CUNA Regulatory Comment Call
September 8, 2005
FASB Proposal on Loan Participations
- The Financial Accounting Standards Board (FASB) has issued an Exposure Draft (proposed Statement or proposal) regarding the accounting treatment for loan participations. FASB has undertaken this project to prescribe how loan participations should be conducted to qualify for accounting treatment as a sale. Credit unions that originate loan participations should be particularly interested in the outcome of this proposal.
- FASB first put out an Exposure Draft on this project in 2003. Based on feedback received, FASB issued a Staff Request for Information in 2004 to solicit information about setoff rights and other issues related to isolation of the transferred asset(s). In addition, FASB held public roundtable meetings to improve the Boards understanding of the factors that practitioners (attorneys and auditors) consider in determining sales treatment. CUNA was represented at the public roundtables, as was NCUA.
- This proposed Statement would amend FASB Statement (FAS) No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities. FAS 140 establishes the requirements that a transfer must meet in order to be considered a sale for financial reporting purposes. One requirement of FAS 140 is that the transferred asset must be isolated from (beyond the reach of) the transferor and its creditors, even in bankruptcy or receivership. This issue has been a major concern for financial institutions, due to the powers of regulators, when acting as a conservator.
- Sales accounting treatment is advantageous for originating institutions because it allows the institution to deduct the transferred portion of the loan from its balance sheet. If the transaction involves the transfer of a member business loan (MBL), the loan balance would be excluded when calculating compliance with the MBL cap (even if servicing the loan is retained). In contrast, loan participations that do not qualify for sales accounting treatment would have to be shown on the books of the financial institution as a collateralized borrowing subject to the MBL cap.
- Consistent with current accounting treatment, credit unions that engage in loan participations sold without recourse (meaning the loan purchaser does not have the ability to sell its portion back to the originator if the loan goes bad), could continue to apply sales accounting treatment (provided all other requirements are met).
- The proposal would continue to make it difficult, if not nearly impossible, to obtain sales treatment for loan participations sold with recourse (meaning the loan purchaser may sell the loan back to the originator if the member-borrower defaults). In addition to the fact that the proposal defines participating interests to exclude interests involving recourse or subordination provisions, it would be difficult for loans with recourse to receive sales accounting treatment because they would have to meet the requirements for surrender of control (very difficult to show given the definition of with recourse). If the originating credit union cannot meet those requirements, it may be able to use sales accounting treatment if it runs the participation through a qualifying special purpose entity (SPE), such as a credit union service organization (CUSO). However, there are specific criteria for SPEs not all CUSOs may quality as an SPE. To ascertain whether a particular CUSO would qualify as an SPE, please see paragraph 35 of the Exposure Draft.
- Basically, the proposed Statement as amended would apply to loan participations occurring in the first fiscal year after the final Statement is issued. It is very likely that this will be effective as of the first of the year (2006). If a credit union has an ongoing obligation in connection with a loan participation which does not meet the surrender of control criterion dealing with isolation (for example, a limited recourse obligation), then when this final Statement is issued the credit union may be required to modify its books to show the transaction as a secured borrowing rather than a sale. Or certain types of restructuring of the transaction could help avoid the requirement to use secured borrowing treatment (including transferring the asset to a qualifying SPE).
- Comments are due to FASB by October 10, 2005. Please send your comments to CUNA by September 30, 2005. Please feel free to fax your responses to CUNA at 202-638-7052; e- mail them to Associate General Counsel Mary Dunn at firstname.lastname@example.org or to Senior Regulatory Counsel Catherine Orr at email@example.com; or mail them to Mary or Catherine in c/o CUNA's Regulatory Advocacy Department, 601 Pennsylvania Avenue, NW, 6th Floor - South Building, Washington, DC 20004. You may also contact us at 800-356-9655, ext. 6743, if you would like a copy of the Exposure Draft, or you may access it here.
DESCRIPTION OF THE PROPOSAL
- The Exposure Draft establishes the following conditions for reporting a transfer of a
portion (or portions) of a financial asset as a sale:
- Under the proposed Statement, the transferred portion (or portions) and any portion retained by the transferor must be participating interests. A participating interest: (1) conveys proportionate ownership rights with priority under the law (2) involves no recourse or subordination provisions, and (3) does not entitle any participant to receive cash before any other participant.
- The transferred portion (or portions) must meet the conditions for surrender of control.
Those conditions are the following:
(1) The transferred financial assets have been isolated - put presumptively beyond the reach of the transferor and its creditors, even in bankruptcy. A true-sale-at-law opinion provided by an attorney is often needed to support isolation. Under the proposal, a true-sale-at-law opinion is not required if the transferring institution has a reasonable basis to conclude that the appropriate legal opinion would be given if requested. For example, the originating credit union might reach a conclusion without consulting an attorney if it had experience with other transfers with the same facts and circumstances.
