In coming weeks, investors will probably hear a lot about "Fin 46."
No, it's not a new French restaurant in midtown Manhattan, but a new off-balance-sheet accounting rule. And it is proving as unsettling to some companies as the service of a snooty French waiter.
Enacted in the aftermath of
shady off-balance-sheet shenanigans, Fin 46 boosts the amount of outside equity a company needs to establish a special-purpose entity. Those are the limited vehicles some businesses can use to keep risky assets and ballooning debts off their balance sheets.
Specifically, Fin 46 ups the minimum outside equity investment in an SPE to 10% from 3%. Those that fail the new standard can no longer be kept off a balance sheet. Companies have until the end of the third quarter to either comply with the new 10% requirement, or start coming clean about any assets and debts they have parked elsewhere.
The new rule is intended to make it more difficult for businesses to emulate Enron, which gussied up its corporate books by hiding billions of dollars in debt and ailing assets in exotically named SPEs. The Financial Standards Accounting Board believes Fin 46 will make it harder for a company to find outside investors willing to put money into a SPE, if the sole purpose of the venture is to whitewash a company's balance sheet.
But Fin 46 also is sending companies with seemingly legitimate SPEs scrambling to meet the approaching deadline. And it appears many won't be able to, even though some money managers see an opportunity to profit from Fin 46 by specializing in helping to meet the 10% requirement.
Credit Suisse First Boston estimates that by the end of the third quarter, companies in the
may have to add about $400 billion in debt to their corporate ledger because of an inability to comply with Fin 46. Given the lack of disclosure, it's impossible to quantify the number further.
Still, a $400 billion rejiggering of corporate America's books has the potential to spook investors, especially those who are surprised to learn that some companies are on the hook for a lot more debt than they thought. In some instances, it could even impact negatively the credit rating on a company's bonds.
The Baby and the Bathwater
Some fear that a reform aimed at addressing Enron's misdeeds could now impact the ability of honest businesses to raise capital.
"The SPE itself is simply a tool or a shell. The risk comes from what people are doing with the shell," said Janet Tavakoli, president of Tavakoli Structured Finance, a consulting firm. "There have been many beneficial uses of special-purpose entities by banks, like for securitizing mortgage-backed securities."
Indeed, the companies likely to be hardest hit by Fin 46 will be banks, brokers, credit card companies and other financial firms that rely on SPEs to sell a wide array of financial products ranging from asset-backed securities to commercial paper to credit derivative obligations. Banks and brokers use SPEs to administer these programs because it's a way of transferring some of the risk associated with these financing deals to other parties.
Fin 46, for instance, is expected to have a big impact on the asset-backed commercial paper market -- a form of short-term financing that raised $726 billion last year for U.S. and foreign companies. Finance experts say if many of the SPEs used to support that market have to be consolidated on balance sheets, businesses may resist using them. Or if it takes a bigger outside investment to continue to keep these SPEs off the balance sheet, banks that manage them could charge higher fees to corporate clients.
David Zion, a CSFB accounting analyst, estimates that of the $400 billion in debt and assets that he expects S&P 500 companies to consolidate on their balance sheets, approximately 65% will be added to the books of financial-services companies. Zion said the 10 companies at the top of the SPE heap are:
J.P. Morgan Chase
Bank of America
"For certain regulated industries, bringing
SPEs back on balance sheet could result in real costs,'' said Zion in a June 24 research report. "The current regulatory rules would require U.S. banks to set aside more capital for the assets that will soon be landing on balance sheet as a result of Fin 46."
But much remains unanswered about the impact of Fin 46 and its eventual cost to business and investor psyches. Even Zion, in an exhaustive 81-page report, noted: "If you think companies are frustrated, the auditors are pulling their hair out and smashing their pocket protectors."
Yet, some on Wall Street smell money to be made in corporate America's anxiety over Fin 46.
Abney & Holloway Asset Management, a small New York investment firm, is setting up a $100 million fund to invest mainly in SPEs. The firm is soliciting wealthy individuals to invest in the fund, which it expects can generate a minimum annual return of 20%. Abney & Holloway hopes to meet its $100 million target by the end of the summer.
"As soon as we hit our target, we will target corporations directly," said Sylvie Durham, the firm's president and a former corporate lawyer. "We will target companies that we know need help."
Nevertheless, it seems even when sophisticated investors hear about SPEs, they either think of Enron or their eyes glaze over.
"What we have found is that most people don't understand structured finance," said Durham. "People have categorized structured finance as Enron-type deals. But that was a miniscule portion of structured finance."