Bringing the shadow banking system into the light could be a messy undertaking.

Sweeping changes due to be finalized this month for accounting rules could push trillions of dollars of assets on to the books of financial companies at the beginning of next year. As a result, legions of opaque vehicles will come out of the dark — a radical change for a system that has financed as much as 60% of the lending in this country.

The impact on balance sheets is clear (they'll be bigger), but when it comes to profit and loss statements, the changes could produce big hits for some companies but gains for others. Further complicating matters, those losses or gains would be earned back or written off over subsequent periods. There is also the fear that the changes will open another capital hole.

"A huge dollar number is coming on to people's balance sheets," said Jason Kravitt, a partner with Mayer Brown LLP. "In 2004, that may have been OK. In 2009, it's a systemic problem … because we're all short on this capital. … I'm not saying the new rules are good. I'm not saying they're bad. But they're going to produce an issue that will have to be dealt with."

The industry has resisted the changes.

In a letter last week to Treasury Secretary Timothy Geithner, a number of trade groups, including the Financial Services Roundtable and the Mortgage Bankers Association, wrote that the consolidation of "many if not all" securitization vehicles would "impact capital and liquidity necessary for lending." The groups urged "policymakers to ensure that any sweeping accounting changes are appropriate and not untimely, and that they do not exacerbate the current economic issues facing American households and businesses."

Paul Miller, a managing director at Friedman, Billings, Ramsey & Co. Inc., said the industry's resistance to the proposed amendments to the Financial Accounting Standards Board's Statement No. 140 and FASB Interpretation No. 46(R) reflects profound uncertainty.

"There's a lot of detail in all of this — people don't know how it's going to play out," Miller said. "I think that's why some of these companies have lobbied the government saying, 'This is one of these Pandora's boxes. It might not be a big deal, but it could be a big deal. … We don't want to wake up six, nine months from now and you guys tell us we have another capital hole. Therefore, let us build our capital bases back up before you make this move.' "

But the FASB is not budging. Christine Klimek, a spokeswoman for the standard-setting body, said it hopes to put out final standards this week and expects no significant changes from what the board decided when it concluded deliberations last month.

The rule changes are poised to encompass everything from the $446.3 billion of securitized credit card receivables and almost $4 trillion of securities guaranteed by Fannie Mae and Freddie Mac; to servicing portfolios for nonconforming mortgages and commercial paper conduits.

Wherever there is an off-balance-sheet repository, the entity with the most control over the assets, along with an economic interest in gains or losses from them, may have to take it on its books.

A critical question may be how regulators risk-weight the assets, since supervisory standards would have the greatest force in determining whether companies seek new capital.

"Just because the accounting changes doesn't mean that the bank regulators have to therefore require more capital," Kravitt said. "I think what they'll do is look at the transaction and ask, 'Did it change the amount of risk the bank was taking or not taking?' And if consolidation didn't change its risk, I think they'll try to write the rules to make sure the regulatory capital doesn't go up. So this will create a much greater divorce between accounting and regulatory capital than used to be the case."

Industry lobbyists have also asked the FASB to wait for the development of joint rules with the International Accounting Standards Board.

"Rather than having U.S. issuers go through dramatic changes in the way they account for sales and consolidations based upon the FASB project and then turn around and have to converge to international accounting standards, … we only want to do this once," said Jim Gross, the MBA's associate vice president of accounting, tax and bank regulation. Making the changes even once "would cost some of our large corporations tens of millions of dollars," he said.

For a preview of what the changes will mean for the industry, the best place to turn may be credit card issuers.

Perhaps more than any other group, these companies have discussed the looming changes in detail. That makes sense, since card issuers are accustomed to putting "managed" results — which include on- and off-balance-sheet activities — in the foreground.

Richard Fairbank, the chief executive of Capital One Financial Corp., said at a presentation last month that his company has always steered investors to managed performance. However, consolidations could have "a significant effect near-term on capital," depending on the approach that companies use.

