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The AAO Weblog covers accounting issues and current events as they relate the practice of investment analysis.

Jul 28

Written by: Jack Ciesielski
7/28/2005 5:56 AM 

R&G Financial - a Puerto Rican bank, no relation to R.G. Associates, publisher of The Analyst's Accounting Observer - filed an amended non-reliance 8-K yesterday afternoon. Its filing was one of those things that you automatically might file mentally under "maybe this is one of the earlier ones."

In the process of securitizing financial assets like accounts receivable, mortgages and other loans, the selling institution will usually retain some portion of the securitization. These retained interests do not always trade in a market, and consequently, their value needs to be estimated for balance sheet presentation.

This is the source of R&G Financial's restatement tale. In April, the firm decided they needed to change the methodology used for valuing residual interests retained from our mortgage loan sale transactions. Their initial estimate of the rewrite: the retained residual interests as of December 31, 2004 could be cut between $55 million to $90 million after taxes ($90 million and $150 million before taxes, respectively).

Since their April announcement, the firm has worked on those estimates using their new, improved methodology; they now believe they must restate financials as far back as 2002. They've found other glitches in accounting for the deferral and recognition of mortgage origination fees and expenses, revenue recognition related to specific loan sales transactions, and the amortization process used in connection with mortgage servicing rights. And they've upped the high end of their estimate for the cut in value in the retained interests by another $10 million, to $160 million pretax. Total bill, to be sent to shareholders' equity: between $116 million to $134 million after taxes ($190 million and $220 million, pretax).

Is it automatically "one of the earlier ones?" Don't think so. Securitizations are chock full of interrelated moving parts: tug on one, you'll throw another out of kilter. We've seen a few other
securitization rewrites this year: at another Puerto Rican bank, Doral; at Fannie Mae; H&R Block; Countrywide; and Providian.

The common thread in these was pretty much simply that the companies erred on their own: there was no seismic shift in interest rates or systemic delinquencies that trashed all assumptions, all across the board. As I said, there are a lot of moving parts in securitizations - and that increases the probability of committing errors. Expect that there will always be a stream of restatements tied to securitizations - maybe sometimes it'll be just a trickle, and it doesn't necessarily prefigure a flood.