FASB and Loan Participations

Northwestern Financial Review, Apr 1-Apr 14, 2004 by Bengtson, Tom

Loan participations are a cornerstone product for many correspondent banks. A lead bank on a participation can fund a loan well above its lending limit and diversify its risk by participating out portions of that loan to community banks that are looking for assets. It is a system that has worked well for decades. So why is the Financial Accounting Standards Board worried about loan participations?

Specifically, FASB is examining whether loan participations can continue to qualify as "sales" for accounting purposes. FASB contends that lead banks do not sufficiently "isolate" the pieces of the loan sold downstream. Because of the way FDIC receivership rules affect participating banks in the event of a lead bank failure, FASB says the loan is not truly isolated; it, therefore, does not qualify as sales. FASB says the loan participations, in fact, are financings and should remain on the books of the lead bank.

The accounting treatment of these transactions is important. Consider the implications of changing the accounting for loan participations. If lead banks needed to show the entire loan on their books, the assets of those banks would show up on the balance sheet at levels far inflated from current practice. And banks that currently buy participations would not be able to record those assets on their balance sheets. They would appear smaller than they currently are. This has implications for capital requirements, lending limits and franchise value. The impact could be huge.

And I go back to my original question: why is FASB interested? It has been 24 years since a bank with a lot of downstream loan participations has gone into FDIC receivership. With all the other corporate accounting issues FASB needs to consider, I don't know why it is wasting its time on loan participations. Its suggestion that lead banks participate out loans through qualified special purpose entities is wholly impractical and would raise costs for everyone.

Representatives from the Fed, OCC, FDIC, OTS and NCUA jointly mailed a letter Dec. 1 to FASB expressing serious concerns about this matter. FASB talked about this issue, known as "statement 140," at its board meetings on Jan. 21 and Feb. 11. They were scheduled to discuss it further at a March 10 meeting but that was delayed to March 17. If FASB decides to pursue the issue, it will open a period for public comment. I encourage bankers to follow this issue closely. Discuss it with your accountant. Encourage them to join you in sending comments to FASB.

By Tom Bengtson, Publisher