Balance Sheets Are Busting Out All Over

About $1.2 trillion in off-balance-sheet assets could end up on the balance sheets of banks that have yet to claim them, or "on no one's balance sheet," a new report claims.

New accounting rules governing off-balance-sheet transactions went into effect for most companies in January. As a result, 53 large companies have already estimated that they will have put back an aggregate $515 billion in assets to their balance sheets during the first quarter, according to a new study of S&P 500 companies released by Credit Suisse.

But the future state of the companies’ balance sheets remains unclear, since they only consolidated 9% of the $5.7 trillion in off-balance-sheet assets they reported in the fourth quarter of last year. About $4 trillion of the remaining assets will be taken up on the balance sheets of mortgage companies Fannie Mae and Freddie Mac, which guaranteed many of the subprime residential mortgages. The rest of the assets — about $1.2 trillion worth — could find their way to the balance sheets of companies that have yet to claim them, or “on no one’s balance sheet,” assert report authors David Zion, Amit Varshney, and Christopher Cornett.

Because some assets are lingering in accounting limbo or hidden by murky disclosures, gauging their final effect on company financials could be akin to hitting “a moving target,” says the report. Indeed, Credit Suisse notes it’s unclear whether all reported estimates issued during the first quarter included deferred taxes, loan loss provisioning, and such off-balance-sheet assets as mortgage-servicing rights. (Selling mortgage-servicing rights is a multibillion-dollar industry.)

The rules that force companies to put such assets back on their balance sheets were issued in 2008 and went into effect at the beginning of this year. They are Topic 860 (formerly FAS 166), which deals with transfers and servicing of financial assets and liabilities, and Topic 810 (formerly FAS 167), the rule governing the consolidation of off-balance-sheet entities in their controlling companies’ financial reports.

In reviewing the results and disclosures as of March 11, the study’s authors found that only 183 companies in the S&P 500 reported the balance-sheet effects of FAS 166 in their financial results, with 24 providing an estimated impact and 117 reporting either no impact or an immaterial one. Forty-two companies are still evaluating the effects of the new rules, while 317 made no mention of the rules at all. In contrast, 342 companies disclosed the effects of FAS 167, with 29 providing estimates and 214 registering no impact or an immaterial one. That leaves 99 companies still evaluating the FAS 167 impact and 158 making no mention of the financial-statement effects.

Predictably, most of the asset increases belong to companies in the financial sector, where off-balance-sheet transactions such as securitization, factoring, and repurchase agreements are popular. As of Q4 2009, financial-services companies in the S&P 500 had stashed $5.5 trillion and $1.6 trillion, respectively, in variable-interest entities (VIEs) and the now-defunct qualified special-purpose entities (QSPEs). That left a mere $110 billion in assets spread among the QSPEs and VIEs associated with companies in nine other industries.

Assets are returning to balance sheets for several reasons, most notably the Financial Accounting Standards Board’s elimination of QSPEs, or “Qs,” in 2008, when it became apparent that the structures were being abused. Indeed, Qs were permitted to remain off bank balance sheets if they took a “passive” role in managing the structures’ finances. But when the subprime crisis hit, and the mortgages being held in Qs began to fail, banks — with the blessing of regulators — took a more active role, reworking the terms of the entities’ mortgage investments. At the time, FASB chairman Robert Herz called Qs “ticking time bombs” that started to “explode” during the credit crunch.

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