FASB Changes Accounting Rule

The Financial Accounting Standards Board (FASB) yesterday gave final approval to accounting rule changes that will require the companies to bring their off-balance sheet assets onto their balance sheets. FASB release can be seen here.

The FASB rule-change affects the so-called Qualifying Special Purpose Entity (QSPEs), which are generally off-balance-sheet entities that are exempt from consolidation under the current rules. The new standard eliminates that exemption from consolidation. The approved standards will be effective as of the beginning of 2010, and will apply to existing qualifying special purpose entities.

QSPEs played an important role in the financial crisis, as many banks used them to hold more risky securities without having to disclose the details or to provide adequate capital for the potential losses. As the securities deteriorated in value, the losses mounted and eroded the capital of the banks.

The changes will make it harder for the banks to keep the assets off balance sheets, and they will also be required to maintain adequate capital for those assets. The rule change will also make securitization of loans and receivables more difficult, since this is mainly done through QSPEs.

The rules will certainly improve the transparency of the banks’ balance sheets. In the stress tests recently conducted, the Federal Reserve had estimates of assets likely to be brought onto the balance sheet as a result of these amendments. It is estimated that 19 banks subjected to stress tests would have to bring about $900 billion of assets onto their balance sheets.

In their latest regulatory filings, Citigroup (C) estimated that the rule change would result in consolidation of $165.8 billion in additional assets, and JPMorgan (JPM) estimated it to be $145 billion.

We think that the new rule is a very positive move by FASB, after the much criticized and much debated revision allowed by it (under intense pressure from Congress) on mark-to-market accounting recently.

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