Off Balance Sheet

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nuppal

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So, one of my superiors asked me to give him a quick 30-second lesson on these types of transactions. So I took a stab at it and came up with this;

It's similar to when you take money out of your checking account and hold the cash in your wallet. While your account shows a decline in cash there is not real way to trace where it has gone. Meanwhile, you still have the same net worth but an essentially invisible way to spend a percentage of that worth. This can lead you to buy something with less utility (read: riskier) and thus create moral hazard by not having the standard accountability in place.

Am I completely off by telling him this? I think he liked my answer, however, I am pretty sure I missed somethings.

__________

"good personality ... or he was known as Lt. Mandingo during his army days."
 
I would have assumed he was more concerned with off B/S liabilities. I think recent accounting rule changes are forcing a lot of them onto the B/S now (maybe one of the CPAs on here can enlighten us), but common ones that immediately come to mind: operating lease obligations, swaps and other derivatives, loan guarantees,etc. If I remember correctly, off B/S liabilities were one of the major reasons for the fall of Enron (maybe the main, don't remember).
 
Huh...I find your stuff confusing.

Off balance sheet liabilities are simply things you owe but that don t show on your B/S.

Obvious example is operating lease.

Other examples are ordinary rent contracts.

Then there are these whole contractual arrangements such as guaranteeing the performance of an affiliate, which would become your liabilities if the affiliate doesn't perform, etc.

No liability position is displayed, but these are all liabilities.
 
Vicery, that's why I posted it. I felt that my exp was a tad confusing. It is probably easier to understand if we were speaking face to face.


Also, where/how did you get your user name? The Vicery hotel is literally across the street from my APT building and they throw some killer Sunday Pool Parties.

__________

"good personality ... or he was known as Lt. Mandingo during his army days."
 
I think the standard example would be SPV's and off-balance sheet financing.
 
Viceroy..... a highly regarded variety of tulip bulb during the Dutch tulipmania of the 17 th century.

Highly regarded, but not as quite as the Semper Augustus.
 
Keep in mind that the original intention behind off-bs SPVs is the isolation and sale of receivables. If the receivables are "sold", then why should they be recognized?

If sold in a true-sale why would they be included as an asset on the BS? They are bankruptcy remote and would not be included in the bankruptcy estate.

Granted, the system was abused a bit, but the reasoning is solid in the most specific interpretation
 
I'm on a fail streak.

First the Russian (who ever put that 1.8 is the age multiplier for Russians was correct). Now OBTransactions...

I need to redeem myself by bedding my gym honey.

__________

"good personality ... or he was known as Lt. Mandingo during his army days."
 
spierce Wrote:
-------------------------------------------------------
> Keep in mind that the original intention behind
> off-bs SPVs is the isolation and sale of
> receivables. If the receivables are "sold", then
> why should they be recognized?
>
> If sold in a true-sale why would they be included
> as an asset on the BS? They are bankruptcy remote
> and would not be included in the bankruptcy
> estate.
>
> Granted, the system was abused a bit, but the
> reasoning is solid in the most specific
> interpretation

Good point.
 
nuppal Wrote:
-------------------------------------------------------
> I'm on a fail streak.
>
> First the Russian (who ever put that 1.8 is the
> age multiplier for Russians was correct). Now
> OBTransactions...
>
> I need to redeem myself by bedding my gym honey.


Nuppal what happened wit the Russian girl?
 
Think IBank has $100 in MBS to sell that they bought and packaged.
2009 BS
$100 Cash
$100 MBS
$0 AR

Now they create a legal entity to offload the risky MBS to shore up their balance sheet by lending $100 to it so it can by the $100 MBS
2010 BS
$200 Cash
$0 MBS
$100 AR

While they are still liable for the sale and AR for that entity, their balance sheet looks much stronger. Simplistic, but I think still somewhat accurate.
 
Bizbanker - that doesnt quite make sense...how did they get $200 of cash with the transactions you mentioned? If they lent the $100 they would be out 100 and cash down to zero. Assuming based on your transactions that the new company then bought the MBS with the $100 lent, cash would go back to $100.