Consolidating at book value would mean that a company would have to take a hit to set aside reserves for credit losses. But at fair value, securities funding the assets could generate a gain, because they currently trade at market discounts, though the gain would run off as the securities mature. (Under accounting rules, market gains and losses can be recognized on both assets and liabilities.)

"This is a pretty important choice that affects what happens to capital in the near term and then how all of us will interpret our financials," Fairbank said.

Which way is Capital One leaning? "Quite frankly, we haven't made that election," Gary Perlin, its chief financial officer, said at a presentation last week.

Despite the banking industry's fears about capital effects, card issuers also say they are prepared to absorb the consolidations — which would dilute tangible equity ratios — without raising more capital.

"Whether we chose the fair value or whether we bring it on at book value," Fairbank said, "we believe that the capital that we have is entirely appropriate to cover our requirements for every constituency, and so we don't think" the amendments will have "any impact on our need to raise any additional capital."

Sanjay Sakhrani, an analyst at KBW Inc.'s Keefe, Bruyette & Woods Inc., said the consolidation approach could depend on a company's capital position.

"If you feel like electing fair value puts you in a better capital position, when you're marginal you may elect fair value," he said. "But to the extent that you're able to absorb the impact, it's probably best to just use historical cost, because it doesn't impact you in future quarters." If a company can take the one-time hit, "it's probably a net positive, because coming out of the cycle, you would release reserves."

Other factors that may weigh on the decision include changes in delinquency trends by the time the consolidation would have to be implemented — an easing could translate into a lower set-aside for credit losses — and changes in the market values of asset-backed securities. Sakhrani said he expects more companies to take the fair-value approach if the environment becomes more challenging,

Dave Reavy, an audit partner at KPMG LLP's banking and finance practice, said the effects of consolidations on income statements could vary widely. "There's almost no way to predict, 'Here's what you should expect in all circumstances.' "

Often there is some "form of interest that already captures the fair value of the economics of the structure that's on the balance sheet," Reavy said. "So there may or may not be an impact when you consolidate. It's really going to depend on the facts and circumstances."

There are "transition provisions" that "will capture some of that potential positive or negative hit," so those gains or losses "may not actually flow through" to the income statement, he said. Still, "in general, with the declines experienced in the overall market, if you do have an impact, it's more likely to be negative."

Large amounts of off-balance-sheet assets — including tens of billions of dollars from structured investment vehicles — have already been brought on to the books during the crisis.

Unexpected card losses have prompted major issuers to pour additional support into securitization programs this year, demonstrating ties with off-balance-sheet receivables that mean they must be included in calculations of regulatory capital ratios.

According to proponents of the rule changes, such moves illustrate that financial institutions' responsibility for the vehicles they have set up has remained unbroken, and they justify the need to revise standards that obscure risk and provide an inaccurate picture of corporate finances.

American Express Co. said in a securities filing last month that steps it had taken to support its securitization master trust "will result in the inclusion of the master trust's assets as risk-weighted assets for regulatory capital purposes."

Last month State Street Corp. said that it had decided to trigger the accounting consolidation of its asset-backed commercial paper conduits, and that doing so would simplify its "reporting and communication requirements."

The $142.1 billion-asset Boston company estimated the consolidation would generate a $3.7 billion after-tax loss associated with the fair-value measurement of the assets in the vehicles, which included bonds backed by mortgages and other assets with a face value of about $22.7 billion.

State Street said it expected to recoup the "vast majority" of the loss as interest revenue over the lives of the assets. Its conduits had already been a focus for investors, and State Street noted that its federal stress test, like the ones conducted for the other 18 large financial institutions, had taken off-balance-sheet obligations into account.

Investors seem to have taken the consolidation in stride. State Street simultaneously announced a $1.5 billion offering of common stock and plans to repurchase $2 billion of preferred stock the government had purchased under the Troubled Asset Relief Program. Its shares have since continued a rally that began in early March.

Subscribe Now

Access to authoritative analysis and perspective and our data-driven report series.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.