Off balance cheet exposure
- Thread starter babu
- Start date
babu,
As you likely know, the balance sheet records the "book value" of assets & liabilities (and increasingly many of thos components are market-to-market). A classic investor issue has long been, "does the balance sheet reflect economic reality?" where the answer has generally been "no" due to accounting principles. So "off balance sheet" referred to anything that was not recorded on the balance sheet (and therefore did not impact some metrics like return on equity, ROE) yet did contain an economic reality for the firm/bank. On the liability side, the classic example is an operating lease; a contractual promise to pay a future stream, which economically is therefore sort of like a bond, yet the PV is not carried on the B/S. (many off balance sheet assets/liabilities are *disclosed* in a statement footnote, but not recorded on the statements themselves).
off balance sheet exposures, in Financial Services, could apply to *economic* liabilities or assets that are not carried on the *accounting* B/S. The implication is generally that, analytically, they should be there; and an financial analyst generally (under any method i'm aware) would "restore" these assest/liabilities to the balance sheet. To do so is to "capitalize" these items and create a more economically faithful B/S
So, on the liabilities side, this could be a written credit default swap if it were (for some reason) not carried as a liability (there are two issues: 1. classification, does it appear on the balance sheet, and 2. Even if it does, it doesn't mean the size of the liability is accurate)
Although i'd say the connotation even further of "exposures" implies off balance sheet assets. This is the immediate association and, in fact, where many (most?) of the failed structures in the credit crisis lied. In short, bank makes loans, loans are assets on balance sheet, bank must hold (internal) economic capital and regulatory capital. Banks were generally motivated to move those assets of the balance sheet - if they are removed yet some risk is retained, then you have an "off balance sheet exposure" The notorious SIVs were off-balance sheet: http://en.wikipedia.org/wiki/Structured_investment_vehicle ... some of FASBs recent work was to undo the ability of banks to create off balance sheet exposures (e.g., the qualified SPE that FASB eliminated: http://www.bionicturtle.com/learn/article/no_qspe_tougher_fin46r_aims_in_the_news/)
...another way to view the issue is: credit-sensitive assets generally have to go on *somebody's* balance sheet ... in a securitization, often times the motive is to avoid "consolidation" which is a way of saying "the assets (and likely associated liabilities) don't get counted on my balance sheet"
Hope that helps...David
As you likely know, the balance sheet records the "book value" of assets & liabilities (and increasingly many of thos components are market-to-market). A classic investor issue has long been, "does the balance sheet reflect economic reality?" where the answer has generally been "no" due to accounting principles. So "off balance sheet" referred to anything that was not recorded on the balance sheet (and therefore did not impact some metrics like return on equity, ROE) yet did contain an economic reality for the firm/bank. On the liability side, the classic example is an operating lease; a contractual promise to pay a future stream, which economically is therefore sort of like a bond, yet the PV is not carried on the B/S. (many off balance sheet assets/liabilities are *disclosed* in a statement footnote, but not recorded on the statements themselves).
off balance sheet exposures, in Financial Services, could apply to *economic* liabilities or assets that are not carried on the *accounting* B/S. The implication is generally that, analytically, they should be there; and an financial analyst generally (under any method i'm aware) would "restore" these assest/liabilities to the balance sheet. To do so is to "capitalize" these items and create a more economically faithful B/S
So, on the liabilities side, this could be a written credit default swap if it were (for some reason) not carried as a liability (there are two issues: 1. classification, does it appear on the balance sheet, and 2. Even if it does, it doesn't mean the size of the liability is accurate)
Although i'd say the connotation even further of "exposures" implies off balance sheet assets. This is the immediate association and, in fact, where many (most?) of the failed structures in the credit crisis lied. In short, bank makes loans, loans are assets on balance sheet, bank must hold (internal) economic capital and regulatory capital. Banks were generally motivated to move those assets of the balance sheet - if they are removed yet some risk is retained, then you have an "off balance sheet exposure" The notorious SIVs were off-balance sheet: http://en.wikipedia.org/wiki/Structured_investment_vehicle ... some of FASBs recent work was to undo the ability of banks to create off balance sheet exposures (e.g., the qualified SPE that FASB eliminated: http://www.bionicturtle.com/learn/article/no_qspe_tougher_fin46r_aims_in_the_news/)
...another way to view the issue is: credit-sensitive assets generally have to go on *somebody's* balance sheet ... in a securitization, often times the motive is to avoid "consolidation" which is a way of saying "the assets (and likely associated liabilities) don't get counted on my balance sheet"
Hope that helps...David
Similar threads
