Though not entirely unexpected - given the slant that the Financial Accounting Standards Board has already indicated this year - FASB dropped a bomb on the industry last Tuesday when it released its proposed amendment to FAS 140. This amendment, which would significantly tighten the guidelines governing QSPEs, would present very real challenges to securitization as it currently functions, said some industry professionals.
Essentially, should the final amendment closely resemble the Exposure Draft, it will be more difficult to satisfy the criteria for Qualifying SPEs, the result being that issuers (or transferors of assets) in even the most vanilla ABS may lose off-balance sheet treatment.
During a conference call last week hosted by Standard & Poor's - and meant primarily to be an update on FASB's FIN 46 - industry accountant Marty Rosenblatt of Deloitte & Touche, who had been privy to a "draft of the draft," shifted the focus of the discussion to the proposed amendment, stating that, "My initial reaction is that this will be a disaster for participants seeking off-balance sheet treatment" (see p. 5 for his synopsis). Rosenblatt admitted, however, that he was taking the draconian view of the draft.
In a nutshell, everything from Agency RMBS to any sort of master trust - as they are currently structured - could fail to meet the QSPE criteria (one of the criteria being that QSPEs cannot reissue beneficial interests under most conditions).
Up until FASB released its final drafting of FIN 46, most took these exposures drafts with a grain of salt, as the final implementations generally met the industry halfway, following a grueling commentary period. The release of FIN 46, however, made few concessions, other than allowing FAS 140 defined QSPEs to be, for the most part, exempt from the FIN 46 consolidation guidelines.
This is why most of the FIN 46 hoopla centered around ABCP conduits and CDOs, both of which were not traditionally structured through Qs. With this proposed amendment, the Q exemption in FIN 46 could be less meaningful after all, as many securitization vehicles, as currently structured, would fail to meet the criteria.
In the original FAS 140, which replaced FAS 125, a QSPE's primary meaning was that it would not be consolidated by the transferor of assets into the trust, though it was less clear about other parties to a transaction, such as investors or servicers.
The Exposure Draft is out for commentary until July 31, at which point a series of roundtables will begin. Implementation is scheduled for sometime next year.
Expected loss tranches
While the FAS 140 amendment did temporarily dominate the discussion, the S&P conference call was mostly an industry update on FIN 46 and the pending regulatory relief. The deadline for implementation of FIN 46 is July 1.
The rush to restructure, however, had lost significant steam, thanks to the U.S. bank regulators. On the S&P call, David Kerns of the Board of Governors of the Federal Reserve said that for an interim period the regulators would not require capital to be held against assets that were consolidated as a direct consequence of FIN 46.
Kerns emphasized that he was expressing his opinion on the developments, and not officially speaking on behalf of the banking regulators that make up the Federal Financial Institutions Examination Council.
The regulators are hoping to publish their relief plan by the end of the month, though it may slip shortly into July, Kerns said. The 0% risk weighting on newly consolidated assets will extend into the first quarter 2004, at which point the "capital transition period" will end. From there on, it looks like the regulators will require 20% risk weight on assets held in an ABCP conduit. If the asset in the conduit would already enjoy capital relief, it would be weighted twice: hence, a triple-A security that requires 20% risk weight (160 basis points) would be weighted again at 20% (32 basis points).
"This proposal will be accounting neutral - whether or not the assets are consolidated," Kearns said.
Even with regulatory relief, institutions are concerned with their leverage ratios, something that equity analysts use for the valuation of companies. The rating agencies, however, have indicated (and S&P re-indicated on its call) that they do not view the accounting change alone as a change in fundamental credit-worthiness.
"The issues are really more cosmetic," said Tanya Azarchs of S&P.
Banks are predominately employing the expected loss tranche approach to avoid consolidation, which would allow a third-party investor to be deemed the consolidator, said Carol Hitselberger of Mayer Brown Rowe & Maw, who spoke on the conference call.
However, only a small handful of these restructurings will actually make the deadline, a source following the developments said. On the call though, Hitselberger indicated that the expected loss tranche restructuring probably will not take a great deal of legwork from the rating agencies as, per FIN 46, the expected loss tranche cannot impact the CP from a credit perspective.
Other approaches include the "joint venture solution," where no one enterprise is the majority expected loss or residual return holder. Also, as seen in Bank of America's Yorktown conduit, other banks are taking the silo approach. Here, the individual sellers are already booking their sales as secured financings on their balance sheets. The facilities are able to be re-documented in a way that the conduit would not be the consolidator under FIN 46. Yorktown is currently $1 billion in size but is expected to reach $6 billion by the end of June.
For the rest of Bank of America's ABCP portfolio - which is about $22 billion in size - the firm will use the expected loss tranche approach, said Whit McDowell, who heads ABCP at BofA. McDowell believes that BofA will still end up consolidating 10% to 20% of its conduit assets even after restructuring.