Last week the Financial Accounting Standards Board reaffirmed its stance that VIE decision-maker fees - with the exception of meeting a stringent set of criteria - will be included in the FIN 46 expected residual return analysis.
This FASB Staff Position (FIN 46-c) primarily affects collateral managers of CDOs. As previously reported, a few managers have already indicated that FIN 46 requires them to consolidate their CDO assets. For example, Federated Investors stated that it might be consolidating $1.1 billion in assets associated with CBOs it manages, while its maximum exposure to loss is less than $1 million (see ASR 11/3/03). Similarly, BlackRock Financial was deemed the primary beneficiary in the six CDOs it manages primarily as a result of the market-based fees it collects, the company said in its quarterly financial statement. BlackRock's fees were about $3.4 million for the three months ended Sept. 30, associated with the $2.6 billion it will consolidate. The company stated that its maximum loss exposure to these CDOs is its vested $14.3 million (see ASR 10/20/03).
Rule No. 1 seems to be that, if the decision maker is also a beneficial interest holder, its fees will be included in the expected residual return analysis. This pretty much eliminates any equity-owning CDO manager from proposed exemptions based on fee characteristics. Further, the fees cannot be subordinate to any other beneficial interests. If the decision maker has no other interests in the variable interest entity, then the characteristics of the fees will be subject to criteria defined in a combined FSP of FIN 46-b and FIN 46-c set for next week.
According to commentary on the meeting from Deloitte & Touche's Marty Rosenblatt, the board tentatively decided that decision-maker fees could only be excluded from paragraph 8(c) when all of the following conditions are met:
* 1 The decision maker can be replaced by a vote of no more than a simple majority of parties other than the decision maker and its related parties and there are no significant barriers to the exercise of that right.
* 2 The fees paid to the decision maker are commensurate with the level of effort needed to provide such services.
* 3 The fees are fixed.
Obviously, this set of criteria introduces measures of subjectivity, specifically regarding whether or not decision-maker fees are commensurate to the service performed. In FASB's view, for fees to be excluded from the ERR analysis, the decision maker should be similar in substance to an employee, or "hired agents," writes Ernst & Young in its summary of the meeting. E&Y describes allowable fees as having a "trivial" amount of variability, adding that the board did not define trivial but "appeared to choose it over insignificant.'"
Apparently, the staff had prepared a table of indicative factors that would "help to make the judgment whether the fees paid to the decision maker are commensurate with the effort (such as customary arms-length terms and the percentage of the entity's variability absorbed by the fee) but did not make that table available to the public," Rosenblatt wrote in his commentary. "The Board specifically rejected the use of the term market-based fees."
According to a staff member at FASB, the illustrative factors of the table for measuring whether a fee is commensurate with the services were (a) customary arm's-length terms; (b) price consistent with prices available in the market; (c) size of fee relative to expected total returns (not residual returns); and (d) percentage of the entity's variability that the fee will absorb.
"Other requirements were discussed besides a fee commensurate with the level of effort," the staff member said. "Some are that: the fee is not subordinated, the fee is not contingent on meeting performance criteria, and the fee is not primarily linked to net income (there was some inclination to delete that one)."
More staff positions to come
This week, the staff will introduce FSP FIN 46-g: "Identifying Variable Interests and Computing Expected Losses under FIN 46." This is, apparently, a replacement of examples for calculating EL and ERR that was removed from Appendix B in the proposed modification to FIN 46.
In an interesting twist, FASB's newest set of opponents to FIN 46 is retail franchisors that would be made to consolidate their franchisees' assets/liabilities should the modified draft be implemented. Participants in this industry, which included franchisees, franchisors and law firms, quickly loaded FASB's Web site with letters opposing the proposed rules. At press time, 21 letters were posted. The board's 46-g will address concerns raised by the franchise industry.
This week's consolidators
While John Hancock Life Insurance Co. elected to defer implementation of FIN 46 until the filing period after Dec. 31, the company has perhaps taken disclosure to a new level, providing a cumulative asset/liability breakdown of CDOs it manages, plus a detailed table of its exposure to loss at the various credit tiers (i.e., its positions in the CDOs it manages). Hancock's total CDO assets were about $5.5 billion ($3.9 billion of which is debt), while the firm's total exposure to loss was about $572 million as of Sept. 30, 37% of which is at the triple-A level.
In August, John Hancock Financial Services petitioned FASB to take management fees out of the FIN 46 expected residual return analysis. It is understood that several other CDO managers expressed similar concerns.
Meanwhile, GMAC last week announced it has consolidated $3.7 billion in assets associated with FIN 46. As for its G-STAR line of CDOs, GMAC said it had originally structured these, or had restructured them since, as QSPEs. GMAC's consolidations included $168 million associated with Central Originating Lease Trust (COLT), plus $1.8 billion and $1.7 billion in mortgage loans and commercial loans, respectively, held for sale, with the corresponding liabilities reflected as debt.
On the banking side, Bank of America announced that it had consolidated $12.2 billion associated with asset-backed commercial paper conduits. BofA referenced a transaction that resulted in the deconsolidation of $8 billion, which is presumably the Yorktown Funding ABCP conduit that used the silo-approach to avoid bank-sponsor consolidation.
JPMorgan Chase also moved ahead with the implementation of FIN 46, announcing in its 10-Q that it had added $15.5 billion in assets to its balance sheet as of Sept. 30, mostly related to the multi-seller conduits it sponsors. An additional $3 billion, which was already consolidated under prior accounting literature, remains consolidated under FIN 46.
Credit Suisse First Boston has opted for the deferral on its VIEs created prior to Jan. 31, but has consolidated about $1.2 billion in assets and $1 billion in liabilities associated with CDOs originated this year. CSFB's maximum exposure to loss is $238 million. In the fourth quarter, CSFB expects to add another $738 million to its balance sheet ($8 million exposure to loss). CSFB also disclosed that it participates in an additional $2 billion in CDOs in which it is not the primary beneficiary, with a loss exposure of $36 million. Other minor investments in CDOs, for which CSFB is not the primary beneficiary, came to roughly $190 million.
Finally, SunTrust Bank announced that it had consolidated about $2.9 billion in assets and liabilities associated with its ABCP conduit Three Pillars.