Project Pages

Conduit Debt—Reexamination of Interpretation 2

Project Description: The objective of this project is to address certain issues related to accounting and financial reporting for conduit debt obligations. The project will consider improvements to the existing guidance in Interpretation No. 2, Disclosure of Conduit Debt Obligations, related to: (1) diversity in current reporting that adversely affects comparability between governments, (2) whether conduit debt obligations are liabilities as defined in the GASB’s conceptual framework and, therefore, should be reported in government-issuers’ financial statements, and (3) the usefulness of required notes to government-issuers’ financial statements decision-making and assessing accountability.

Status:
Initial deliberations began: September 2017

Conduit Debt—Reexamination of Interpretation 2—Project Plan


Background: The GASB addressed conduit obligations in Interpretation 2, issued in 1995. Interpretation 2 describes conduit debt obligations as follows:
 
The term conduit debt obligations refers to certain limited-obligation revenue bonds, certificates of participation, or similar debt instruments issued by a state or local governmental entity for the express purpose of providing capital financing for a specific third party that is not a part of the issuer’s financial reporting entity. Although conduit debt obligations bear the name of the governmental issuer, the issuer has no obligation for such debt beyond the resources provided by a lease or loan with the third party on whose behalf they are issued. [Paragraph 2, footnote omitted.]
 
Conduit obligations generally are tax exempt, provided that they conform to relevant portions of the Internal Revenue Code. Thus, these financings are a way for not-for- profit organizations—for example, hospitals, nursing facilities, and educational institutions—to secure financings at tax-exempt rates. Third-party borrowers also may be other governments. This structure is popular when the issuer is considered to have financing expertise and economies of scale (for example, a state bond bank). Finally, some borrowers may be for-profit corporations. Many issuers receive a fee for arranging conduit financings and some are government agencies organized solely to issue conduit debt. A third-party borrower generally is identified in bond documents, such as offering statements and bond indentures. Based on the GASB’s pre-agenda research, users generally consider information about conduit debt obligations to be important.

Interpretation 2 requires that conduit debt obligations be disclosed in the notes to the financial statements of the government issuer, including: (1) a general description of the conduit debt transactions, (2) the aggregate amount of all conduit debt obligations outstanding at the balance sheet date, and (3) a clear indication that the issuer has no obligation for the debt beyond the resources provided by related leases or loans. For those conduit issuers that currently report their conduit debt obligations as liabilities on their balance sheets along with related assets, Interpretation 2 does not alter that reporting or the reporting of future conduit debt obligations that are substantially the same as those already reported.

Accounting and Financial Reporting Issues: Major issues that will be addressed by this project, presented in order of their relative significance, are as follows:
  1. What is the definition of a conduit debt obligation? In the event of a third-party borrower’s default, some government-issuers make commitments to cover debt service as a moral obligation or to make appropriations. How do those commitments affect the definition of a conduit debt obligation?
  2. Given the definition of a liability in Concepts Statement 4, when should a conduit debt obligation be reported as a liability by a government-issuer, if ever?
  3. Given the criteria for notes to financial statements in Concepts Statement 3 and the needs of users, what information should government-issuers disclose?
  4. Are commitments by third-party borrowers to cover debt service or lease payments assets of government-issuers?
  5. Some conduit debt obligations are structured as leases. How do such financings affect the definition of a conduit debt obligation and its reporting?
  6. Conduit debt obligations may be refunded. Should that occur, what effect should it have on reporting conduit debt obligations, if any?
Project History:
  • Pre-agenda research approved: December 2016
  • Research results reported to the Board: July 2017
  • Proposed for addition to current technical agenda: August 2017
  • Initial deliberations began: September 2017
Current Developments:
At its January 2018 meeting, the Board considered housing-related financings in relation to conduit debt obligations. At its March 2018 meeting, the Board considered accounting for different scenarios within the general premise of an additional arrangement associated with conduit debt obligations. The Board also considered potential disclosure requirements for conduit debt obligations.
 
Work Plan:
 

Board Meetings

Topics to Be Considered

July 2018 T/C: Review ballot draft and consider an Exposure Draft for approval.
August–October 2018: Comment period.
November 2018–January 2019: Redeliberations.
March 2019: Review preballot draft of a final Statement.
April 2019: Review ballot draft and consider a final Statement for approval.
 

Conduit Debt—Reexamination of Interpretation 2—Recent Minutes


Minutes of Meeting, July 10—12, 2018

The Board reviewed a preballot draft of an Exposure Draft, Conduit Debt Obligations, and discussed clarifying edits. The Board then agreed to move forward with a ballot draft of an Exposure Draft of a proposed Statement at the July 2018 teleconference.

