Printer Friendly

Secondary market.


On June 29, 1990, the Federal Financial Institutions Examination Council (FFIEC) issued for comment an advanced notice of proposed rule-making on the regulatory reporting and capital treatment of asset sales with recourse. The five member agencies of FFIEC (namely, the Federal Reserve System, the FDIC, the NCUA, the OCC, and the OTS) are considering, among other things, whether generally accepted accounting principles (GAAP) should be rejected in favor of more stringent reporting requirements for these transactions. Because the regulators' final decision on this matter is likely to have profound and long-lasting effects on the financial services industry, MBA carefully considered the issue before concluding that GAAP is the best approach.

At issue is whether GAAP or current regulatory accounting practice (RAP) is the more appropriate accounting for transactions in which assets are sold and the selling institution retains risk associated with them. Presently, the primary distinction between GAAP and RAP is that GAAP allows for more individual judgment in determining whether these transactions should be accounted for as sales or financings. Because sale treatment provides for the recognition of income at the time of the transaction (whereas financing treatment does not), it is to the advantage of the selling institution to recognize these transactions as sales. Additionally, sale treatment allows the removal of assets from the balance sheet thereby reducing the amount of capital that must be maintained for them.

Unlike GAAP that allows individual discretion in determining whether a sale has taken place, current regulatory accounting practice restricts sale treatment to specifically defined circumstances. The prevailing sentiment of the regulators is that because RAP is more restrictive than GAAP, it is safer and, therefore, the better approach. GAAP, in fact, was explicitly rejected by FFIEC in 1985 as being improperly focused on whether there has been a transfer of economic benefits in the recourse transaction. The federal banking supervisors concluded that the transfer of risk should be the primary consideration in these decisions.

Setting aside questions of focus, the real message is that the regulators have lost confidence in the ability and/or willingness of the financial services industry - and the accounting profession - to properly account for these transactions. Their concern boils down to: how can we assure ourselves that financial institutions will account for these transactions safely and objectively? And, correspondingly, how can we assure ourselves that financial institutions will maintain capital sufficient to protect against the risks associated with these transactions? Unfortunately, the truth of the matter is that it is impossible to provide absolute protection against unknown future events and that any attempt to do so is likely to be counterproductive.

Because there is no definitive way to account for uncertain events, MBA sees the present dilemma as a quest for "better" rather than "inferior" information. Considered in this light, the question becomes: will GAAP or RAP provide better information in reporting assets sold with recourse? FASB Statement of Concepts No.2, "Qualitative Characteristics of Accounting Information," offers some insight into the difficulties in deciding between alternative accounting methods. Paragraph 10 of that statement contains the following observation: "There are some who seem to harbor the hope that somewhere waiting to be discovered there is a comprehensive scoring system that can provide the universal criterion for making accounting choices... Consequently, those who must choose among alternative are forced to fall back on human judgment to evaluate the relative merits of competing methods."

Consistent with this view, we believe that the "better" information will be derived - not from a regulatory prescription of one rule, or a set thereof, for a wide spectrum of continually changing transactions - out from able and educated judgments made on a case-by-case basis giving due consideration to all benefits and risks involved. In our estimation, GAAP provides the proper leeway for judgments to be made regarding whether a transaction is more accurately represented as a sale or as a financing. In addition, GAAP requires an assessment of all probable losses on a case-by-case basis and the accrual of those losses as of the sale date. GAAP also requires that "if collectibility of the receivables and related costs of collection and repossession are not subject to reasonable estimation...the transaction shall be recorded as a financing."

The presumption that GAAP is too liberal has lead some people to conclude that the use of judgment in the management and recordation of these transactions should be removed (or at least restricted) from the private sector. While this approach would have the advantage of ensuring that capital is maintained for all possible future losses, it would also have the significant disadvantage of tying up capital that could be put to far better use and over time could strengthen the selling institution, the industry and the economy in general. This approach would also stifle creative incentive by restricting the degree to which management would be allowed to manage their companies.

A wholesale approach to these transactions would also tend to compromise the accounting profession's standard setting process. Because the Financial Accounting Standards Board (FASB) is scheduled to review the accounting for asset sales with recourse during the next year as part of its financial instruments project, a ruling from the regulatory sector would be pre-emptive and serve to nullify the accountant's work. Additionally, rejections of GAAP will erode confidence in and reliance on standards that have been subjected to a great deal of professional scrutiny and, thereby, add to diversities in practice.

Because the problem at hand involves trying to account for events for which no one can devise a fool-proof "scoring system," we believe human judgment should play a role in determining how these transactions are recorded. Furthermore, we believe that how much individual judgment should be allowed in the decision-making process is a question that should be left to the accounting experts.
COPYRIGHT 1990 Mortgage Bankers Association of America
No portion of this article can be reproduced without the express written permission from the copyright holder.
Copyright 1990 Gale, Cengage Learning. All rights reserved.

Article Details
Printer friendly Cite/link Email Feedback
Title Annotation:Federal Financial Institutions Examination Council's proposed rule on regulatory reporting and capital treatment of asset sales
Author:Utermohlen, Alison
Publication:Mortgage Banking
Article Type:column
Date:Sep 1, 1990
Previous Article:Checking up on business: just a spoonful of preventive medicine keeps mortgage businesses, like people, strong and healthy.
Next Article:Economic trends.

Related Articles
Mutual recognition: integration of the financial sector in the European Community.
Final rule--amendment to regulation H. (Legal Developments).

Terms of use | Copyright © 2016 Farlex, Inc. | Feedback | For webmasters