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Rep. Frank On Statement 140

Jun 21

Written by: Jack Ciesielski
6/21/2007 1:29 AM

This item brought to you through the FEI Financial Reporting Blog.

SEC Chairman Chris Cox is on the receiving end of a letter sent by House Financial Services Committee Chairman Barney Frank and nine other members of Congress. The letter posits the questions: "Does FAS 140 clearly address whether a loan held in a trust can be modified when default is reasonably foreseeable or only once a delinquency or default has already occurred? If not, can it be clarified in a way that benefits both borrowers and investors?"

Background: Statement 140 sets the conditions for when assets transferred from a firm's balance sheet constitute a sale - such as when mortgage loans are transferred from a lender's balance sheet to a qualified special purpose entity - a kind of trust - for the purpose of securitizing the loans. Once a transfer has taken place and accounted for as a sale, the originator of the assets has no further involvement with the assets put into the trust - otherwise, it contradicts the assertion that an asset has been sold. Tinkering with the assets in the trust after its creation could negate the sale and result in its reversal. So, with subprime loans dissolving all over the country, banks that originated the loans and transferred them into securitizations might be hesitant to change loan terms. To do so might indicate a continuing involvement, and make the assertion of a sale contestable. They might find that they have to restate past financials where a gain on sale was recognized and treat the securitization as a borrowing instead - which would be a negative for their balance sheet. They might also be willing to go ahead and change the terms, and add more assets of their own, and toss to the wind any concerns about the accounting treatment. That could be the case if they are concerned about keeping intact their access to this kind of financing. What Representative Frank and his co-signors seem to be suggesting: does it say in 140 that you'll ruin the sale treatment if a firm modifies terms of assets in a trust when you figure that they're going to fail without some negotiation? It doesn't explicitly say that, but it's implied. Because it's implied only, it sounds like the Congressmen want Chairman Cox to get the FASB to issue some kind of exemption so that lenders might be willing to postpone the inevitable from their deadbeat subprime borrowers without risking accounting consequences. In other words, can we have our cake and eat it, too? Sounds a lot like what happened with regulatory capital in the late '80's savings and loan debacle.

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A recent edition of The Analyst’s Accounting Observer looks at the problematic reporting, with an eye focused on the "phantom income" results shown by 42 companies having negative OPEB costs. While the report is available only to paid subscribers, a condensed version is available for free upon request. To receive it, send an e-mail to Brenda Rappold at brappold@accountingobserver.com, with “OPEB Costs” in the subject line.

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