The American Securitization Forum (ASF) last weeksubmitted a letter to federal banking regulators.
The letter requested a six-month moratorium on any regulatory capital rule changes related to the implementation of accounting standards FAS No. 166, Accounting for Transfers of Financial Assets, an Amendment of FASB Statement No. 140, and FAS No. 167,Amendments to FASB Interpretation No. 46, and the proposed elimination of the option for ABCP conduit sponsors to disregard consolidation of conduits for risk-based capital purposes.
The ASF stated that by the time final rules are promulgated, banks will probably have no choice but to start capital raising and reallocating resources. These moves would be based on the conservative approach that the proposed rules take, regardless of any changes that the final rules might include.
This, according to the ASF, could have negative consequences on both the banking system and on general credit availability.If regulators are unwilling to grant the moratorium, the ASF requested that they announce a phase-in period of at least four quarters.
The root of the problem is that the new proposed regulatory capital rules will be tied to the new accounting rules, which make it very difficult to take ABS transactions off banks' balance sheets. As a result, sources said, these financial institutions will have to keep the same amount of capital against their securitizations as though they engaged in only secured financings.
Jason Kravitt, senior partner at Mayer Brown, said at a recent ASF Sunset Seminar that with these new regulatory capital rules, when the economy begins to grow again and consumers start to behave less conservatively, banks would be less able to recycle their capital, so the important benefits from securitization of incremental credit creation and transfer of risk would be materially reduced.
The combined negative effects of the regulatory capital rules and the implementation of the Financial Accounting Standard Board's (FASB) FAS 166 and FAS 167 call into question the future viability of securitization.
Aims of New Accounting Rules
The FASB had several goals in mind in implementing the accounting changes.One was to improve the relevance and transparency of the data reported by institutions in their financial reports. In this light, Statement 166 modifies a number of key principles of the derecognition requirements, as market participants have expressed concern that some financial assets that have been derecognized should still be reported in the financial statements of transferors.
"The FASB eliminated the concept of a QSPE. QSPEs were previously exempt from consolidation under FIN 46(R)," said David Thrope, a partner at Ernst & Young. In addition, Thrope said that the FASB decided that a transfer of a portion of a financial asset cannot be accounted for as a Statement 166 sale unless it is the transfer of a participating interest (as defined in Statement 166) in an entire individual financial asset.
One application of this would be in ABCP, where "sellers of receivables to conduits that are structured as senior, undivided interest will likely have difficulty getting sales treatment," Thrope said.
Thrope added that what is significant about the changes is not with achieving sales treatment under Statement 166 (other than for undivided interests as described above), but what is likely to be significant is that many transferors will likely have to consolidate non-ABCP conduit securitization vehicles under FAS 167.
The changes related to FAS 167 deal with the elimination of the qualifying special purpose entity (QSPE) concept from Statement 140. They also respond to concerns regarding an enterprise's involvement with variable interest entities (VIEs).
One of the major changes under FAS 167 has to do with the determination of who the primary beneficiary of a voting interest entity (VIE) is. FASB decided that determinations of an entity's VIE status and a VIE's primary beneficiary should not consider kick-out rights unless they are held by a single enterprise who has the unilateral ability to exercise the rights, Thrope said.
Despite the good intentions, FASB's new rulings might place the concept of true sale in jeopardy for some bank-originated assets, according to Standard & Poor's.
After FASB's adaptation of FAS 166 - which will hinder banks from continuing to treat transfers of financial assets to their securitization vehicles as sales for accounting purposes - the conditions for the application of the Federal Deposit Insurance Corp.'s (FDIC) 2000 Securitization Rule would no longer be met. This became a concern for S&P.
"Inapplicability of the Securitization Rule could raise, in our view, new risks for some bank-originated securitizations that, if not addressed, could have a rating impact on these transactions," analysts said in a report released in August called Is True Sale In Jeopardy In Certain U.S. Bank-Originated Securitizations?
The Securitization Rule, which was adopted to make sales of financial assets for securitization purposes, provides that eligible transfer of financial assets by a bank to a securitization transaction will be treated as sales by the FDIC acting as receiver or conservator if an institution becomes insolvent. One of the conditions that need to be met to apply the Securitization Rule is that the asset transfer be treated as a sale for accounting purposes.
