As if the new consolidation guidelines weren't dampening enough to CDOs, the Financial Accounting Standards Board will release Statement No. 149 this month, which is expected to eliminate the favorable treatment banks receive for their trust preferred securities, among other things.
This could take a significant bite out of the future supply pool for trust preferred deals, as banks might choose other means of raising capital. Several investment banks have developed platforms for these CDOs, anticipating supply.
According to Hee Lee, partner at Ernst & Young, FAS 149 is a split-off of the larger equity liability project undertaken by FASB, which has since been broken into three parts, FAS 149 being the first.
"I don't believe it will have a huge impact for banks because they're already on the balance sheet," Lee said. "People do it to get the favorable tax treatment of the instrument - hopefully the rating agencies are looking at it based on substantive, not presentation."
"We've generally reviewed trust preferreds as having little equity content," confirmed David Fanger at Moody's Investors Service.
According to current GAAP, trust preferred securities are accounted for as mezzanine equity, eligible as tier-one capital. As trust preferreds are considered "mandatorily redeemable," they will be reclassified as liability contracts following implementation of FAS 149. Trust preferreds received favorable regulatory treatment because banks could defer interest for 20 to 30 quarters.
Broader reaching than securitization, perhaps, Lee noted that existing debt-to-equity covenants for some corporates could be triggered (FAS 149 will classify certain repurchase agreements and put options). However, he adds, "If you look at the substance of it, nothing has changed here. Are they truly looking at this in an economic perspective, rather than an accounting representation?"