followed by an optional two-quarter phase-in of the effect of the accounting changes on risk-weighted assets and the amount of banks’ allowance for loan and lease losses includable in Tier 2 capital. The final rule does not provide any transition relief for a bank’s leverage ratio requirement.

Fed issues regs on FASB 166 and 167

The federal banking and thrift regulatory agencies today announced the final risk-based capital rule related to the Financial Accounting Standards Board's adoption of Statements of Financial Accounting Standards Nos. 166 and 167. These new accounting standards make substantive changes to how banking organizations account for many items, including securitized assets, that had been previously excluded from these organizations' balance sheets.

Banking organizations affected by the new accounting standards generally will be subject to higher risk-based regulatory capital requirements. The rule better aligns risk-based capital requirements with the actual risks of certain exposures. It also provides an optional phase-in for four quarters of the impact on risk-weighted assets and tier 2 capital resulting from a banking organization's implementation of the new accounting standards.

The final rule, issued by the Office of the Comptroller of the Currency, Board of Governors of the Federal Reserve System, Federal Deposit Insurance Corporation, and Office of Thrift Supervision, will take effect 60 days after publication in the Federal Register, which is expected shortly. Banking organizations may choose to comply with the final rule as of the beginning of their first annual reporting period after November 15, 2009.

FDIC issues regs on FASB 166 and 167

The federal banking and thrift regulatory agencies today announced the final risk-based capital rule related to the Financial Accounting Standards Board's adoption of Statements of Financial Accounting Standards Nos. 166 and 167. These new accounting standards make substantive changes to how banking organizations account for many items, including securitized assets, that had been previously excluded from these organizations' balance sheets.

Banking organizations affected by the new accounting standards generally will be subject to higher risk-based regulatory capital requirements. The rule better aligns risk-based capital requirements with the actual risks of certain exposures. It also provides an optional phase-in for four quarters of the impact on risk-weighted assets and tier 2 capital resulting from a banking organization's implementation of the new accounting standards.

The final rule, issued by the Office of the Comptroller of the Currency, Board of Governors of the Federal Reserve System, Federal Deposit Insurance Corporation, and Office of Thrift Supervision, will take effect 60 days after publication in the Federal Register, which is expected shortly. Banking organizations may choose to comply with the final rule as of the beginning of their first annual reporting period after November 15, 2009.

Attachment: Agencies Issue Final Rule for Regulatory Capital Standards Related to Statements of Financial Accounting Standards Nos. 166 and 167 - PDF 300KB

FDIC allows banks to transition to higher capital rules

AGENCIES: Office of the Comptroller of the Currency, Department of the Treasury; Board of Governors of the Federal Reserve System; Federal Deposit Insurance Corporation; and Office of Thrift Supervision, Department of the Treasury.

ACTION: Final rule.

SUMMARY: The Office of the Comptroller of the Currency (OCC), Board of Governors of the Federal Reserve System (Board), Federal Deposit Insurance Corporation (FDIC), and the Office of Thrift Supervision (OTS) (collectively, the agencies) are amending their general risk-based and advanced risk-based capital adequacy frameworks by adopting a final rule that:

  1. eliminates the exclusion of certain consolidated asset-backed commercial paper programs from risk-weighted assets;
  2. provides for an optional two-quarter implementation delay followed by an optional two-quarter partial implementation of the effect on risk-weighted assets that will result from changes to U.S. generally accepted accounting principles from the Financial Accounting Standard Board’s Statement of Financial Accounting Standards No. 166, Accounting for Transfers of Financial Assets, an Amendment of FASB Statement No. 140, and Statement of Financial Accounting Standards No. 167, Amendments to FASB Interpretation No. 46(R);
  3. provides for an optional two-quarter delay, followed by an optional two-quarter phase-in, of the application of the agencies’ regulatory limit on the inclusion of the allowance for loan and lease losses (ALLL) in tier 2 capital for the portion of the ALLL associated with the assets a banking organization consolidates as a result of FAS 167; and
  4. provides a reservation of authority to permit the agencies to require banking organizations to treat entities that are not consolidated under accounting standards as if they were consolidated for risk-based capital purposes, commensurate with the risk relationship of the banking organization to the structure. The delay and subsequent phase-in periods of the implementation will apply only to the agencies’ risk-based capital requirements, not the leverage ratio requirement.


"Federal Deposit Insurance Corp. Chairman Sheila Bair said she may give banks including Citigroup Inc. and JPMorgan Chase & Co. a reprieve from raising capital to support billions of dollars of securities that firms will have to bring onto their balance sheets.

“Giving some breathing room in terms of when they can transition in is acceptable to us,” Bair said in an interview at Bloomberg News’s Washington bureau today. Bair said she wants the FDIC to vote on the issue at a Dec. 15 board meeting even as “we don’t completely have agreement yet among the regulators.”

Agencies including the FDIC and the Federal Reserve are considering financial industry requests to permit a phase-in of capital requirements, which rise starting next month under a change approved by the Financial Accounting Standards Board. The rule, passed in May, eliminates off-balance-sheet trusts known as Qualifying Special Purpose Entities, forcing banks to move billions of dollars of assets and liabilities onto their books.

