November 26, 2007

Off Balance Sheet SIV Exposure

Accounting firms are preparing for the year end audits particularly for banks. A financial times article, view here, talks about how the big four accounting firms are meeting to discuss their approach to valuing all these CDOs, SIVs, and all three letter acronyms you can imagine.

In a sign of the seriousness of the situation, this is the first time the six have sat down and formally compared their internal practices in such a way.
Accounting firms have taken flask in the past for collapses in Enron and World com and others. You can rest assure that they will come out blazing for this year audits. They do not want another episode like Enron or they do not want the precarious position the rating agencies are in due to the whole sub-prime rating issues. The y want to be out of the spot light by being extra diligent.

A sensitive issue will be the SIVs ownership. banks have structured these to be off the books vehicles. But will auditing firms allow some of these SIVs to float off the balance sheet, like Enron did. Citi have $41 billion exposure to SIVs, HSBC have more than $45 Billion. These are large amounts to be taken back on thier balance sheets. This action may force some selling.

Banks structure these SIVs off their books so they can maintain a specific capital ratio to allow them to originate more loans. If these SIVs to be added back to their balance sheet, it will mean that these ratios are no longer satisfactory. A state that can lead to fire sales of assets to raise their capital ratios.

The wall street Journal have reported regarding the state of these SIVs, read here (subscription required):

The fate of the $41 billion rests on the outcome of a debate going on in accounting circles over what constitutes a "reconsideration event." Those who say Citi needs to put these securities, known as collateralized debt obligations, onto its balance sheet argue that because Citi acted over the summer to backstop some of them, its relationship with them changed, prompting a reconsideration event.

At the moment, it seems unlikely Citigroup will be forced to bring the assets onto its books. The bank doesn't believe such a reconsideration event is in order. A spokeswoman says Citigroup is confident its "financial statements fully comply with all applicable rules and regulations."

I believe that accounting firms will err on the side of caution and consolidate some of these amounts back to bank's financials. A move that can force more volatility in earnings and business activity for the banks.

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