WASHINGTON – The exchanging of a loan participation among credit unions is at the root of a Financial Accounting Standards Board (FASB) proposal that some in the industry say could hurt those CUs close to the 12.25% member business lending cap. FASB has proposed amending FASB Statement No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, and the right of setoff – the common-law right of debtors and creditors to setoff (net) amounts due to one another if one of the parties defaults, becomes insolvent, or enters into bankruptcy or receivership. The FASB is considering banning the sales aspect for loan participations indicated by rights of setoff. If an institution is in bankruptcy or receivership, setoff allows the customer to offset or cancel any debts owed to them with any outstanding loans. That institution can offset or cancel any debts owed with any deposits belonging to the customer. This would mean CUs would have to use the less beneficial accounting choice of keeping their assets as secured borrowing. Typically, the accounting portion of a loan participation allows the transfer of part of the loan off the selling CU's books to the CU purchasing the book. Scott Waite, senior vice president/CFO of Patelco Credit Union, is the only credit union representative on the FASB's newly-formed Small Business Advisory Committee (SBAC). The 24-member committee recently met for the first time and expressed its opposition to the FASB proposal. Waite is also chairman of the CUNA Accounting Task Force, which also sent a comment letter to FASB with concerns about the proposal. Waite said presently, these types of loans are treated as "complete sales," which means loans are removed from the financial statement of the originating credit union and then placed on the books of the participating credit union. If the FASB proposal goes in and if the loan participation doesn't qualify as a true sale, the originating credit union must keep the outstanding balance of the loan on their financial statement. If they do sell a participating interest, that would be recognized as secured borrowing with a liability added to the originating credit union financial statement, he explained. "If a credit union has a large amount of loans that they have sold a participating interest to, they can continue to reduce the balance sheet size, which will keep them under the 12.25% member business lending cap," Waite said. "If they can not move the loans, they would have to put them back on their books and that could push them over the cap." Waite said because member business lending is a "vibrant" activity for credit unions and other financial institutions, the SBAC has opposed the FASB proposal. In a May comment letter, CUNA Associate General Counsel and Senior Vice President Mary Dunn told FASB that there are already sufficient safeguards in place to address the accounting group's concerns about isolating the loan participation asset from the reach of the originating credit union and its creditors in liquidation. Any changes to FASB 140 would, thus, not be necessary, she wrote. Dunn also wrote that CUNA opposes requiring credit unions and other institutions to run participations through a "qualified special purpose entity" (QSPE) in order for the participations to receive true sale treatment, particularly because doing so is a costly and needless expense. Also, rather than adopting universally applicable provisions, FASB should recognize provisions incorporated into loan participation agreements that would alleviate FASB's concerns about legal isolation. Waite said in addition to the impact the FASB proposal would have on the credit unions and the member business lending cap, many could see effects on their net worth ratio. "The other piece is by leaving the (loans) on the balance sheet and recording liability interest in those loans, you inflate the balance sheet size, which could impact the net worth ratio" and potentially steer into prompt correction action (PCA) territory, Waite said. Of course CUNA also supports the Credit Union Regulatory Improvements Act which would push the MBL cap to 20%. At this point, the SBAC is working with the FASB to find a solution that will qualify the loans as legally, separate entities, he added. At the SBAC's first meeting on May 11, FASB Board Member Edward Trott said the FASB is currently gathering more information on the right of setoff from members of the legal community and other constituencies. FASB is scheduled to release a draft of the proposal for public comment in the third quarter. [email protected]