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Securitization Tricks 'n Treats

Nov 3

Written by: Jack Ciesielski
11/3/2008 8:23 AM

No trick, maybe all treat for financially distressed homeowners. On Halloween, news spread that JP Morgan Chase would work with homeowners holding about $70 billion of mortgages. While JP Morgan Chase didn't step into the subprime swamp when it was percolating, it inherited a large number of subprime loans from its acquisition of Washington Mutual - who wasn't shy at all about making bad loans.

Terrific idea - keep the loans whole, build customer loyalty, keep people in their houses and just maybe, help stabilize the real estate market. In short, do what you can to keep the economy going.

Investors can't help but wonder, though: what are the economic effects on the bank? They're going to give up something to keep the consumers whole. And you have to wonder about the effects that renegotiation may have on the status of any of those loans securitized by WaMu. While it's not a black-and-white area of securitization accounting in Statement 140, a renegotiation of loans in a securitization trust could be considered evidence that a genuine sale of loans never took place. To present a true picture of what exists, the sale would best be reversed with the loans being returned to the bank's balance sheet and the pass-through security being a part of the bank's debt.

There's a bye given by the SEC to such renegotiations however, from the Office of the Chief Accountant early in 2008. No need to worry about shareholder presentation of events as they exist; just move along folks, nothing to see here.

Nothing indicating yet that this is the route JP Morgan Chase is taking. It's noteworthy, though, if they spark a wave of renegotiations among other banks. One would hope that happens - but investors need to exercise skepticism about the genuineness of loan sales in securitizations. In any case, if the additional securitization disclosures proposed by the FASB for this year come to pass, investors would be best off by using them to estimate what leverage would look like in the absence of securitization sale accounting - whether or not there have been loan renegotiations.

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Unexplored Obligations: Other Postretirement Benefits

Defined benefit pension plans take center stage in the pantheon of investors’ fears when it comes to worrying about liquidity effects or earnings distortions. Yet they rarely consider the cash demands and earnings distortions resulting from other postretirement benefit plans.

Since they’ve been required to measure - and display - a figure expressing the value of the promises made for providing employee health care benefits, managers have dealt vigorously with the obligations. Their growth has been held in check while pension obligations have grown ever higher. Yet even as they’ve become more controlled, other postretirement benefit plans are worth investor attention. As the benefit plans become less fearsome, the accounting principles involved have helped an increasing number of companies recognize phantom earnings - negative benefit costs - even while they’re putting cash into benefit payments under these plans. It’s better to be alert to such a trend early: firms may not always bring it to the attention of investors.

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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