"We have been speaking to issuersto find out what their plans are to address the risk outlined in the article" said Felix Herrera, analytical manager at S&P, who was one of the authors of S&P's August report. "We have rated a handful of transactions for issuers wherewe believe this risk was addressed."
Sabine Zerarka, associate general counsel at S&P,explained that thediscussions are taking place with banks, since they could lose the benefit of the securitization rule safe harbor,and particularly thosethat securitize revolving assets.According to Zerarka, someissuers haveaddressed the issue by obtaining true sale opinions.
In the August report, the rating agency said that it will be reviewing the structures that bank originators present to the rating agency that attempt to address the risks that were discussed in the article. This would be done at closing for new transactions and prior to the effective date of the accounting changes for existing deals that securitize revolving assets.
Consequences for ABCP
With the new accounting rules, the agencies are proposing to eliminate existing provisions in the risk-based capital rules allowing banks required to consolidate an ABCP conduit that it sponsors under GAAP to exclude the consolidated ABCP program assets from risk-weighted assets.
This exclusion allows the financial institutions to assess the risk-based capital requirement against any contractual exposures of the organization resulting from the ABCP program.
Sources said that the removal of this exclusion, which has been in place since 2004 under FIN 46(R), will force institutions to hold 100% risk weighting against all consolidated assets associated with these ABCP facilities, changing the economics of administering these vehicles. It will also put U.S. conduits at a disadvantage beside their European counterparts, which are required to hold much less capital against their ABCP programs.
"I think that there is confusion about what ABCP is," Deborah Toennies, managing director at JPMorgan, said.
Toennies said that the only type of program that the market has been left with are multi-seller conduits, which have 100% contractual or explicit support typically from the sponsoring bank or the administrator of the conduit. Any support offered to these programs by their sponsoring banks already had capital held against it.
This type of support has been in place since 2004 when, under FIN 46, banks were required to hold capital against the credit enhancement and liquidity facility arrangement the banking organizations provide to thesefacilities.
By contrast, structured investment vehicles, extendible ABCP (both structures have been gone from the market for at least three years) and credit card master trusts don't have the explicit support that multi-seller ABCP programs have.
Furthermore,multi-seller ABCP programs, according to a presentation given by Toennies at the same ASF Sunset Seminar, allow for the active management of transactions in downside scenarios. Additionally, tighter triggers and the real threat of a liquidity drawhave resultedin sellers' willingness to fix the transactions to avoid higher pricing.The 364-day tenor of liquidity allowsthe reassessment ofthese transactions annually,giving the opportunity to fix problems. The significant diversification of underlying assets funded within multi-seller structures hasalso resulted in overall risk reduction.
By removing the exclusion for ABCP programs in the new accounting rules, U.S. institutions will not be on a level playing field with their European counterparts. European banks under Basel II require only between 7% (for triple-A)and 20% (for single-A) risk weighting. U.S. institutions are required to have 10% risk weighting for eligible liquidity facilities, which is still within the European banks' ballpark. The new rules will not differentiate between the consolidated assets in an ABCP program, and the 100% risk weighting would have to be applied to all consolidated ABCP assets regardless of rating.
Toennies explained that even when U.S. banks start to adopt Basel II, they would still be subject to athree-year parallel period before U.S. and European banks or programs would be on a level regulatory playing field.
Omar Bolli, head of securitization at Norddeutsche Landesbank Girozentrale (NORD/LB), said that judging from regulators' comments, they are not out to kill the commercial paper market. "It seems like the U.S. regulators drafted the proposed regulatory changes for conduit asset consolidation based on new rules formulated by FASB for financial statement purposes without considering the potential impact on capital requirements," he said. "Frankly, it's something we might have to live with."
For European institutions like NORD/LB, they are allowed to use the internal assessment approach (IAA) under Basel II. This is an option currently not open to U.S.-based banks, unless there is an early adoption of Basel II.
The internal assessment approach, according to Bolli, involves using their internal rating models based on those of the rating agencies to determine the risk weight that should be applied to transactions.
"My worst fear is that if the new U.S. regulations remove the option of using the IAA in the future implementation of Basel II, European regulators will copy the U.S. in not using the internal assessment approach," Bolli said. "But I'm not that negative. I am confident that the U.S. regulators will see the need to allow the IAA."
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