Treasury's Capital Purchase Program Raises Accounting Issues


With $250 billion dollars in play, questions have arisen regarding the accounting treatment for the Treasury Department’s injection of capital into banks through its Capital Purchase Program (CPP), which is part of the Treasury’s effort to ease the financial crisis.


The capital injections through the Troubled Assets Relief Program (TARP) are being made as special issues of preferred stock bundled with warrants that function like call options. But unlike most stock issues, the government’s purchases have special strings attached. The preferred stock pays a 5% dividend that rises to 9% after five years; it cannot be redeemed for at least three years; it restricts dividends on junior preferred stock or common stock; it has no voting rights; it restricts executive compensation in accordance with the requirements of the Emergency Economic Stabilization Act; and it is fully transferable (the term sheet is available here).


The FASB staff and the SEC’s Office of the Chief Accountant (OCA) have taken the position that the warrants can be classified as equity under U.S. GAAP. In an Oct. 24 letter to the Treasury Department, FASB and OCA staff said, “We would not object if the warrants, as defined in the documents provided, were to be classified as permanent equity under applicable U.S. GAAP.” The letter did not address the preferred stock classification.


So by classifying the TARP funds as equity on their balance sheets, are banks making the right decision? “When it comes to making the decision to classify these instruments as debt or equity, banks are obligated to follow the guidance of the FASB, the SEC, and their independent public accountants,” said James Bean, director of accounting policy for Wells Fargo, which received $25 billion from the Treasury.


But some FASB watchers were not convinced the government capital should be classified as equity. It sounds a lot like debt because it is “debt with an equity skin around it,” wrote Jack Ciesielski, CPA, in the Analyst’s Accounting Observer blog (see full comments here). “When it comes to financial reporting to public investors, it would be more realistic to see it classified as a liability,” said Ciesielski. “How much risk is there to Treasury compared to common equity holders? None—the Treasury is playing the role of a lender, with all the protections a lender requires,” he wrote.


The 36-page securities purchase agreement that banks are required to sign to receive CPP funds also contains a conspicuous unilateral amendment provision. Section 5.3 allows the Treasury to “unilaterally amend any provision of [the] agreement to the extent required to comply with any changes after the signing date in applicable federal statutes,” banking expert Bert Ely pointed out in a Nov. 19 speech at the AICPA National Conference on Banking & Savings Institutions in Washington. Ely questioned whether such language required disclosure in financial institutions’ financial statements.


“If I held the scepter of the czar of accounting, I would classify these instruments as debt, not equity,” said Paul B.W. Miller, a professor of accounting at the University of Colorado who has worked for both FASB and the SEC. “If I were a user of these financial statements, then I would lift the reported preferred stock out of equity and put it in the category of subordinated unsecured demand debt.”

Miller also would treat the warrants as liabilities. “Warrants are simply call options, which means they are derivative liabilities,” he said. “Such options are classified as equity under GAAP, and FASB made the GAAP call by saying they’re permanent equity if the company doesn’t have the capacity to perform by issuing additional shares. That doesn’t mean ‘permanent’ in the positive sense that it will last forever; it’s more like the equity is serving a life sentence without possibility of parole.”


Credit rating agency Moody’s took a position that appeared to be somewhere between FASB and its critics. “The TARP capital injection is coming at a time when banks have limited, if any, access to capital, and it has the effect of immediately lifting regulatory capital ratios,” said Moody’s Vice President Jean-Francois Tremblay in a Nov. 21 news release accompanying a report on the issue. “Since we do not consider the TARP preferred stock to be permanent, we will not be treating the TARP investment as 100% equity and, consequently, we do not expect upgrades of our bank ratings following an infusion of TARP funds.”


Matthew G. Lamoreaux is a senior editor for the JofA. His e-mail address is

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