U.S. accounting board tightens loan rules

WASHINGTON — The board that sets U.S. accounting standards on Monday moved to end companies' use of a device that allowed them to park hundreds of billions of dollars in loans off their balance sheets without capital cushions and has been blamed for helping stoke banks' losses in the housing boom.

The change will tighten the use of so-called "qualifying special-purpose entities" by requiring companies to report to regulators the loans contained in them and to increase their capital reserves in proportion as a cushion against potential losses.

It was the lack of disclosure and absence of capital supporting ballooning subprime-mortgage loans in these special entities that aggravated the massive losses sustained by banks, regulators say.

The change by the Financial Accounting Standards Board (FASB) could result in about $900 billion in assets being brought onto the balance sheets of the nation's 19 largest banks, according to federal regulators.

The information was provided by Citigroup, JPMorgan Chase & Co. and 17 other institutions during the government's recent "stress tests," an analysis designed to determine which banks would need more capital if the economy worsened.

In its quarterly regulatory filing earlier this month, Citigroup said the rule change could have "a significant impact" on its financial statements. Citigroup estimated it would result in the recognition of $165.8 billion in additional assets, including $90.5 billion in credit-card loans.

JPMorgan estimated in its quarterly filing that the impact of consolidation of the bank's qualifying special-purpose entities and variable-interest entities could be up to $145 billion.

In general, companies transfer assets from balance sheets to special-purpose entities to insulate themselves from risk or to finance a large project. Under the change by the FASB, many qualifying special-purpose entities will have to be moved back to a company's main balance sheet.

Outside investors often take interests in those entities, for example, making an investment in a bank's holdings of mortgage loans in exchange for payments from borrowers.

Under the new standard, companies must bring back any entity in which they hold an interest that gives them "control over the most significant activities," according to FASB. Companies must perform analyses to determine that.

In cases where companies have "continuing involvements" with off-balance-sheet entities, they will have to provide new disclosures.

"That's a step in the right direction," said Edward Ketz, an associate professor of accounting at Pennsylvania State University. He cited estimates that U.S. banks will need to report up to $1 trillion in loans due to the rule change.

The FASB said the rule change was intended "to improve consistency and transparency in financial reporting." The FASB voted 5-0 to adopt it at a public meeting of its board at its headquarters in Norwalk, Conn. A revised proposal had been opened to a public comment period.

The rule change, which applies both to public and privately held companies, takes effect for companies' annual reporting periods starting after Nov. 15.