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Thursday, September 22, 2011 - 02:15

S&P: Accounting Rule Cld Boost Lrg US Banks'Assets By Ave 68%

WASHINGTON (MNI) - An accounting rule that has yet to be adopted has the potential to boost U.S. large banks assets by an average 68%, and liabilities by nearly 72%, Standard & Poor's said Wednesday.

The International Accounting Standards Board (IASB) and its U.S. counterpart, the Financial Accounting Standards Board (FASB), have been struggling to converge their approaches to offsetting financial assets and liabilities.

And if convergence is not achieved, which Standard & Poor's deems "the likely final outcome" in a report titled "Accounting Proposal Struggles To Create Global Convergence In Balance Sheet Offsetting," the differences between global accounting regimes will be "significant."

And in this case, U.S. banks will mostly feel the impact relative to their European counterparts.

The FASB put out an exposure draft in January 2011 on Balance Sheet Offsetting that provides guidance on when companies can offset financial assets and liabilities.

Also in January, the IASB put out an equivalent proposal called "Offsetting Financial Assets and Financial Liabilities."

Of particular importance both to large banks and their regulators is the issue of netting derivatives subject to so-called 'master netting agreements,' which are standardized contracts defining rights such as netting, in relation to one or more derivatives contracts or repurchase and swap agreements.

If the FASB proposal is "finalized in its current form, U.S. companies would not be allowed to offset as many financial assets and liabilities (particularly derivatives) as now permitted," Standard & Poor's said. "This will result in larger balance sheets, particularly for large, complex financial institutions."

And that at a time U.S. regulators are trying to address the issue of too-big-to fail.

Under the current U.S. accounting regime, companies can only net financial assets and liabilities if the counterparty is the same and there is a legally enforceable right to offset.

However, exceptions are granted for derivatives under a single master netting agreement under certain conditions.

The proposed U.S. standards, however, eliminate exceptions for derivatives under a master netting agreement. "Simply put, it would gross up U.S. balance sheets," S&P said.

Under the international financial reporting standards (IFRS), there are no exceptions, either in the current or the proposed standards, which is why the impact for companies already using IFRS would be less than for U.S. financial institutions, many of which use the option to apply the netting.

Based on a sample of large U.S., Standard & Poor's estimated that assets would increase by an average 68.4%, ranging from a 31.4% increase for Citigroup to +104.7% for Morgan Stanley as a result of grossing up derivatives assets and liabilities.

The increase in liabilities would be an average 71.7% for the large U.S. banks.

"We estimate the potential average increase for the U.S. financial institutions in derivative assets and derivative liabilities would by approximately $961 billion and $935 billion, respectively, under the proposed standard," the report said.

On the other hand, "We do not expect the impact of the proposed standard to be significant for European financial institutions, because the differences between IFRS and the proposed standard are minimal," the report added.

The rating agency urged convergence of the standards, but warned that reporting derivatives on a gross basis "may obscure the company's financial risks."

Standard & Poor's also noted that banking regulators have yet to decide about their own treatment of derivatives.

For instance, "gross presentation under the proposed standard would weaken the leverage ratio currently used by U.S. banking regulators. Consequently, if the standard is finalized in its current form, the new rules could cause regulators to modify their minimum leverage ratios."

"Alternatively, regulators may decide to exclude derivatives subject to master netting agreements for regulatory capital purposes altogether," the report continued. "If the regulators decide to simply retain the current rules, potentially resulting in banks holding greater amounts of capital, we believe it would be viewed most unfavorably by the banks."

Especially as large banks are now facing a growing reality of not being rescued in case of failure, which triggered Moody's to downgrade some of them Wednesday.

The report also suggested that the impact of adopting new rules on banks' balance sheets could translate into higher premiums charged by the Federal Deposit insurance Corporation, which changed the assessment base to assets from liabilities earlier this year.

It remains to be seen how the FDIC would adjust, if at all, should FASB's new standards be implemented and banks' assets increased as a result.

** Market News International Washington Bureau: 202-371-2121 **

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