Minutes of Meeting, May 29–31, 2018
 
The Board continued discussion of conduit debt obligations for the purpose of developing an Exposure Draft of a proposed Statement. The Board tentatively decided to include that the third-party obligor or its agent of a conduit debt obligation should be the ultimate recipient of proceeds from the debt issuance and the primary beneficiary of the debt obligation as part of the proposed characteristics that define conduit debt obligations. The Board also tentatively decided to include that the third-party obligor has the primary obligation for debt service payments as part of the proposed characteristics that define conduit debt obligations.
 
The Board also reviewed a draft of the Standards section of a proposed Exposure Draft and discussed clarifying edits. The Board agreed that the project staff should present a preballot draft of an Exposure Draft for discussion at the July 2018 meeting.

Minutes of Meetings, April 17 and 18, 2018

The Board continued discussion of conduit debt obligations for the purpose of developing an Exposure Draft of a proposed Statement. The Board discussed whether the intended benefits of information to users and other stakeholders from the tentative decisions justify the anticipated costs to preparers and other stakeholders. The Board tentatively decided that the expected benefits associated with the proposed reporting requirements are anticipated to justify the perceived implementation and ongoing costs. The Board tentatively decided that the proposed transition provisions should include retroactive application of the standards.
 
The Board tentatively decided that the proposed effective date should be for periods beginning after December 15, 2020, and that early implementation should be encouraged. The Board also tentatively decided that the comment period for the Exposure Draft of the proposed Statement should be 90 days.
 
Finally, the Board discussed the characteristics of the financial information that would be provided as a result of the tentative decisions in this project. The Board tentatively agreed that the proposed accounting and financial reporting requirements would meet the all of the characteristics in Group 1 financial information and, therefore, are within the scope of the GASB’s authority.

Minutes of Meetings, March 6−8, 2018

The Board continued discussion of conduit debt obligations for the purpose of developing an Exposure Draft of a proposed Statement. The Board considered three scenarios within the general premise of an additional arrangement associated with conduit debt obligations in which (a) a capital asset is financed with a conduit debt obligation, (b) the government-issuer holds the title to the capital asset from the beginning of the additional arrangement, (c) a nongovernmental third-party obligor is the counterparty in that arrangement, (d) the payments associated with the additional arrangement are structured to cover the conduit debt obligation principal and interest payments and are made by the third-party obligor to the debt holder or the independent trustee, and (e) the term of the additional arrangement is structured to coincide with the debt repayment period.
 
In Scenario 1, the third-party obligor gets the exclusive use of the capital asset for the term of the additional arrangement. At the end of the additional arrangement, at which time the conduit debt obligation is paid off, the third-party obligor receives title to the capital asset. Regarding this scenario, the Board tentatively decided that (a) the government-issuer should not report a liability for the conduit debt obligation, (b) the government-issuer should not report the capital asset as its own capital asset, (c) the government-issuer should not report a receivable for the payments related to the additional arrangement, and (d) the additional arrangements are not leases for financial reporting purposes and, therefore, the government-issuer should not apply the requirements in Statement No. 87, Leases.
 
In Scenario 2, the third-party obligor gets the exclusive use of the capital asset for the term of the additional arrangement. At the end of the term of the additional arrangement, the conduit debt obligation is paid off, the third-party obligor does not receive title to the capital asset, and the government-issuer assumes control of the capital asset. Regarding this scenario, the Board tentatively decided that (a) the government-issuer should not report a liability for the conduit debt obligation, (b) the government-issuer should not report the capital asset as its own capital asset until the conduit debt obligation is paid off and the additional agreement ends, (c) the government-issuer should not report a receivable for the payments related to the additional arrangement, and (d) the additional arrangements are not leases for financial reporting purposes and, therefore, the government-issuer should not apply the requirements of Statement 87.
 
In Scenario 3, the third-party obligor does not get the exclusive use of the entire capital asset but gets the exclusive use of some portions of the capital asset, for example, certain parts of a building, for the term of the additional arrangement. At the end of the additional arrangement, at which time the conduit debt obligation is paid off, the government-issuer assumes control of the entire capital asset. Regarding this scenario, the Board tentatively decided that (a) the government-issuer should not report a liability for the conduit debt obligation, (b) the government-issuer should report the capital asset as its own capital asset, (c) the government-issuer should not bifurcate the capital asset based on the third-party obligor’s exclusive use and nonexclusive use,
(d) the government-issuer should not report a receivable for the payments related to the additional arrangement, and (e) the additional arrangements are not leases for financial reporting purposes and, therefore, the government-issuer should not apply the requirements in Statement 87.
 
For Scenario 3, the Board also tentatively decided that the issue of the credit side of the journal entry for the capital asset transaction reported by the government-issuer should be addressed in this project rather than being deferred to future projects. The Board also tentatively agreed that the credit side of the journal entry when the government-issuer recognizes the capital asset in Scenario 3 should be reported as a deferred inflow of resources and that the deferral should be reduced over the term of the additional arrangement as revenue is recognized.
 
