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WASHINGTON — The board that sets U.S. accounting standards on Monday moved to end the use of a bookkeeping device that allowed banks to park hundreds of billions of dollars in loans off their balance sheets and that has been blamed for stoking financial companies' losses as the housing market collapsed.
The change will tighten the use of so-called "qualifying special purpose entities" by requiring banks and other companies to report to regulators the loans contained in the entities 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 move by the Financial Accounting Standards Board "addresses the critical need for continued improvement to the accounting for arrangements that were at the epicenter of the financial crisis," James Kroeker, acting chief accountant at the U.S. Securities and Exchange Commission, said in a statement. "The SEC staff is committed to working with companies and their auditors to assure an effective transition as FASB's improvements are implemented."
The change 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 Inc., JPMorgan Chase & Co. and 17 other institutions during the government's recent "stress tests," which were 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.
The FASB said the rule change was intended "to improve consistency and transparency in financial reporting." The board voted 5-0 to adopt it at a public meeting at its headquarters in Norwalk, Conn. A revised proposal had been opened to a public comment period that ended in November.
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 stakes 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 onto their balance sheets 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 rule change applies both to public and privately held companies. It takes effect for companies' annual reporting periods starting after Nov. 15, so for most companies in early 2010.
"It's great to see that they didn't defer it," said Jack Ciesielski, a Baltimore-based accounting expert who writes a financial newsletter. Investors finally "will get an idea of how leveraged these things really are," he said.
The change by FASB cuts in the opposite direction of its move last month — surrounded by controversy and with some dissension by board members — giving companies more leeway in valuing assets and reporting losses. That revision in the so-called "mark-to-market" accounting rules was expected to help boost battered banks' balance sheets, while the new rule change likely will result in financial institutions recognizing on their books billions in high-risk loans that may default.
FASB acted on the mark-to-market rules amid intense pressure from Congress, which threatened legislation. The board received hundreds of comment letters opposing the move from mutual funds, accounting firms and others contending that it would damage honest financial reckoning by masking the deficiencies and risks lurking within the system.
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AP Business Writer Sara Lepro in New York contributed to this report.
