United States GAO General Accounting Office Washington, D.C. 20548 General Government Division B-282342 April 14,1999 The Honorable Tom Bliley Chairman, Committee on Commerce House of Representatives Subject: Accounting Standards Treatment of Asset-Backed Securities Dear &fr. Chairman: This letter responds to your request for information on whether the greater discretion allowed to banks as opposed to securities broker/dealers under accounting standards and practices may have resulted in less transparency in the value of asset-backed securities held by banks.’ Your concern stemmed from the fact that banks, unlike broker/dealers, are allowed to carry some securities at amortized cost, which is less transparent than carrying them at fair value.’ As a result, if there were a decline in the fair value of securities carried at amortized cost, investors would not see it reflected in the related financial statement balances. Your letter also suggested that a movement of these securities into banks may have contributed to a loss of liquidity in the marketplace this past fall. Because the largest portion of asset-backed securities are securities whose underlying assets are residential mortgages, called mortgage-backed securities @ IDS), we agreed with your office to focus on MBS.3 Specifically, we agreed to provide information on (1) the accounting treatment applied to securities (including MBS) held by banks and broker/dealers and (2) the accounting for securities holdings by the six largest bank holding companies and whether such holdings might have affected the transparency of financial statements. To meet these objectives, we reviewed the accounting standards and practices for reporting securities held by banks and broker/dealers. In addition, we examined data in the December 31,1997, and September 30,1998, annual and quarterly investor reports filed by the six largest bank holding companies in order to assess whether banks’ accounting for securities might have resulted in less transparency to investors. These bank holding company (BHC) reports provided consolidated data for the holding company and all of its subsidiaries, both banks and nonbanks, and showed the accounting treatment of securities held. As of September 30, ‘Asset-backed securities are bonds or debt securities backed by the cash flow from pools of underlying assets, such as mortgages, car loans, or credit card receivables. *Amortized cost is the face value of the securities plus the unamortized premium or less the unamortized discount. Fair value is defined as the amount at which an item could be exchanged in a current transaction between willing parties, other than in a forced or liquidation sale. Because fairvah~e generally represents a more current value than amortized cost, reporting securities at fair value is more transparent to securities investors. “As of September 30,1998, there was a total amount of $3,156 billion of asset-backed securities outstanding in the United States; Ml3S accounted for 81 percent of this amount Page 1 GAO/GGD-99-63R Asset-Backed Securities B-282342 1998, the 6 largest BHCs accounted for 49 percent of the total assets of the top 50 BHCs in the United States. They accounted for an even larger share+61 percent-of the top 50 BHCs’ trading and investment accounts4 We also examined data that showed the 50 largest concentrations of MBS held in BHCs and the banks’ accounting treatment of mortgage pass- through securities.5 In addition, we interviewed officials at the Federal Reserve Board to obtain their views on what the large BHCs had done in their securities activities in 1998. We obtained oral comments on a draft of this letter from Federal Reserve officials, and their comments are discussed at the end of this letter. We did our work in February and March 1999, in accordance with generally accepted government auditing standards. Results in Brief Accounting standards allow banks and most other companies to report their securities holdings at either fair value or at amortized cost, depending on the nature of the securities and the purpose for which the securities are held. Because fair value reporting generally represents a more current value of reported assets than amortized costs do, assets reported at fair value offer readers of financial statements greater transparency. A review of the securities holdings at the six largest bank holding companies showed that they were reporting the bulk of their securities holdings at fair value. F’urther, between December 1997 and September 1998,these companies’ combined holdings of securities reported at amortized cost had declined, and the securities holdings reported at fair value had substantially increased. As a result, the transparency of their securities holdings improved during this period. At the Federal Reserve, officials had reviewed developments in the financial markets through the fourth quarter of 1998 and data on individual entities’ securities transactions through the third quarter of 1998.They said their review revealed two instances in which