Tuesday, April 8, 2008

SIVs SPEs - R.I.P.

This item, from FT's Alphaville, reports on changes that are in the works at the Financial Accounting Standards Board ("FASB", the entity that sets the standards in the US for Generally Accepted Accounting Principles - or "GAAP") that may well kill the off-balance sheet entities that have been blamed for much of the credit crises of the last eight months.

While creative minds at the leading investment banks and accounting and law firms may resurrect Special Purpose Entities, their use as off-balance sheet mechanisms seems doomed.

Of course, accounting rules change over time, and these discussions may not yield any results, but we probably won't be hearing about new SIVs and (off-balance sheet) SPEs for some time.

Death by accountancy for the SIV could mean more asset creep

It’s hard to get excited when there’s so many acronyms flying around. But the bottom line is that the FASB last week tentatively voted to remove the QSPE concept from FAS 140.

Now before you get partying, a little background.

Qualified Special Purpose Entities (QSPEs) are vehicles sometimes used for off-balance sheet securitisations, and as such, have come in for quite some flak over the past few months.

The QSPE enshrines the idea that in securing off-balance sheet or “sale treatment” for assets, the bank or originator must have given up control of those assets.

Yet when SIVs hit trouble, and the banks that spawned them were prompted by reputational concerns to step in and help out, the supposedly “sold” assets came back on board those institutions’ balance sheets.

Explains the FEI blog, the QSPE concept has also been criticised by some because the restrictions prohibiting the management of underlying “sold” assets (unless pre-specified in the securitisation documentation) were seen to have hampered the ability of lenders, say, to modify mortgage terms to help borrowers avoid foreclosure in the light of the credit crunch.

In cases where restructuring did occur, with the originator also acting as the servicer often making these calls, in what sense have the assets really been “sold”?

The blog links to the details of the board meeting held last week at the Financial Accounting Standards Board, the US standard setter. In the meeting the FASB considers changes to when vehicles can be “derecognised” or transferred off balance sheet.

The issue of QSPEs has been on the FASB’s agenda since back in 2005, but has been stepped up since last summer. As board member Larry Smith is quoted as acknowledging:

For five years now we’ve struggled with application of [FAS] 140 [and] the fundamental question related to servicer discretion. We said, it’s almost impossible to structure a vehicle with the objectives the board had in mind when they created QSPEs: that is, an entity that has no decision making whatsoever relative to the run-out of these assets.

The latest draft of simplified guidance on asset transfer is expected in the second quarter.

What next then?

Credit Suisse analyst David Zion noted the FASB’s move to eliminate the QSPE concept and warned that changes, which could see a new rule by the end of the year, may mean more assets coming back onto corporate balance sheets.

Eliminating QSPE’s, along with other changes the FASB will discuss in the coming weeks may end up bringing more assets back on corporate balance sheets—along with the debt from the securitizations. However, the Board is considering allowing the assets and liabilities of certain entities to be shown on the company’s balance sheet in a new way; a “linked presentation” where both may be shown together on the asset side of the balance sheet (i.e., the liabilities are treated as a contra asset).

Either way, adds Zion, investors require better information on what companies may have parcelled off in such vehicles. Current disclosures are inconsistent and incomplete.

And next up for potentially burgeoning balance sheets, the FASB is set to discuss FIN 46R, the accounting rule that covers everyone’s favourite - the variable interest entity (VIE), an acronym which hit the headlines - thanks to another round of banking disclosure - in February.

Says Zion:

The FASB could decide to change how companies determine if they control a VIE (focusing on more qualitative factors) and force companies to reconsider whether or not the VIE stays off balance sheet more often than they do today, changes that could land more off-balance-sheet activity back on balance sheet. We plan to follow these developments and follow up with future reports on off-balance-sheet accounting. Stay tuned…

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