Saturday, February 10, 2007


Lifting the Lid: Securitization-ripe for results massaging?

Lifting the Lid: Securitization-ripe for results massaging?
Fri Feb 9, 2007 4:08 PM ET

By Tim McLaughlin (Who needs the POS WSJ?)

NEW YORK, Feb 9 (Reuters) - Packaging loans and unpaid customer bills into bond-backed securities is a lifeblood of corporate finance. It's used by Wall Street, automakers, mortgage lenders, and a number of other industries.

But a new study strongly suggests securitization financing could be more susceptible to accounting abuse than previously thought.

Research by two University of Michigan accounting professors found that U.S. corporations routinely cluster billions of dollars worth of securitization financing deals around the last few days of a quarter.

Companies can book immediate gains from these deals, creating a temptation to massage their financial statements. A well-timed securitization deal could be the difference between a blockbuster quarter and a dud. The process is opaque because disclosure of the gains can lag several months.

Georgia Tech University accounting professor Charles Mulford said it's possible to camouflage what can be essentially one-time gains as core earnings.

"There's just not enough disclosure," Mulford said.

Patricia Dechow and Catherine Shakespeare, professors at the University of Michigan's business school and authors of the study, said by waiting until the tail end of a quarter, "managers know best how much 'earnings' are needed to meet analysts' forecasts."

"With the help of their investment banker, (managers) can structure the deal to best achieve their financial reporting goals," the professors said.

Bank of America , Countrywide Financial Corp. , General Motors Corp. and Citigroup are among the most active securitizers,

It is not the major securitizers who show the greatest tendency to execute their transactions during the last few days of the quarter, the study found. Instead, it is companies that do it more occasionally that are most likely to show a knack for such timing.

Recording securitizations on financial statements is tricky.

Today's accounting gains are derived partly from assumptions on how much cash will be generated from consumer payments that will take months and years to materialize.

Here's how it works: a credit card issuer, or an auto company that provides financing to customers, or any other company with financial assets makes a series of loans and sells most of them to a trust. The trust issues bonds to investors.

The company hangs onto an interest in the asset, and bears the risk of their value declining by a certain amount.

The company can choose to account for the financing as collateralized borrowing, or an actual sale of assets.

Most companies opt for the second method, which reduces on-balance sheet debt and boosts cash flow.

It also gives them flexibility in valuing the retained stake and determining the gain on their income statements.

But companies can use overly optimistic assumptions -- regarding, say, how many borrowers are likely to refinance their mortgages, or how many borrowers will likely default -- to boost earnings.

Each year, U.S. companies are involved in several hundred billion dollars of securitization deals.

New York University accounting professor Stephen Ryan said the gain or loss on a securitization-related sale must be disclosed. However, its classification on the income statement does not.

Dechow said it's a murky area because quarterly disclosures are not required.

The Michigan professors analyzed more than 11,000 securitization transactions between 1987 and 2005. They found that the number of transactions spiked in the third month of a quarter, with a big upswing in the last five days.

"The consistent explanation for our findings is that flexibility to window-dress the financial statements is an attractive side benefit of engaging in securitizations," the professors' study said.

© Reuters 2007.

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