Banks Stressing Over New Accounting Requirements

An accounting change mandated by the Financial Accounting Standards Board (FASB) as part of accounting rules revisions made in the wake of the financial crisis will force banks to bring more than $1 trillion of assets back on their books.  Credit-rating agency Fitch Ratings said in a new report that it does not expect FASB’s recent amendments to off-balance-sheet accounting standards to result in negative rating actions, but it believes there will be challenges for issuers and analysts in transitioning to the new standards.  U.S. financial regulators have expressed concern over the impact of the change on banks’ capital ratios.

New Accounting Rules

SFAS 166 and 167 will bring more information about off-balance-sheet special-purpose entities and securitizations back onto banks’ balance sheets (see Accounting for Financial Instruments—Joint Project of the IASB and FASB).  Banks will have to move such assets back on to their books on Jan. 1, 2010, but regulators want feedback on the impact of the accounting change and whether it might be prudent to phase in the risk-weighted capital that must be held against the assets.  One concern is that, by forcing banks to hold capital against positions in which they may have sold up to 95 percent of their stake, some banks may lose their “well-capitalized” rating, which could result in another credit crisis. 

The Federal Deposit Insurance Corp. has posted an agenda for its August 26 Board Meeting on its website indicating that regulators will propose a rule that seeks input.  Sheila Bair, chairman of the FDIC, acknowledged earlier this month that the change would be a tough hit for some banks and could derail the recovery of the securitization market, which helps lenders extend credit. 

Fitch Ratings noted that the economics of the off-balance-sheet transactions will remain the same.  For issuers, “The structuring of financial products could change as the qualified special-purpose entity ceases to exist and the test for consolidation of variable-interest entities switches to a qualitative focus from a quantitative one,” said Fitch senior director Meghan Crowe. “Furthermore, eliminating the regulatory capital arbitrage associated with off-balance-sheet accounting could yield lower ABS volumes, although Fitch believes this market will remain a necessary component of many issuer funding profiles.” 

Analysts will need to deal with changes in financial statement content, which could hamper the evaluation of credit on a historical and relative basis, and it could become more difficult to identify unencumbered assets with more secured financing added to the balance sheet. Additionally, the four measurement methods for reconsolidation permitted by FASB could make peer comparisons more difficult going forward. 

The Fitch report, “Off-Balance Sheet Accounting Changes: SFAS 166 and SFAS 167” discusses the analytical implications associated with the accounting changes, outlines the four measurement methods for reconsolidation permitted by FASB, and presents a hypothetical example of adjustments made to the balance sheet and income statement as a result of reconsolidation.

Impact on Banks

The impact of the change could be significant.  The Federal Reserve, during a recent “stress test” of the largest 19 U.S. banks, said the change could mean about $900 billion of assets being brought onto the books of those institutions. 

Citigroup said in a recent regulatory filing the rule could force it to bring $159.3 billion of assets back on its books, including $85.5 billion of credit card-related assets and $14.2 billion of student loans. 

JPMorgan Chase said it would likely have to add $130 billion of assets to its balance sheet, and said the change would decrease its Tier 1 capital ratio. 

During the stress-test process, the Federal Reserve ensured that these largest institutions had large enough capital cushions to weather the change, but it could still affect their leverage ratios, and slightly smaller banks’ capital levels could more dramatically change.