U.S. accounting rules could hurt earnings and more

NEW YORK, Jan 27 (Reuters) – New rules designed to prevent Enron-esque shenanigans might force companies to shift billions in assets and debt onto their balance sheets in a move that, in some cases, could hurt earnings, accounting experts say.

It's not clear whether companies will in the end be required to make these shifts under the rules, and even if they do, there may be loopholes, accountants said.

“We're still figuring out what the new rules really mean,” said Jim Mountain, a partner at Deloitte & Touche LLP, the Big Four accounting firm based in New York.

The worst-case scenarios looked unlikely in early drafts, but seemed increasingly possible in final rules the Financial Accounting Standards Board issued earlier this month, Mountain said.

The rules make it harder to hide debt and assets via specialized finance affiliates. Companies like Enron used these so-called “special-purpose entities” to conceal debt and pump up their return on assets.

But special-purpose entities, or SPEs, have legitimate uses, and accounting professionals fear that regular financing activity could be tripped up by the new rules, increasing borrowing costs and cutting into some lenders' earnings.

For example, banks that arrange low-cost financing for customers via SPEs called asset-backed commercial paper conduits might have to move the debt and assets connected to those conduits onto their balance sheets.

If a bank has more assets on its balance sheet, its earnings could fall, because higher assets demand higher capital. Holding capital in reserve instead of using it for other purposes could cut into earnings, said David Thrope, partner at Ernst & Young in New York.

Standard & Poor's Ratings Services estimates that banks' assets, in total, could swell by as much as about $250 billion.

Banks are not the only ones that could get hit — asset management companies that issue bonds secured by portfolios of debt might have to move those portfolios and that debt onto their balance sheets.

Some asset management companies believe that increasing the liabilities on their balance sheets could make them appear to have more debt than they actually do, Thrope said.

Higher debt levels increase companies' debt-to-equity ratios, which could make them less attractive to investors and lenders.

That is especially problematic for any company borrowing money from a bank. Companies often have loan agreements that require them to maintain certain debt-to-equity ratios. Increasing debt on the balance sheet could lead companies to violate those agreements.

Accountants and companies are searching for loopholes to the rules. As a result, financing techniques that the FASB was believed to be attempting to quash may remain in use as accountants find ways around the new rules, accountants said.

One such technique is the synthetic lease, which was legal under the previous rules and was used to make a company look like it had a better return on assets and less debt than it actually did, while minimizing its tax bills.

But even if such techniques can be used legally in the aftermath of FASB's new rules, a culture of accounting caution creeping across corporate America in the wake of Enron and other scandals might achieve what a sheaf of new rules cannot.

For example, the number of businesses entering synthetic leases for real estate, by far the most popular use of the technique, has shrunk to almost nil over the past year.

“More and more people think synthetic leases will be perceived as deceptive,” said Pat Donoghue, head of financial structuring for leases and receivables at BTM Capital in Boston.

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