So I would see this transaction having no net impact on assets, unlike what you have posted...am I missing something in your example? I would see it with cash of 100 and AR of 100.
 
BizBanker Wrote:
-------------------------------------------------------
> Think IBank has $100 in MBS to sell that they
> bought and packaged.
> 2009 BS
> $100 Cash
> $100 MBS
> $0 AR
>
> Now they create a legal entity to offload the
> risky MBS to shore up their balance sheet by
> lending $100 to it so it can by the $100 MBS
> 2010 BS
> $200 Cash
> $0 MBS
> $100 AR
>
> While they are still liable for the sale and AR
> for that entity, their balance sheet looks much
> stronger. Simplistic, but I think still somewhat
> accurate.

Most times (not all), if you retain the majority of economic interest in the entity the entity has to be consolidated for accounting purposes. That's how FAS140 worked and I'm pretty sure that's how FIN46 works.

FAS140 required minimal retained economic interest and "control" over the entity, as well as limited corporate activity of the "brain dead" corporation. For example, you might be able to retain the I/O strip and OC (aka equity, retained interest) as well as the servicing strip, however, you had to sell down to a bare minimum of those items.

I believe FIN46 took that a step further.

It all depends on the structure and the auditors.
 
OK forget that one, I have a bit of a head cold. So say the 2010 BS shows $100 Cash and $100 AR, now that assets are in a separate entity and not being marked down with the market. I think the point of off balance sheet on the Asset side is to isolate volatile or potentially dangerous assets that can compress the equity out of a highly leveraged firm. AR would be more stable than a portfolio of MBS. There is another rule that says if a bank makes a loan of < 365 days it doesnt have to show it on its balance sheet. Not sure where I read this one, but then the sale would just show MBS straight to cash. Of course the accounting rules have become more strict to deal with this sort of offloading, but I think an audit came out of LB just recently explaining the use of Rule 105 or some such policy that sent the junk off the balance sheet and recorded a sale.
 
BizBanker Wrote:
-------------------------------------------------------
> OK forget that one, I have a bit of a head cold.
> So say the 2010 BS shows $100 Cash and $100 AR,
> now that assets are in a separate entity and not
> being marked down with the market. I think the
> point of off balance sheet on the Asset side is to
> isolate volatile or potentially dangerous assets
> that can compress the equity out of a highly
> leveraged firm. AR would be more stable than a
> portfolio of MBS. There is another rule that says
> if a bank makes a loan of < 365 days it doesnt
> have to show it on its balance sheet. Not sure
> where I read this one, but then the sale would
> just show MBS straight to cash. Of course the
> accounting rules have become more strict to deal
> with this sort of offloading, but I think an audit
> came out of LB just recently explaining the use of
> Rule 105 or some such policy that sent the junk
> off the balance sheet and recorded a sale.


Off-BS entities, by and large, have nothing to do with mark to market accounting for the seller/servicer. The actual investors in the assets does the MTM. Now, that was certainly abused in the last several years, but the premise remains the same. Why mark something you don't own? It's up to the owners to mark.

Sorry, but by and large, off-bs entities aren't used to relieve "equity compression" (if there is such a thing), it is to gain cheaper financing by originating assets, isolating the assets from a lower-rated parent (seller/servicer), which reduces the risk of investing in the assets, structuring them to different ratings, gaining a cheaper cost of funds.

If you are a BB- company but originate good assets, why not leverage those assets (pushing forward cash flow), by isolating them from your BB- rating. Selling them into the SPV, isolating them from bankruptcy, and structuring them (properly) will allow A/AA/AAA funding, resulting in a far lower cost of funds than at BB-.

The 364-day rule is obsolete. The usual game was that if there was a committment to lend for greater than 364 days you had to consolidate the position for capital purposes (AFAIK, not accounting). Thus, banks would issue conduit securitization positions for 364 days, gaining preferential treatment for the liquidity agreement between the bank and the conduit. This does NOT apply for term securitizations, only conduits.

Theoretically it could show MBS "straight to cash". However, that was one of the more nefarious uses of conduits, SIVs. SIVs have essentially disappeared from the ABCP world.
 
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