“We support bringing all this back on balance sheet,” Bair said. “It should have been on, frankly, all along. And we know that now.”

Banks should be given three years to raise capital to offset assets and liabilities brought onto balance sheets, Citigroup Chief Financial Officer John Gerspach said in an Oct. 15 letter to regulators. Requiring banks to “assume the risk- based capital effects immediately, or even over one year, is an undeniably severe penalty,” he wrote.

New York-based Citigroup argued that the FASB rule would lead the bank to cut financing for securitizations that fuel credit-card lending, residential mortgages and student loans. Additional consumer loans will be cut as well, the bank said.

‘Negative Impact’

The capital requirements “will have a significant and negative impact on the amount of consumer-conduit funding that will be made available by U.S. banks,” JPMorgan Managing Director Adam Gilbert said in an Oct. 15 letter to regulators. “We strongly support a phase-in period for the rule changes.”

Investors are wary of a company’s unknown obligations after the world’s biggest banks and brokerages reported more than $1.7 trillion in writedowns and credit losses since the start of 2007, some stemming from losses in off-balance-sheet vehicles.

Many lenders made profits before the subprime-mortgage market collapsed by selling pools of loans to off-balance-sheet trusts, which repackaged the pools into mortgage-backed securities. Some banks then sold those securities to other off- balance-sheet vehicles they sponsored, concealing from investors that the securities were backed by deteriorating mortgages.

Norwalk, Connecticut-based FASB, which writes U.S. accounting standards, is overseen by the Securities and Exchange Commission. FASB’s rules aren’t subject to approval by the banking regulators.


"A preliminary analysis indicates that the implementation of FAS 166 and FAS 167 will increase the amount of assets and liabilities reported on some banks’ balance sheets and, for some banks, result in significantly higher regulatory capital requirements.

In light of this, the NPR requests comment on the appropriateness of a phase-in of the increase in banks’ capital requirements that would result from the implementation of these accounting standards.

The NPR also requests comment on various matters involving the effect of FAS 166 and FAS 167 on securitizations and related activities by banks and any accounting treatment and risk-based capital requirements involving those activities.

FASB announcement on 166 and 167

The FASB today published Financial Accounting Statements No. 166, Accounting for Transfers of Financial Assets, and No. 167, Amendments to FASB Interpretation No. 46(R), which change the way entities account for securitizations and special-purpose entities. The new standards will impact financial institution balance sheets beginning in 2010. The impact of both new standards has been taken into account by regulators in the recent "stress tests."

These projects were initiated at the request of investors, the SEC, and The President`s Working Group on Financial Markets. Copies of the new standards are available at the FASB`s website, along with a concise briefing document.

Statement 166 is a revision to Statement No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, and will require more information about transfers of financial assets, including securitization transactions, and where companies have continuing exposure to the risks related to transferred financial assets. It eliminates the concept of a "qualifying special-purpose entity," changes the requirements for derecognizing financial assets, and requires additional disclosures.

Statement 167 is a revision to FASB Interpretation No. 46(R), Consolidation of Variable Interest Entities, and changes how a company determines when an entity that is insufficiently capitalized or is not controlled through voting (or similar rights) should be consolidated. The determination of whether a company is required to consolidate an entity is based on, among other things, an entity`s purpose and design and a company`s ability to direct the activities of the entity that most significantly impact the entity`s economic performance.

Robert Herz, chairman of the FASB, said: "These changes were proposed and considered to improve existing standards and to address concerns about companies who were stretching the use of off-balance sheet entities to the detriment of investors. The new standards eliminate existing exceptions, strengthen the standards relating to securitizations and special-purpose entities, and enhance disclosure requirements. They`ll provide better transparency for investors about a company`s activities and risks in these areas."

Both new standards will require a number of new disclosures. Statement 167 will require a company to provide additional disclosures about its involvement with variable interest entities and any significant changes in risk exposure due to that involvement. A company will be required to disclose how its involvement with a variable interest entity affects the company`s financial statements.

Statement 166 enhances information reported to users of financial statements by providing greater transparency about transfers of financial assets and a company`s continuing involvement in transferred financial assets.

Both Statements 166 and 167 will be effective at the start of a company`s first fiscal year beginning after November 15, 2009, or January 1, 2010 for companies reporting earnings on a calendar-year basis.

Financial Accounting Standards Board Neal McGarity, 203-956-534

The large banks on FASB 166

"... Taking a cue from the ABA, the big 3 record earners have decided to join in: last thing one would want is JPMorgan not earning yet another record amount in Q4. First Citi chimes in:

Banks should be given three years to raise capital for offsetting assets and liabilities that must be brought onto their balance sheets, Citigroup Chief Financial Officer John Gerspach said yesterday in a letter to regulators. Requiring banks to “assume the risk-based capital effects immediately, or even over one year, is an undeniably severe penalty,” he wrote.

Then you have record earner JPMorgan:

The capital requirements “will have a significant and negative impact on the amount of consumer-conduit funding that will be made available by U.S. banks,” said the letter from JPMorgan, the New York-based bank that this week reported its biggest quarterly profit since the subprime-mortgage market collapsed in 2007.

