The future of securities arbitrage conduits darkened last week as tentative decisions from the Financial Accounting Standards Board seemed to rain on the QSPE parade for this $200 billion-plus segment of the ABCP market.
The board has apparently decided that liquidity lines, such as those structured into arbitrage vehicles by their sponsoring institutions, are not in line with the intended characteristics of a FAS 140 qualifying SPE.
If FASB's amendment were to eliminate a QSPE strategy for securities arbitrage structures, it will not have been entirely unexpected. The market has been counting the days ever since the board assumed the QSPE "permitted activities" project (formerly 02-12) from the Emerging Issues Task Force earlier this year.
In fact, uncertainty on where the board would come out - on this and other related issues in its technical agenda - has left the market in a state of limbo, despite a fast-looming FIN 46 deadline to restructure or consolidate. FIN 46 is in full adoption mode come June 30. Recall from last week's issue the FASB has posted six staff positions on FIN 46, with a commentary deadline on May 26 (see ASR 4/28). FASB intends to issue an exposure draft for its amendment to FAS 140 either late May or early June, with comments due July 31.
FASB has indicated that a variable interest entity cannot be a QSPE if it is not self-liquidating. Since arbitrage conduits are financing longer-term assets by continually rolling over CP, financial strength is dependent on bank liquidity lines to repay maturing CP in the event that the conduit cannot access the market. Bank liquidity lines such as these are instant disqualifiers.
The top item on FASB's list of 140 amendments states that, "A [QSPE] may not hold a commitment from the transferor, its affiliates, and agents to provide additional cash or assets to make the contracted payments to beneficial interest holders (for example, liquidity commitments and financial guarantees of the beneficial interests). That requirement is not intended to prohibit servicing advances that do not require the servicer to make the advance if it believes it will not recover its advance."
One of the board's views, apparently, is that QPSEs should not be permitted to hold assets longer dated than the beneficial interests that they issue.
Back to the books
Arbitrage conduits are a major source of funding for some of the less liquid ABS asset classes, which generally fit the spread income profile the conduits are looking for. These include CDOs, typically the A class notes. In fact, 90% to 95% of the arb conduit asset universe is triple-A, according to Sam Pilcer, head of ABCP at Moody's Investors Service.
Arbitrage conduits fund off rates close to Libor, so purchasing a triple-A CDO, which may be yielding Libor plus 50, can generate spread income. Having to consolidate the portfolio of assets, however, could dampen the economic advantage by tying up capital.
That said, since the conduit's assets are weighted so heavily in the triple-A range, the capital charge might not be considered terrible.
Still, most bank sponsors - at least those subject to GAAP accounting - had hoped to restructure their arbitrage conduits into QSPEs by tweaking the documentation to limit the apparent discretion of the administrators. Many of these were already structured to fit current guidelines for QSPEs, sources said.
"A number of sponsors have indicated that they would terminate their programs if they were to be consolidated," Moody's Pilcer added. "Some others, however, still like these vehicles and will keep them running even if they are consolidated."
It is possible, Pilcer said, that the banks may choose another restructuring route more in line with other conduit types, such as multi-sellers, which were never really candidates for QPSE status. One of the more talked-up strategies, for example, is the issuance of an equity tranche equal in size to what FASB considers the expected loss.
If a bank were to consolidate a conduit per the June 30 deadline, it could restructure at a later date, bringing the assets back off balance sheet, although this could create disclosure complexities, an industry accountant said.