How Fair Values and Accounting Structures Allow Triple-Counting Income

Abstract

The legal and economic rationales for using off-balance sheet structures for securitizations of receivables are compelling. However, accounting standards enabled self-interested parties to participate in the securitizations in nontransparent ways. For instance, securitizing firms set up the off-balance sheet structures, sold tranches to these structures, and often booked gains on these sales based on internally determined valuations. In addition, the tranches retained by the firm were marked to market, again based on internally determined valuations. In the wake of the financial crisis, the accounting standards changed and began requiring most off-balance sheet structures to be reconsolidated. However, the standards continued to allow nontransparent treatments. Namely, the securitized assets, which had largely become nonperforming, were written down in a way to avoid income recognition, providing incentives to overaccrue allowances, which are now being released as gains in income. We provide a case study to illustrate the issues in detail, and we expand our study to the group of the largest credit card securitizers. We highlight the implications of triple-counting income for research analysts, academicians, and policy makers.