“We strongly support a phase-in period for the rule changes,” according to JPMorgan’s letter, which was signed by Managing Director Adam Gilbert. The change would take effect for annual reports after Nov. 15.

And last, Wells Fargo:

The rule “could lead to the result that every $1 billion of additional capital held from newly consolidated assets ‘crowds out’ more than $15 billion in loans,” Paul Ackerman, Wells Fargo’s treasurer, wrote in a letter yesterday to the Fed, FDIC, Office of the Comptroller of the Currency and Office of Thrift Supervision. The comment period ended yesterday.

And just so it is clear it is not just the ABA which is using the "we will stop lending" trump card, here is Citi:

Citigroup, the New York-based bank that yesterday reported a third-quarter profit of $101 million, argued that bringing off-balance vehicles onto its books would lead the bank to cut financing for securitizations that fuel credit-card lending, residential mortgages and student loans. Additional consumer loans will be cut as well, Citigroup said.

“We do not plan to reduce lending in only those businesses specifically impacted by the incremental regulatory capital requirements,” Gerspach wrote.

Credit card securitizations and FASB 166

You’ve heard of mortgage loan modifications, now witness the effects of credit card loan modifications on banks.

On Monday, a number of US banks released credit card master trust data for October. Credit card master trusts are the off-balance sheet securitisation vehicles used by banks to bundle up their credit card exposure (they are also the things that will come back on balance sheet when accounting rules FAS 166 and 167 come into force).

Here’s a rundown of the October data:

  • Bank of America - BAC’s NCOs [net charge-offs] declined for the second consecutive month, decreasing 103bps in October to 13.22%. This follows a 28bps decline in September. Overall delinquencies rose for the second consecutive month, increasing 6bps in October to 7.59% (from 7.53%). . .
  • Citigroup - C’s NCOs declined for the second consecutive month in October falling 136bps to 8.79%, following its 199bps decline in September. Delinquencies also increased for the second straight month, rising 17bps to 5.67% after increasing 12bps last month . . .
  • JP Morgan - JPM’s NCOs declined for the second consecutive month, falling 10bps in October after declining 81bps in September. Overall delinquencies increased 26bps from September to 4.95% . . .

According to BarCap this is the second consecutive month that NCOs — or loans written off as uncollectable — declined at all three banks.But, it seems loan modifications and so-called payment holidays might have had a rather big impact.Here’s BarCap’s Jason Goldberg:

"We believe that results at the banks are being impacted by modifications and payment holidays. BAC noted in its recent 10Q filing it had modified over $12 billion of credit card loans ($10.9bn domestic, $1.4bn foreign) or 7.5% of its $164.5 billion in managed card loans.

In June, JPM gave certain customers the opportunity to skip their next payment (i.e. a “payment holiday,”) which impacted delinquency and charge-off rates. JPM’s outlook calls for 9% charge-offs in 4Q09 and 11% in 1Q10 as the payment holiday will actually depress 4Q loss rates. Note, the payment holiday is expected to reduce NCOs by 75bps in 4Q and increase it by 50-75 bps in 1Q10. In addition, at 3Q09, JPM modified $4.6 billion of on balance sheet credit card loans (3% of managed). Its modification program may include canceling the customer’s available line of credit, reducing the interest rate, and placing the customer on a fixed payment plan (up to 60 months). If the cardholder does not comply with the modified terms, then the credit card loan agreement will revert back to its original terms, with the amount of any loan outstanding reflected in the appropriate delinquency “bucket” and the loan amounts then charged-off in accordance with JPM’s standard charge-off policy.

In its recent 10-Q filing, C noted that loss mitigation programs that entail a reduction in customers’ monthly payments obligation constituted less than 5% ($7bn) of its $141 billion total managed portfolio (Citi-Branded $84bn; Retail Partner $57bn) at 3Q09. According to C, these programs along with other loss mitigation activities have stabilized reported delinquencies and net credit losses.

An increasing number of credit card loan modifications is interesting since it seems to be happening at the same time that credit card companies are raising their rates (quite significantly in some cases) in an effort to make up their losses and head off a new law limiting the practice next year.

Which of these two things will have the greatest effect on master trusts — which have already seen their profit margins squeezed in recent months — and by extension the banks which support them, remains to be seen.

CFA Institute webinar on fair value

(Note the webinar specifically covers IAS 39 replacement)

The financial crisis has sharpened focus on accounting treatment of financial instruments. The accounting approach can influence investor appreciation of risk exposures associated with complex financial instruments. Treatment of the accounting for financial instruments also represents an area of potential differences between U.S. GAAP and IFRS, and investment professionals should understand the potential consequences of these toward the ongoing convergence of global financial reporting.

IASB representatives Patrick Finnegan, CFA, (IASB Board Member) and Sue Lloyd (IASB Senior Technical Adviser) give a presentation moderated by J.P. Morgan’s Dane Mott, CFA, in which the IASB’s approach to financial instrument accounting is reviewed.

This is a recording of a live event that occurred on Tuesday, 3 November 2009.

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