Despite final rules published last month, banks running ABCP conduits are continuing discussions with regulators in an effort to temper new capital rules they say could shift assets to non-U.S. banks and potentially reduce what has been a successful short-term funding source for U.S. companies.
"The requirements significantly increase the cost of being in this business, and they could shrink credit capacity," said Debbie Toennies,JPMorgan's head of conduit management and business development.
The plight of U.S. banks running ABCP programs was triggered by new accounting standards - effective Jan. 1 for companies reporting earnings on a calendar-year basis - that prompt them to bring most securitized assets on balance sheet, subjecting them to capital requirements.
After FAS 167, Amendments to Financial Accounting Standards Board (FASB) Interpretation No. 46, was approved by the FASB, banks anticipated regulators tweaking regulatory capital rules to align them more with their assets' risks rather than the accounting.
"The federal bank regulators did the unexpected by tying risk-based capital to accounting, and actually adopted a more conservative rule than the one proposed," says Jason Kravitt, a partner at Mayer Brown and the founder of its securitization practice.
A more conservative market that requires banks to keep more capital at risk is a boon to some investors. ABCP conduits are currently buying mostly the assets they purchased when they were originated nearly 30 years ago - company trade receivables, consumer loans, and the like - as a way to provide short-term financing to corporate customers.
"My ABCP analyst is in love with this market," said Deborah Cunningham, chief investment officer for taxable money markets at Federated Investors. "The credit quality of the underlying assets is much higher and easier to monitor on a monthly basis."
Some of that "return to the basics" stemmed from banks' anticipation of having to consolidate assets on their balance sheets, although much of it resulted from the credit-crisis deleveraging the overall market has undergone over the last few years.
The regulators proposed last September to eliminate an exclusion allowing banks running ABCP programs to exclude assets in those programs from their risk-weighted consolidated assets, and instead assess risk-based capital requirements only on their contractual exposures to the program.
Toennies said the industry shared data with regulators illustrating the ABCP market's strong performance since its inception 27 years ago. And it agreed to limit the definition of "customer conduits" - to those buying well-understood assets such as trade receivables, and credit card and auto loans - that would qualify for the exclusion.
"Therefore, the industry was quite surprised when the exclusion was not reinstated," Toennies said.
The new regulatory capital rules first emerged Dec. 15 when they were discussed at a Federal Deposit Insurance Corp. board meeting, and they were published in the Federal Register Jan. 28. Despite issuance of final rules, banks continue to discuss with regulators the possibility of a "special carve-out" for multi-seller conduits or a lower risk weighting for those assets, according to Tom Deutsch, deputy executive director of the American Securitization Forum (ASF).
Deutsch noted that ABCP is very much a customer-focused product, a "bread-and-butter form" of securitization, in contrast to transactions focused on seeking arbitrage opportunities for which regulators have harbored the greatest capital-adequacy concerns.
"These customer-based multi-seller ABCP conduits, as differentiated from other structures such as SIVs and securities arbitrage conduits, provide a vital source of financing for a broad array of companies in the U.S. and have proven to be stable and safe for their sponsoring banks for many years," noted the ASF in a Nov. 4 letter to John E. Bowman, the acting director of the Office of Thrift Supervision.
The letter included another letter previously sent to members of Congress and signed by more than 50 ABCP corporate users, ranging from AmeriCredit Corp. to Dean Foods. It expressed their concerns about the regulatory proposal threatening "our access to this vital source of capital."
The threat stems from the ramped-up capital requirements under the new rules that banks said will make ABCP conduits uneconomical to run, reducing an effective short-term funding alternative for companies.
The alternatives that banks currently are discussing with regulators would provide capital relief to their institutions under the Basel I Accord, issued by the Basel Committee on Banking Supervision.
The new U.S. regulatory rules' treatment of ABCP conduits under the Basel II Accord, which banks will begin adopting next year, has provided an even more shocking surprise to U.S. banks.
Assuming the consolidation of ABCP assets, several banks' comment letters recommended speeding up the adoption of the Internal Assessment Approach (IAA). It is a risk-weighting alternative under Basel II that would allow banks to internally rate ABCP assets using a methodology similar to the rating agencies' and therefore relatively familiar and easy to apply.
"There was at least one bank that had substantially completed this process and would have been ready to adopt the IAA by the second half of 2010," Toennies said.
Instead, the final rules exclude banks from using that alternative for consolidated assets altogether, a conservative approach that wasn't even contemplated in the proposal. For consolidated assets, that means banks will have to pursue the costly approach of having the numerous and wide-ranging assets in the typical multi-seller conduit rated by a third-party rating agency, or employ another alternative called the Supervisory Formula Approach (SFA).
The SFA methodology is problematic for banks because it is significantly different - and presumably more resource intensive - than the rating-agency approach to which they're accustomed. And it requires data that some customers, such as those selling commercial loans to conduits, may be unwilling or unable to provide. If conduit sponsors can't rate conduit assets or use the SFA approach, they must match those assets with the same amount of capital.
Those alternatives, however, could prompt banks to maintain those easier-to-understand assets in the conduits, rather than the more opaque ones, Cunningham said.
Kravitt said U.S. banks are currently mulling several options, including how to get the necessary data to apply the SFA approach, whether they can get some conduit assets rated, and whether they should shrink their conduits.
Another option under consideration is whether to seek off-balance-sheet treatment for conduits under FAS 167, although Kravitt said that would result in the loss of some control over the conduit and the related economic benefits.
Banks can begin implementing the new rules immediately, but regulators also allow for a two-quarter delay and then a two-quarter phase-in that would apply 50% of the capital requirements in the second half of this year, and the full 100% starting next year.
One-to-one matching of capital against assets could make ABCP cost-prohibitive. Bankers worry that even the other alternatives will be costly enough to put U.S. banks at a disadvantage to non-U.S. financial institutions, which at least for now still have the less-intrusive IAA alternative open to them, and will shrink the domestic ABCP market. A credit analyst at a large institutional investor said she doesn't know what the "magic number" is when major investors will view shrinking conduits as too small to provide adequate liquidity. However, "if it gets too small, then resources get constrained working on a program that may or may not have the capacity for what you need," the executive said.
The ABCP market's volume, at $400 billion and change, is about a third of its peak in summer 2007. Some of that shrinkage can be attributed to the disappearance of the structured-investment-vehicle (SIV) market, but much of it stems simply from lack of demand from companies operating in a recessed economy.
Cunningham noted, in fact, that the ABCP market's percentage of the overall CP market, at a bit below half, has remained relatively constant over the last few years, and that it's likely to increase in size in tandem with other short-term financing alternatives when the economy rebounds.
Cunningham noted alternative sources of short-term funding, such as certificates of deposit, that banks are using to support short-term lending efforts from their own balance sheets.
However, she doesn't see ABCP going away. "The economics are not as attractive, so maybe instead of banks sponsoring a $10 billion program it will be $8 billion or $5 billion," Cunningham said. "But I don't think banks will abandon them; it just won't be as cheap a form of financing as it used to be."
(c) 2009 Asset Securitization Report and SourceMedia, Inc. All Rights Reserved.