Next, the Board considered potential disclosure requirements for conduit debt obligations. The Board tentatively decided that the existing disclosure requirements in Interpretation No. 2, Disclosure of Conduit Debt Obligations, including conforming edits, should be included in the proposed Statement. If a government-issuer recognizes a liability for a commitment it has made in relation to the conduit debt obligation, or when a government-issuer has made debt service payments for the conduit debt obligation during the reporting period, the Board also tentatively decided that the disclosures found in paragraph 15 of Statement No. 70, Accounting and Financial Reporting for Nonexchange Financial Guarantees, which will be conformed to the terms used in this project, should be proposed for conduit debt obligations. Finally, the Board tentatively decided that neither the information about the identity of third-party obligors nor the projects being financed with conduit debt obligations should be proposed for conduit debt obligations.

Minutes of Meetings, January 23−24, 2018
 
The Board continued discussion of conduit debt obligations for the purpose of developing an Exposure Draft of a proposed Statement. The Board tentatively decided that it is not necessary to separate housing-related conduit debt obligations from conduit debt obligations in general, or to develop separate distinguishing characteristics for housing-related conduit debt obligations. The Board also tentatively agreed to refine the general definition of conduit debt obligations.

Minutes of Meetings, December 12−14, 2017
 
The Board continued discussion of conduit debt obligations for the purpose of developing an Exposure Draft of a proposed Statement. The Board tentatively decided to propose that a conduit debt obligation not be recognized as a liability because it does not meet the definition of a liability. The Board then tentatively agreed that the alternatives for recognition of loss contingencies in a conduit debt obligation should be those found either in the contingencies literature in Statement No. 62, Codification of Accounting and Financial Reporting Guidance Contained in Pre-November 30, 1989 FASB and AICPA Pronouncements, or in the nonexchange financial guarantee literature in Statement No. 70, Accounting and Financial Reporting for Nonexchange Financial Guarantees. For all categories of a conduit debt obligation, the Board tentatively decided to propose that the recognition criteria for loss contingencies in conduit debt obligations be when a payment is more likely than not, as in Statement 70. Following that, for financial statements prepared using the economic resources measurement focus, the Board tentatively decided to propose that liabilities resulting from issuers’ commitments be measured consistent with the literature that is used for recognition—Statement 70.
 
Next, the Board considered liability recognition for financial statements prepared using the current financial resources measurement focus. The Board tentatively agreed that the guidance found in Statement 70 for such financial statements should be included in a proposed Statement, with conforming edits. Finally, the Board tentatively decided that the proposed Statement should provide qualitative factors and refer to historical data, similar to those in Statement 70, when evaluating whether a liability should be recognized for issuers’ commitments in a conduit debt obligation.
 
Minutes of Meetings, October 31–November 2, 2017

The Board continued discussion of the definition of a conduit debt obligation for the purpose of developing a proposed Statement. The Board tentatively decided to propose that a third-party borrower and an issuer not be within the same financial reporting entity and that exclusion be included as another key characteristic of a conduit debt obligation. The Board then tentatively decided that the purpose of a conduit debt obligation should not be limited to capital financing. The Board also tentatively decided that the terms revenue bonds, limited obligation, and limited-obligation revenue bonds should not be included in the definition of a conduit debt obligation. The Board then tentatively decided that whether a government-issuer is the recipient of debt proceeds or the provider of debt service payments should not be a defining characteristic of a conduit debt obligation. The Board also discussed a proposed definition but agreed to continue its discussion of the definition at a future meeting.

Minutes of Meetings, September 27 and 28, 2017

In its initial deliberations of the project, the Board discussed the definition of a conduit debt obligation. The Board tentatively decided to propose that the key characteristic of a conduit debt obligation be that there are three participants: the government-issuer, the third-party borrower, and the bondholder. The Board then tentatively decided to propose that the definition of a conduit debt obligation be expanded to include all issuers’ commitments.
 