account balances changed in a way that might indicate intracompany securities transactions, but they pointed out that the changes could also be attributable to other causes. They also observed that the reduced liquidity in certain markets in late 1998 was part of a more general phenomenon in which market participants had become very risk averse at that time. ‘Securities that banks have bought for short-term resale at a profit are placed in the trading account; other securities are placed in the bank’s own investment portfolio, which is commonly called the investment account SMortgage-backed securities consist of mortgage pass-through securities and collateralized mortgage obligations (CMOS). Mortgage pass-through securities entitle investors to share on a pro rata basis in all principal and interest payments received from a mortgage pool. CMOSdivide the principal and interest payments from the underlying pool into classes with different risk characteristics and issue securities for each class. In September 1998,all commercial banks in the United States held $277 billion of pass-through mortgage securities compared to $156 billion of CMOS Page 2 GAOIGGD-99-63R Asset-Backed Secnrities IS-282342 Accounting Standards and Practices for Securities Held by Bank Holding Companies The following accounting standards and practices apply to holdings of securities (including MBS) by bank holding companies and their subsidiaries. l Broker/dealer subsidiaries (called Section 20 subsidiaries)6 are to utilize specialized accounting practices in which substantially all securities held are to be reported on the balance sheet at fair value, with unrealized gains and losses reflected in net income. l Securities held in the bank subsidiaries of a bank holding company are subject to the accounting standards set forth in F’inancial Accounting Standards No. 115, Accounting for Certain Investments in Debt and Equity Securities (FAS 115). l Similar to the accounting treatment for broker/dealers, securities that are held for trading purposes are to be reported in the trading account line of the balance sheet at fair value, with unrealized gains and losses reflected in net income. l Securities that are held for longer term purposes are to be reported in the investment account and designated either as “held-to-maturity” or “available-for-sale.” Securities may be designated as held-to-maturity only if the entity has the intent and ability to hold them to maturity, in which case they are to be reported in the balance sheet at amortized cost, with disclosures in the notes regarding fair market value and unrealized gains and losses. Securities designated as “available-for-sale” are to be reported in the balance sheet at fair value. Unrealized gains and losses are not to be reported in earnings but reported in the notes to the financial statements and reflected in equity as an adjustment to net income. l A security may not be classified as “held-to-maturity” if that security can be contractually prepaid or otherwise settled in such a way that the holder of the security would not recover substantially all of its recorded investment. MBS that meet this criterion must be classified as “available-for-sale” or trading and are to be reported on the balance sheet at fair value. Accounting for Securities Holdings by the Six Largest Bank Holding Companies We analyzed the quarterly reports to investors (known as FormlO-Qs)~ and the annual reports of the six largest bank holding companies, focusing on the areas where securities are reported-namely the trading and investment accounts. The data indicated that as of September 1998 the bulk-98.2 percent-of their holdings in these accounts were recorded at ‘Banking organizations that are members of the Federal ReserveSystem are permitted to conduct broker/dealer business only if they are authorized by the Federal Reserve Board to have a Section 20 subsidiary, which is a nonbank subsidiary of a bank holding company. This name refer to Section 20 of the Glass-SteagallAct (12 U.S.C. set 377). A Section 20 subsidiary can function as an investment bank by underwriting (publicly distributing new issues of securities) and as a broker/dealer by buying and selling securities for its own account or for other. ‘Quarterly Report Ftnsuant to Section 13 or 15(d) of the Securities Exchange Act of 1934. Page 3 GAO/GGD-99-63R Asset-Backed Securities B-282342 fair value. (See table 1.1.) These data encompass not only MBS but also all other types of securities, as well as derivatives held for trading.’ Because bank holding companies are to carry all assets in the trading account at fair value, we focused on the investment account portfolios of these six BHCs. The Form 10-Q reports for these companies indicated that 95.7 percent of their investment account securities were reported at fair value in September 1998, up from 93.8 percent in December 1997. The lowest percentage reported at fair value among the six companies in September 1998 was 94.2 percent. For the six BHCs, their combined holdings of securities reported at amortized cost declined $2.4 bilhon between December 1997 and September 1998, notwithstanding a $33.8 billion increase in the total holdings of securities in their investment accounts. Thus, even if there were any intracompany shifts of securities, by the end of the period the transparency of their securities holdings was probably greater than at the beginning of the period. Banks’ Holdings of MBS On September 30,1998, banks held $483.6 billion of MBS, compared to the nationwide total amount of $2,458 billion of outstanding MBS. Within banks’ holdings of MBS, 64 percent were pass-through securities. Table I.2 presents the accounting treatment of the 50 largest portfolios of pass-through MBS held at banks. (The data in table I.2 do not show the holdings of the largest 50 banks; instead, they show the largest 50 portfolios, regardless of the size of the company.) In these 50 portfolios, 91 percent of the dollar volume was available for sale, i.e., carried at fair value; and 9 percent was carried at amortized cost. For all banks in the United States, the figures were 88 percent at fair value and 12 percent at amortized cost. Thus, for this one important part of the securities portfolio, transparency did not appear to be a significant issue at the end of September 1998. Federal Reserve Board O fficials’ Observations on Bank Holding Companies’ Activities Officials at the Federal Reserve Board provided us with their observations on BHCs’ activities concerning trading and investment accounts in 1998. In general, they saw strong growth in banks’securities holdings in both accounts in the fourth quarter of 1998. Within bank holding companies, the officials looked at the overall data for Section 20 subsidiaries through the third quarter of 1998 but did not see anything they viewed as signnicant While in two cases sizable changes in securities holdings were noted, they said that these data did not provide a sufficient basis from which to draw conclusions. For one thing, the officials stressed that trading account balances are very volatile and that data are available for only the four call report dates each year. For another, they noted that decreases and increases in such accounts could reflect transactions with third parties, rather than intracompany transactions. The %erivatives are fiuancial products that enable risk to be shifted from one party to another; their value is based on an underlying reference rate, index, or asset, such as stocks, bonds, commodities, interest rates, fore&u currency exchange rates, and various market indexes. Page 4 GAOKGD-99-63R Asset-Backed Securities B-282342 officials said that discovery of the specific causes for changes in the trading and investment account totals would require close bank-by-bank examination. Regarding the reported loss of liquidity in MBS markets, the Federal Reserve officials attributed this to the fact that dealers had become very risk averse. They said this was a general phenomenon, present in different types of dealers and in various financial instruments. Agency Comments We requested comments on a draft of this letter from the Federal Reserve. On April 1,1999, we received oral comments from the Deputy Associate Director, Division of Banking Supervision and Regulation. He generally agreed with the contents of our letter and made technical comments, which we incorporated as appropriate. We will send copies of this letter to Representative John Dingell, Ranking Minority Member, House Committee on Commerce; Alan Greenspan, Chairman of the Board of Governors at the Federal Reserve System; Arthur Levitt, Chairman, Securities and Exchange Commission; John D. Hawke, Jr., Comptroller of the Currency, Office of the Comptroller of the Currency; and other interested parties. We will also make copies available to others on request. We hope that this information is useful; if more information is desired, we will be glad to assist. If you have any questions, please call me or John Treanor at (202) 512-8678. Sincerely yours, Thomas J. McCool Director, Financial Institutions and Markets Issues Enclosure Page 6 GAO/GGD-99-63R Asset-Backed Securities Enclosure I Selected Financial Data on Banks’ Holdings of Securities Table 1.1: Assets in the Trading and lnvestment Accounts of the Six Largest Bank Holding Companies Dollars in millions increase Accounts December 1997 September 1998 (decrease) A. Trading account’ $337,888 $352,723 $14,835 6. Investment account 209,515 243,342 33,827 of which: B.l. Reported in balance sheet at amortized cost 12,894 10,475 (2,419) 8.2. Reported in balance sheet at fair value 196,621 232,867 36,246 Share of investment account held at fair value 93.8% 95.7% C. Total assets in the two accounts (A plus B) 547,403 596,065 48,662 C.1. Reported at amortized cost (B. 1) 12,894 10,475 (2,419) C.2. Reported at fair value (A plus B.2) 534,509 585,590 51,081 Share of total held at fair value 97.6% 98.2% Note: Ranked bv assets as of SeDtember 1998, the six largest bank holding comDanies were BankAmerica