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SEC Staff Position on Sub-Prime Loans

Monday, August 6, 2007

In a letter issued on July 24, 2007 by SEC Chairman Christopher Cox to Barney Frank, Chairman of the Committee on Financial Services of the U.S. House of Representatives, the SEC responded to Congressman Frank’s inquiry about the potential impact of FASB Statement No. 140,Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities-a replacement of FASB Statement No. 125 (FAS 140) on mortgagors’ ability to make loan modifications to forbear foreclosure.

The letter provides the SEC staff position that, “consistent with general agreement in practice, such loan modifications would not result in a requirement for entities to account for those securitized assets on their balance sheets. In this case, modifications undertaken when loan default is reasonably foreseeable should be consistent with the nature of modification activities that would have been permitted if a default had occurred.” More specifically, Congressman Frank and other members of Congress asked Chairman Cox to answer the following question:

Does FAS 140 clearly address whether a loan held in a trust can be modified when default is reasonably foreseeable or only once a delinquency or default has already occurred? If not, can it be clarified in a way that will benefit both borrowers and investors?

In his reply to Congressman Frank, Chairman Cox included a staff memorandum prepared by the SEC’s Office of the Chief Accountant that addresses the issue and describes a June 22, 2007 educational forum that the FASB hosted at the request of the SEC staff. There was general agreement among participants at the forum that, subject to certain constraints, the ability to restructure mortgages when default is reasonably foreseeable is an activity that is not inconsistent with the notion of continued off-balance sheet accounting treatment. The staff memorandum also provides the staff’s current view that additional interpretive guidance is not necessary in order to clarify the application of FAS 140 to the contemplated types of securitized mortgage loan work-out activities.

Congressman Frank’s letter of inquiry to Chairman Cox as well as Chairman Cox’s response (including the staff memorandum referred to above) can be accessed by clicking on the respective links.

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