A year and a half ago the Financial Accounting Standard Board, FASB, announced a new regulation, FAS 157, requiring companies to use more stringent mark-to-market appraisals for their portfolios. That opened the gates for all those mega-billion dollar charges that are continuing into this quarter. The charges have resulted in the Financial sector reporting negative earnings for the past four quarters, with this one very much in doubt for turning positive.
That however was last year’s regulation change. Now, the FASB has turned its attention to off balance sheet items. They have issues an amendment to FAS 140 that is effective with periods ending after December 15, which means that we are expecting to start hearing from companies on it soon, and that it will be in the upcoming annual reports. While 157 dealt with what was already on company’s books, the 140 amendment deals with what isn’t on their books, and therefore what investors don’t know. The current off balance sheet items are in a separate corporation known as Special Purpose Entities (SPE), Qualified Special Purpose Entities (QSPE) or Variable Interest Entities (VIE). They typically hold transferred assets, from the original owner, which is the public corporation, to the new private entity (SPE, QSPE, VIE), and consists of loans or securities from mortgages, credit cards, and student loans. The value of these assets, along with any obligation of the company is the main unknown to investors – the items do not currently appear on the books, there is no disclosure of the potential liability and there is little commentary about them in the footnotes. The new rule requires companies to disclose and discuss these off balance sheet items, but not put them back on their books. Additionally, they will have to disclose what their potential liability is under any agreement, as well as what event may require them to take the liability back on to their books.
For some issues the disclosure will help alleviate investor fears of the unknown, and therefore help stabilize the stock. For other however the news may add uncertainty, as analysts construct proforma balance sheets which quantify potential obligations and increasing liquidity fears. The transition will be quick, and in this market so will any reaction. But the additional information will assist investors in making more informed financial decisions, and therefore over the long term will be beneficial. Knowing the liability doesn’t change the reality of the situation, but it does change your knowledge, and it could change your choices.