Collateral damage

Is the Financial Accounting Standards Board overreacting to Enron’s manipulation of special purpose entities?

Is the Financial Accounting Standards Board overreacting to Enron’s manipulation of special purpose entities?

By Julie Satow
December 2002

For many investors, off-balance-sheet financing has become so tainted that it is seen as a red flag for accounting chicanery. And regulators are rushing to restrict its usage wherever they find it. But not all deals are necessarily suspect. Although some off-balance-sheet transactions, notably Enron Corp.'s, may have been used to manipulate earnings, others, like the $750 billion asset-backed commercial paper market, are accepted means of lowering funding costs and reducing risk. That’s one reason asset-backed commercial paper has been one of the hottest markets in the past year.

“We want our investors to understand that we have a strategy for doing this off-balance-sheet financing,” says Bibiana Boerio, CFO of debt-beleaguered Ford Motor Credit Co. “It is one of the lowest-cost means of funding receivables, especially as spreads have widened.”

Adds Cynthia Ranzilla, vice president of U.S. funding and global markets at General Motors Acceptance Corp., “This is one of the best ways to liquefy assets, and we’re doing it in a cost-effective manner.” Both companies are massive issuers of asset-backed paper. Other major issuers include General Electric Capital Corp. and ChevronTexaco Corp. There has never been a default of these instruments.


Most asset-backed paper uses off-balance-sheet special purpose entities, which are often sponsored by commercial banks. The SPEs take receivables from companies and then issue commercial paper against them. The SPEs hold the receivables, which are thereby removed from the balance sheets of both the companies and the banks.

In August the Financial Accounting Standards Board issued an exposure draft for a new rule that would make it more difficult for sponsors of SPEs to keep them off their balance sheets. If the rule goes into effect as written, sponsors would have to put billions of dollars of assets and liabilities on their balance sheets. That, in turn, would skew their capital ratios, potentially requiring them to increase their capital. According to Sam Pilcer at Moody’s Investors Service, J.P. Morgan Chase & Co.'s tier-1 capital ratio would drop from a healthy 8.3 percent to 7.8 percent, suggesting financial weakness, and possibly triggering capital calls from the Federal Reserve Board. Other sponsors of asset-backed commercial paper would have similar problems, says Pilcer.

“This could drive the cost of issuing ABCP to a prohibitive level and limit the market’s liquidity,” says Lloyd Gold, an account director at REL Consultancy Group. He is advising clients to wean themselves off this source of financing in case the market dries up.

Maureen Coen, head of asset-backed originations for Credit Suisse First Boston, believes the FASB proposal will not improve transparency, which is its stated intent. Instead, she says, it will only result in sponsors of SPEs “putting assets they don’t own and liabilities they aren’t liable for on their balance sheets.”

FASB spokeswoman Sheryl Thompson says the agency is considering comments on the proposal. She adds that FASB remains market-neutral and that if the asset-backed commercial paper market suffers, it will be a function of investor choices and not the agency’s policies. The rule would take effect in the first quarter of 2003 for new issues.

Pilcer believes FASB must recognize a crucial distinction between asset-backed paper and the off-balance-sheet funding used by Enron and others. “The ABCP market has been swept up into ‘Enronitis,’” he says. "[Asset-backed paper] is mostly used for working capital and not revenue acceleration -- the issue plaguing SPEs.”

Some companies remain optimistic that FASB will appreciate this difference and make the necessary changes to exclude asset-backed commercial paper from the proposal in some manner. “I think investors and issuers have begun to recognize that there are differences between what Enron did and the asset-backed commercial paper market,” says Ford’s Boerio. She plans to continue issuing asset-backed paper to fund the company’s short-term capital expenditures.

But if FASB is adamant in pro-mulgating its new rule, the cost of capital for Ford is likely to go up. The balance sheet may be more transparent, but it will also cause stockholders more pain.

The weight of sponsored debt
If the Financial Accounting Standards Board has its way, banks will have to list asset-backed commercial paper issues on their balance sheets, damaging their capital ratios.
Top ten issuers of asset-backed commercial paper
Sponsor $ billions
Citibank $73.8
ABN Amro Bank 50.4
Bank One 43.5
General Electric Capital Corp. 34.2
Bank of America 32.2
Liberty Hampshire Co. 30.8
Westdeutsche Landesbank Girozentrale 29.6
J.P. Morgan Chase Bank 28.6
Barclays Bank 22.0
Bayerische Hypo- und Vereinsbank 19.8
Source: Moody’s Investors Service.