Conduit Debt—Reexamination of Interpretation 2—Tentative Board Decisions to Date


In developing an Exposure Draft, the Board tentatively decided to propose that:
  • The key characteristic of a conduit debt obligation be that there are at least three participants: the government-issuer, the third-party borrower, and the bondholder.
  • A conduit debt obligation have the following characteristics:
    • There are at least three parties involved: an issuer, a third-party obligor, and a debt holder or a debt trustee.
    • The issuer and the third-party obligor are not within the same financial reporting entity.
    • The debt obligation is not a parity bond of the issuer, nor is it cross-collateralized with other debt of the issuer.
    • The third-party obligor or its agent, not the issuer, ultimately receives the proceeds from the debt issuance.
    • The third-party obligor, not the issuer, is primarily obligated for the payment of all amounts associated with the debt obligation. The issuer’s commitment related to the debt service payments is limited. Generally, an issuer makes a commitment limited to resources provided by the third-party obligor. However, an issuer can make an additional commitment of its own resources beyond those provided by the third-party obligor.
  • The purpose of conduit debt obligations not be limited to capital financing.
  • The terms revenue bonds, limited obligation, and limited-obligation revenue bonds not be included in the definition of a conduit debt obligation.
  • Issuers not recognize conduit debt obligations as liabilities.
  • The recognition criteria for loss contingencies in conduit debt obligations be when a payment is more likely than not, as in Statement No. 70, Accounting and Financial Reporting for Nonexchange Financial Guarantees.
  • For financial statements prepared using the economic resources measurement focus, liabilities resulting from issuers’ commitments be measured consistent with the literature that is used for recognition—Statement 70.
  • Liability recognition for financial statements prepared using the current financial resources measurement focus be consistent with the guidance found in Statement 70, with conforming edits.
  • When evaluating whether a liability should be recognized for issuers’ commitments in a conduit debt obligation, provisions include references to qualitative factors and to historical data similar to provisions established in Statement 70.
  • For the three scenarios within the general premise of an additional arrangement associated with conduit debt obligations in which (a) the capital asset is financed with a conduit debt obligation, (b) the government-issuer holds the title to the capital asset from the beginning of the additional arrangement, (c) a nongovernmental third-party obligor is the counterparty in that arrangement, (d) the payments associated with the additional arrangement are structured to cover the conduit debt obligation principal and interest payments and are made by the third-party obligor to the debt holder or the independent trustee, and (e) the term of the additional arrangement is structured to coincide with the debt repayment period, the following accounting treatments apply based on the different circumstances in each scenario:
    • In Scenario 1, the third-party obligor gets the exclusive use of the capital asset for the term of the additional arrangement. At the end of the additional arrangement, at which time the conduit debt obligation is paid off, the third-party obligor receives title to the capital asset. Regarding Scenario 1:
      • The government-issuer should not report a liability for the conduit debt obligation.
      • The government-issuer should not report the capital asset as its own capital asset.
      • The government-issuer should not report a receivable for the payments related to the additional arrangement.
      • The additional arrangements are not leases for financial reporting purposes and, therefore, the government-issuer should not apply the accounting requirements in Statement 87, Leases.
    • In Scenario 2, the third-party obligor gets the exclusive use of the capital asset for the term of the additional arrangement. At the end of the term of the additional arrangement, at which time the conduit debt obligation is paid off, the third-party obligor does not receive the title to the capital asset, and the government-issuer assumes control of the capital asset. Regarding Scenario 2:
      • The government-issuer should not report a liability for the conduit debt obligation.
      • The government-issuer should not report the capital asset as its own capital asset until the conduit debt obligation is paid off and the additional arrangement ends.
      • The government-issuer should not report a receivable for the payments related to the additional arrangement.
      • The additional arrangements are not leases for financial reporting purposes and, therefore, the government-issuer should not apply the accounting requirements in Statement 87.
    • In Scenario 3, the third-party obligor does not get the exclusive use of the entire capital asset but gets the exclusive use of some portions of the capital asset for the term of the additional arrangement. At the end of the additional arrangement, at which time the conduit debt obligation is paid off, the government-issuer assumes control of the entire capital asset. Regarding Scenario 3:
      • The government-issuer should not report a liability for the conduit debt obligation.
      • The government-issuer should report the capital asset as its own capital asset.
      • The government-issuer should not bifurcate the capital asset based on exclusive use and nonexclusive use.
      • The government-issuer should not report a receivable for the payments related to the additional arrangement.
      • The additional arrangements are not leases for financial reporting purposes and, therefore, the government-issuer should not apply the accounting requirements in Statement 87.
      • The issue of the credit side of the journal entry for the capital asset transaction reported by the government-issuer should be addressed in this project, rather than being deferred to future projects.
      • The credit side of the journal entry when the government-issuer recognizes the capital asset should be a deferred inflow of resources, and the deferral should be reduced over the term of the additional arrangement as revenue is recognized.
  • The existing disclosure requirements in Interpretation No. 2, Disclosure of Conduit Debt Obligations, including conforming edits, be included.
  • The disclosures found in paragraph 15 of Statement  70, with conforming changes to be consistent with the terms used in this project, be required disclosures for conduit debt obligations for which government-issuers have recognized conduit debt obligation liabilities or have made payments during the reporting period.
  • The following disclosures not be proposed:
    • Third-party obligors’ identities.
    • Information about the projects being financed with conduit debt.
  • The intended benefits of the proposed CDO guidance justify the anticipated costs of implementation and ongoing compliance. The transition provisions include retroactive application of the standards.
  • The effective date be for reporting periods beginning after December 15, 2020.
  • Early implementation be encouraged.