The debate over appropriate risk weighting for ABCP liquidity lines may prove next to meaningless, should the cost to qualify for the better treatment outweigh the capital savings.

At the forefront, the U.S. bank regulators are requiring that liquidity facilities seeking favorable capital treatment be subject to a standardized non-defaulted asset test. While non-defaulted asset tests are common in ABCP liquidity facilities, the standard for determining the definition of a defaulted asset is crafted by banks to the specifics of the particular asset being financed. The Fed is mulling over the unified definition of a defaulted asset in a conduit - specifically, how long past due before the asset is written down and no longer fundable by "eligible" liquidity. It has tentatively proposed a single definition that any conduit-owned asset more than 60 days past due is considered defaulted, which differentiates liquidity support from credit enhancement.

At last week's ASF-hosted conference, Debbie Toennies of Banc One Capital Markets argued that a one-size-fits-all approach is not appropriate for conduits, which fund multiple asset and security types. To make her point, Toennies offered up the differing delinquency/default criteria used in various market segments. For example, banks may be required to write down a credit card receivable after it's 180 days past due. Student loans can go 270 days past due before they are written down. For guaranteed student loans, the government covers 98% of the loss when this threshold is reached, so, from an economic perspective, the asset is still not truly defaulted. Trade receivables, a common ABCP asset class, often uses 90-120 days past due as a defaulted asset definition.

A further stipulation of the regulators for eligible liquidity would require that liquidity would not be available to fund an asset if it is rated less than investment grade (below BBB-' or Baa3'). Industry sources also think this is an unrealistic standard. Many conduit assets are revolving facilities that have been internally rated by the liquidity banks. They cannot realistically be rated by the rating agencies or be re-rated by the bank at the time of a liquidity draw requirement, which would be on a few hours notice. For securities arbitrage conduits, eligible liquidity facilities may be overly limited by rating thresholds. For example, liquidity lines may not be able to fund, out of the conduit, assets downgraded below investment grade. The write-down - or the market value loss - would draw on credit enhancement instead. Most arbitrage conduits have liquidity facilities that are available for funding until an asset declines to a CCC'/'Caa' rating. Using less than the triple-B standard would materially increase credit enhancement requirements of arbitrage conduits and probably render them uneconomic.

Currently, the federal regulators are asking for a 20% risk conversion factor on eligible liquidity. This figure was proposed (or embedded) in the landmark relief package the regulators delivered to the ABCP industry last fall, when they granted a draft of proposed permanent rules that exclude ABCP conduit assets and liabilities from capital adequacy calculations if these were specifically consolidated as a result of implementing Financial Interpretation No. 46. This exclusion is expected to be written in final form within the next few months.

The ABCP market is lobbying for a 7% risk conversion factor, instead of the proposed 20%.

Copyright 2004 Thomson Media Inc. All Rights Reserved.

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