Home Equity: FASB Defends Rule Requiring Booking of Projected Gains

The Financial Accounting Standards Board is standing firm on keeping a controversial accounting rule that has led to massive writedowns for some home equity lenders.

The accounting board "has not yet seen or heard enough to indicate that it ought to revisit the question" of whether FAS 125 should continue to be mandatory, said Halsey Bullen, the board's senior project manager.

The rule requires lenders to book projected gains on securities. Several had to take massive hits to earnings last year and this year when competition prompted borrowers to switch lenders, leading to prepayments that wiped out such gains.

Mr. Bullen suggested the writedowns would recede as lenders got more familiar with the rule.

At a panel discussion hosted by the New York Society of Securities Analysts last week, analysts Steven Eisman of CIBC Oppenheimer and Reilly Tierney of Fox-Pitt Kelton complained that the rule forces lenders to make near-impossible predictions.

Companies are put in a "no-win" situation, Mr. Tierney said. "Companies that had stable business before now have so much competition that performance (of their securities) has become incredibly uncertain, and FASB doesn't recognize that."

Mr. Eisman called for elimination of the rule, though he acknowledged that the transition would be a "nightmare" for lenders.

Mr. Bullen said the rule merely reflects the nature of the home equity business. "Some accounting methods have masked these risks. This one reveals them more strongly," he said. "The big thing isn't the accounting. There has been a change in the marketplace."

The FASB is considering stiffer disclosure requirements, Mr. Bullen said. Investors and analysts struggle to obtain information about lenders' prepayment speed assumptions. Lenders generally refuse to reveal them, citing the need to keep such information from their competitors.

"We are interested in suggestions about what additional disclosure would be appropriate," Mr. Bullen said. He said the accounting board is writing an "exposure draft" to the rule that could include disclosure requirements.

Meanwhile, home equity loan prepayment rates may not be as much of a problem as the industry has feared, according to the most recent Salomon Smith Barney bond market roundup.

"While speeds did increase in March, in response to the drop in interest rates in early 1998, they were generally in line with our expectations," the report said. "Fears of a huge spike were overdone."

Aggregate prepayments for home equity loans remained below 40%, Salomon Smith Barney said, and are not expected to increase significantly in April.

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