A Financial Accounting Standards Board task force is set to meet this week to discuss modifying and possibly delaying a vague recommendation that could require fixed-income investors to report short-term losses in their portfolios. The recommendation is causing controversy in the mortgage-backed securities market because it does not clearly define on which securities investors must report losses. Instead, the FASB directive only states that investors must report losses deemed "other than temporary." Mortgage-backed professionals predict a strict interpretation of this definition could lead to a drop in liquidity in some securities and an increased need to hedge interest-rate risk.
The new standards would affect the fixed-income investments held by banks, insurance companies and the government-sponsored enterprises. And since these institutions are the major players in the mortgage-backed securities market, it is seen as most vulnerable.
Larry Smith, chairman of FASB's Emerging Issues Task Force in Norwalk, Conn., said he cannot predict how or if the wording will be revised, but noted it is likely implementation will be delayed for as long as six months. "I would imagine a lot of people won't complain if we defer," he said, acknowledging some of the concerns. "The basic issue revolves around whether sales out of an available for sale portfolio will taint an entire portfolio," he added. Smith noted FASB's primary concern is to improve the accuracy of financial accounting and any fallout on the markets is a secondary consideration.
The task force meets Wednesday to debate Issue 03-1, which was adopted this spring and is set to take effect for third-quarter earnings. Yet it is only in recent weeks that market professionals have begun to digest 03-1 and focus on the vague "other than temporary" wording. This deeper look into 03-1 and the resulting confusion has generated a flood of comment letters to FASB from trade groups such as the American Bankers Association and insurers including AllState Corp.
Specifically, 03-1 would require fixed-income investors to account for losses in securities, such as from rate movements or credit deterioration, that are "other than temporary." To take that one step further, a major concern of investors is that if a loss on one security in a pool is deemed other than temporary, then other losses in the pool could be deemed so as well. Steve Abrahams, managing director in mortgage research at Bear Stearns in New York, said market activity of late has been muted--potentially because of the uncertainty but also perhaps as a result of last week's Republican National Convention. "It is a huge issue. The key will be the degree to which FASB identifies either a narrow or wide set of circumstances. If they articulate the narrowest, this accounting issue will be very hot and could have a major impact," he said.