The Financial Accounting Standards Board has signaled its support for accounting rules that should not disrupt banks' use of loan participations to diversify assets and spread credit risk.
At a meeting Wednesday, the board laid out requirements banks must meet to structure loan participations as "true sales," which would let them keep the participated portion off their balance sheet.
The decision will probably help ease the anxiety that has been building within the industry since February, when the board appeared to be headed toward a conclusion that would have precluded sale treatment for participations.
"It looks as though banks will be able to achieve sale accounting for loan participations," said Gwen Ritter, an accounting expert at the American Bankers Association. "We're relieved that throughout this process FASB realized the critical role that loan participations play in managing credit risk, liquidity, and lending in general. It's fundamental to the banking industry."
In a participation, a bank originates a loan and sells a portion of it to another bank. Because the originator services the entire loan, the sale is generally transparent to the borrower.
Small banks use participations to extend larger loans than they could otherwise because of limitations on loans to one borrower. Banks of all sizes use the participations to spread credit risk.
The purchaser reaps its own benefit - portfolio diversification and an earning asset picked up at little cost.
But the FASB had said that Federal Deposit Insurance Corp. receivership rules could in some circumstances threaten sale treatment. The board convened two public roundtables this summer to discuss the legal issues raised by receivership.
Banks and their regulators argued that the little-exercised provision of the receivership rules was too remote to undermine an important tool in managing risk.
Under the proposal approved at Wednesday's meeting, banks must secure true-sale opinions from lawyers on loan participations and address several other requirements to prove isolation. The originator must act in a custodial capacity in handling the loan and its proceeds and may not commingle the loan with other assets.
The originator must also pass loan proceeds directly to the participating bank - except for servicing fees - and "administer the financial assets under a standard that does not give it unfettered discretion as to all matters," according to guidance prepared by the FASB staff.
Dennis Hild, an accounting expert for America's Community Bankers, said the development was "good news, but we need to work on interpreting exactly what it is going to mean."
Banks will have to be more careful about participations, Mr. Hild said. Even with a true-sale opinion, "you are going to have to pay very close attention to these conditions and keep in mind that bank auditors are going to do the same thing."
Still, he said, "most banks would welcome this result compared to where we could have been."
Resolving the issue of loan participations allows the board to focus on revising other elements of its asset-transfer standard. A draft of its revisions might not be made public until late this year or early next year. A public comment period and board deliberation of those comments would occur before the revisions could take effect.
