FASB Change: Transparency at a Cost

An impending change to the accounting rules governing off-balance-sheet financing could force a new round of losses and capital-raising at financial institutions.

The proposed modification of the FAS 140 accounting standard has mostly flown under the radar, but the issue has become a hot topic on recent earnings calls and is increasingly popping up in company filings with the Securities and Exchange Commission.

As with fair value accounting, investors would get more transparency into public companies if FAS 140 is modified. However, the rule change -- which could be implemented as early as January 2009 -- would also make matters worse for financial institutions that have already reported massive losses and raised dilutive new equity.

"We're in a credit crunch. The last thing people want to do is throw gasoline on the fire," says Robert Napoli, an equity analyst at Piper Jaffray.

The Issue

In April, the Financial Accounting Standards Board, or FASB, agreed in principal to eliminate qualified special purpose entities, which are the bankruptcy-remote off-balance-sheet accounting vehicles used by firms to securitize their loans.

Firms that would be heavily impacted by the change include banks and credit card companies such as JPMorgan Chase (JPM Quote) and Discover Financial (DFS Quote). Even less obvious companies -- like CarMax (KMX Quote), which relies on securitization to sell its used-car loans -- could be pinched.

The motivation to eliminate the off-balance-sheet accounting vehicles stems from the subprime crisis -- as investors in collateralized securities began using their rights to sell back such bonds to the giant financial institutions that originated them. Suddenly, banks were found to have all sorts of liabilities that were never stated on their balance sheets.