(2) The transferee has the right under the loan participation agreement to pledge or exchanged the transferred financial assets it received.
(3) The transferor does not maintain control through an agreement that entitles and obligates the transferor to repurchase or redeem the assets before their maturity or the ability to unilaterally cause the holder to return specific assets. The analysis must consider any arrangement or agreement made in connection with the transfer even if it was not entered into at the time of the transfer.
- If the transfer does not meet those conditions, sales accounting can be achieved only by transferring the entire original financial asset or group (pool) of assets to a qualifying special purpose entity (SPE), for example a CUSO that meets the qualifying criteria. In that case, the entire transferred financial asset(s) must meet the conditions for surrender of control.
- Once it has been determined that the transfer will be accounted for as a sale, the
originating credit union must:
(1) Allocate the previous carrying amount (the amount at which the loan was carried/shown on the books) between the assets sold and the servicing assets, if any, based on their relative fair (market) values at the date of the transfer.
(2) Derecognize (take off the books) all the transferred assets sold.
(3) Initially measure any participating interest retained and any servicing assets at the allocated carrying amount as calculated in item (1).
(4) Recognize and initially measure at fair value servicing liabilities and any assets obtained including rights to contractual interest from the participating interests sold that represent the originating credit unions gain on the sale, if any. If it is not practicable to estimate the fair value of an asset or a liability, the originating credit union shall apply alternative measures (see paragraphs 71 and 72 for more detailed information) and adjust the recognition of gain or loss accordingly.
(5) Recognize in earnings any gain or loss on the sale.
- During its deliberations, FASB considered disallowing sales treatment for loan participations marked by rights of setoff (the common- law right of debtors and creditors to set off that is, net amounts due to one another if one of the parties defaults, becomes insolvent, or enters into bankruptcy or receivership.) FASB tentatively decided that because of a right of setoff in a receivership and because the second institution must stand in line for funds with other creditors of the originating institution, the participating institution is not isolated from the originating institution. Under that analysis, FASB reached the conclusion that loan participations marked by rights of setoff are not sales.
- In comments to FASB, CUNA responded that under the Federal Credit Union Act there is no right of setoff. CUNA noted that National Credit Union Administration (NCUA) has taken the view that setoff does not exist because in order for such rights to apply, a mutual debtor- creditor relationship must exist between the institution and the member/shareholder. As a result of comments received from CUNA and others, FASB has backed away from its initial concern over rights of setoff precluding the use of sales accounting treatment.
- In addition, earlier this year FASB had tentatively decided that in order to receive sales treatment, a loan participation must pass a true-sale-at-law test rather than simply receive a true-sale-at-law opinion provided by an attorney. The test had three parts: each interest in the participation, including any retained interest, must have equal rights to the cash flow from the underlying assets; no interest in the participation could be subordinate to any other interest; and there would be no recourse to the originating financial institution or any other interest holder. If the loan participation does not pass the test, then the financial institution must use an SPE to transfer the participation. In this new revised Exposure Draft, FASB opted for the more flexible approach of an attorney opinion rather than a strict test. Furthermore, the proposal indicates that the originating financial institution would not necessarily need to obtain a true-sale-at-law opinion in every case.
QUESTIONS REGARDING THE PROPOSAL
- Does your credit union currently conduct many loan participations with recourse?
If so, what costs/burdens would be associated with changing your credit unions practice to conducting only loan participations without recourse (for example, changing the loan participation agreement)?
- Do you agree with the conditions for surrender of control?
If not, why?
- Do you believe that, under the proposed Statement, in most situations credit unions would not
be required to obtain a true-sale-at-law opinion (because the credit union would have a reasonable
basis to believe that their attorney would provide one if requested)?
If not, please explain why not.
- Do you foresee any difficulties associated with credit unions running their loan participations
through an SPE (for example, a qualifying CUSO)?
If so, what are those problems?
- Is the likely effective date reasonable?
If not, what effective date do you believe would be appropriate?
- Other comments?
Eric Richard General Counsel (202) 508-6742 firstname.lastname@example.org |
Mary Mitchell Dunn SVP & Associate General Counsel (202) 508-6736 email@example.com
Jeffrey Bloch Assistant General Counsel (202) 508-6732 firstname.lastname@example.org
Lilly Thomas Assistant General Counsel (202) 508-6733 email@example.com
Catherine Orr Senior Regulatory Counsel (202) 508-6743 firstname.lastname@example.org