Cbrporation; Cha& Manhattan dorporation:Citicorpp; J.P. M&gan k Co., Incorporated; First Union Corporation; and Bankers Trust Corporation. ’The trading account includes both securities and the positive value of derivatives held for trading purposes. Sources: GAO analysis of the companies’ quarterly reports on Form 1 O-Q and annual reports. Page 6 GAO/GGD-99-63R Asset-Backed Securities” Enclosure I Selected Financial Data on Banks’ Holdings of Securities Table 1.2: Top 50 Portfolios of Pass-Through MBS at Banks as of September 30,1998 Dollars in millions Portion available for Bank holding companies Total Held to maturiw Available for saleb sale (percent) Chase Manhattan Corporation $35,017 $987.4 $34,029.3 97% Bar&America Corporation 31,173 1,573.6 29,599.5 95 First Union Corporation 23,459 835.7 22,623.6 96 Nonvest Corporation 16,005 0.0 16.005.4 100 Republic New York 12,550 6,714.4 5,835.2 46 ABN Amro Americas 7,909 99.8 7.809.0 99 Fleet Financial Group 7,525 0.0 7.525.2 100 Bane One Corporation 6,720 62.8 6,657.5 99 Fifth Third Bancorp 6,001 0.0 6,000.5 100 Mellon Bank Corporation 5,061 1,605.2 3.455.4 68 Wachovia Corporation 3,359 525.7 2,832.8 84 BankBoston Corporation 3,296 137.8 3,157.7 96 National City Corporation 2,851 0.0 2,850.5 100 U.S. Bancorp 2,622 0.0 2,622.l 100 WAla .-..- Fan-in . -.= - R ---_Go. 2.530 _)___ 0.0 -.- 2.530.3 -,---_- 100 .-- . ra\rl?nm Ly-mp 3A7R.m- k, on -.- 3A7Rn -, . . -.- Inn ..,w Crestar Financial Comoration 2.410 20.1 2.390.1 99 L”,II~ll~cl Illb”l~“‘~Lcw T;,L.JY C,~..Kz.” I”” Bank of Montreal 2,004 ii;; 2,003.8 100 Commerce Bancorp 1,975 977.3 997.6 51 AmSouth Bancorp 1,899 975.1 923.9 49 Bankers Trust .--.- Comaratinn -. -.- _.-.. 1.860 .,--- 0.0 -.- 1.859.5 .I----- 100-- Allied Irisi., Rlrhba -- I-.-. trl .,,.a. 1 7.14 nn “.” 17RAn .,s v ..- 1flf-l I”” _-_. Cornoration PRRT --.r -.--.- -- 1.677 0.0 l-676.7 k4.1 100_- i TfYF -, .Finannial ..._.._._. --.r-.- _._.. Cnmnration .,__. 1.664 0.0 -.- 1 , - - .. . 1fM.l .-- CNB Bancshares Incorporated 1,541 58.4 1,482.6 96 North Fork Bancotp 1,467 638.8 827.6 56 SunTrust Banks Inc. 1,416 0.0 1,416.0 100 Cullen/Frost Bankers Incorporated 1,413 115.2 1,298.2 92 SouthTrust Corporation 1,401 351 .o 1,050.5 75 Summit Bancorp 1,303 986.9 316.5 24 Star Bane Corporation 1,302 0.0 1,302.l 100 Regions Financial Corporation 1,287 50.1 1,236.6 96 Mercantile Bancon, _._.-- .._.. - --...- - .~ 1.224 ~I-~ 73.3 1,151.l 94 L-.---..-:a.* 0 1,111, “I uty CL.+ PI-lA.l...mn r113&“cLllnaIIcIIci3 , Q,tc I,LIcl 0.0 1,214.5 100 HSBC Holdinos. Plc 1.195 0.0 1.195-o 100 F. dQ,,,,b wslll”ly TIIIa,ucIIQI ““lfJ”l~~WCl l,l=3L -rJ”.-v I G3il.i) ;;ntJ;r Bancshares lncomorated 1.082 0.0 1.082-l l”o’o Y I,\ “1 VIW..W. .w .,--- 1.w . ,‘W”.W I”” Firstar Corporation 1,049 906.3 142.6 14 Marshall & llsley Corporation 1,044 0.0 1,044.2 100 US Bancorn lnanmnrded 775 289.1 485-s 674 Union Plainters Corporation ‘.r . ..--. r -.---- %iJ ---. 0.0 . 768.6 .--.- 100 M&TBa ncorporation 732 0.0 732.3 100 ------I:-- -r,-%rl Iad nr\ ‘V.V 7-4 n ..-.n Hibernia Corporarlon I.3I.Y IVU -Page 7 GAOIGGD-9943R Asset-Backed Securities Enclosure I Selected Financial Data on Banks’ Holdings of Securities Dollars in millions Portion available for Bank holding companies Total Held to maturity” Available for saleb sale (percent) Centura Banks Incorporated 726 0.0 726.3 100 First Security Corporation 705 0.0 705.2 100 Fulton Financial Corporation 660 133.7 526.5 80 UST Corporation 612 0.0 611.7 100 Valley National Bancorporation 587 64.3 522.7 89 Totals for the top 50 $212,545 $18,638 $193,907 91% Totals for all commercial banks $277,192 $32,506 $244,686 88% Note 1: Pass-through MBS are mortgage-backed securities in the form of pass-through securities, which entitle investors to share on a pro rata basis in all principal and interest payments received from a mortgage pool. Note 2: This list is the 50 largest portfolios of pass-through MB.8 not the 50 largest bank holding companies (BHC) by asset size. Totals may not add because of rounding. ‘Held to maturity securities are recorded on the balance sheet at amortized cost. bAvailable for sale securities are recorded on the balance sheet at fair value. Source: Copyright 1999, American Banker. Reproduced with permission; unauthorized reproduction prohibited. Page 8 GAO/GGD-99-63R Asset-Backed Securities Page 9 GAO/GGD-99-638 Asset-Backed Securities Page 10 GAO/GGD-99-63R Asset-Backed Securities Ordering Information The first copy of each GAO report and testimony is free. Additional copies are $2 each. Orders should be sent to the following address, accompanied by a check or money order made out to the Superintendent of Documents, when necessary. VISA and Mastercard credit cards are accepted, also. Orders for 100 or more copies to be mailed to a single address are discounted 25 percent. 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Accounting Standards: Treatment of Asset-Backed Securities
Published by the Government Accountability Office on 1999-04-14.
Below is a raw (and likely hideous) rendition of the original report. (PDF)