October 30: Industry Risk – Ten Questions to Ponder About the Crumbling US Credit Market

Location: New York
Author: Dina Maher
Date: Tuesday, October 30, 2007

Fitch Ratings, in the form of a special report, yesterday released a list of ten key questions to provide insight into the issues that Fitch analysts are addressing when reviewing and comparing the results of issuers affected by the U.S. credit market turmoil of the past quarter.

The report, 'Market Turmoil and Accounting Impact: 10 Key Questions' is the result of Fitch's continuing efforts during the third-quarter 2007 market turmoil to review largely new accounting standards and reporting requirements and how they may affect analysts and investors' ability to obtain information they need to understand the repercussions of the recent market disruption.

In the U.S., the standards 'Fair Value Measurements' (SFAS 157) and 'Fair Value Option for Financial Assets and Financial Liabilities' (SFAS 159) will be mandatory for companies from fiscal-years beginning after Nov. 15, 2007 and early adoption by some but not all US financial institutions has rendered comparability more difficult. IFRS issuers have a similar fair value option that was implemented in 2004.

'The ramification of the changes in accounting for certain financial instruments and conduits can be significant for a company, particularly a financial institution, in terms of covenant tests, regulatory capital requirements and access to the capital markets,' said Dina Maher, Senior Director, Fitch Ratings.

In the report Fitch asks the following questions on accounting issues:

Fair Value Measurements

How is the fair value of financial instruments determined in the current market?
Are there opportunities for gains at initial recognition, i.e. Day One Gains?
How are companies that have not yet adopted SFAS 157 and IFRS companies reporting their fair value measurements?
Were any declines in the fair value of available-for-sale or held-to-maturity securities deemed to be impaired?

Fair Value Option

Why were certain financial liabilities marked to fair value?
Have the parent and subsidiary elected the fair value option on specific financial assets and liabilities in the same manner?

Loan Commitments

How did the company account for unfunded and funded loan commitments that have declined in value

Consolidation Issues

Did substantial losses by a variable interest entities (VIE) result in a re-evaluation by senior beneficial interest holders as to whether or not they must consolidate the VIE because of concern (or fact) that they, too, will be forced to absorb losses?
As a result of the decrease in fair value of the assets, has the company been forced to consolidate any VIE that it had previously determined was not required?
Have any actions that the sponsor took in support of a VIE (such as a securitized trust or asset backed commercial paper (ABCP) conduit) resulted in the reconsolidation of any entity that was previously accounted for off balance sheet?