New FASB Rules May Threaten Loan Participations
The Financial Accounting Standards Board is considering new rules that potentially disqualify many loan participations from being treated as sales, thus dramatically affecting the loan participation market.
FASB is considering the issue as part of its effort to clarify Statement No. 140 Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities and permitted activities of qualifying special purpose entities or QSPEs. A number of companies involved in corporate accounting scandals, including Enron, used QSPEs as part of an effort to remove unwanted liabilities from their balance sheets.
Originally, it appeared that FASB was going to require a bank to establish a QSPE if it wanted to qualify a loan participation as a sale under accounting rules and remove the asset as a loan from its books. In a letter to FASB, federal bank regulators objected strongly, saying that such a requirement would add great compliance and legal cost to the loan-participation process and could result in substantial competitive inequities for community banks.
In a Feb. 11 meeting, FASB deferred action on QSPEs. However, FASB members indicated that the borrower's ability to satisfy a loan (including the part that has been transferred) with its funds on deposit without any of those funds being passed along to the participating bank suggests that the transferred portion is not beyond the reach of the transferor. One of the conditions (paragraph 9 (a)) that must be met to indicate that the transferor has surrendered control over transferred assets (and thus can be considered a sale) is that the assets be isolated from the transferor-put presumptively beyond the reach of the transferor and its creditors, even in bankruptcy or other receivership.
FASB plans to revise language in SFAS 140 to clarify that all criteria contained in paragraph 9 must be met to receive sale accounting treatment, with particular attention given to the requirements of paragraphs 9(a) and 9(b). Concerns have been raised that this will disqualify many transfers of financial assets for sale accounting treatment, unless a QSPE is used. If all criteria in paragraph 9 are met, a QSPE would not be necessary for sale treatment. (Paragraph 9(b) relates to the right to pledge or exchange assets while the last criteria in 9(c) relates to control over transferred assets.)
Since most loan participations do permit the originating bank to have setoff rights, many loan participations could be disqualified from being considered sales, requiring the originating banks to retain the participation as an asset on their books.
In March, FASB plans to issue an exposure draft on its proposed changes for public comment. ICBA is monitoring developments and will comment to FASB.