As if new capital requirements penalizing risky asset-backeds weren't enough, banks may soon have to pay higher deposit insurance assessment fees relative to the riskiness of the ABS they hold on their books. This further challenges their participation in the securitization market.
Under new rules issued last February, banks with $10 billion or more in assets, will have to apply a complicated methodology to securitizations they hold on their books.
In one provision, if more than half of those underlying assets fit into one of four high-risk categories defined by the rule, including subprime and leveraged loans, then banks will have to "look through" to the underlying assets and pay the full assessment on them. That's regardless of credit enhancements or other measures structured into the bonds to reduce risk.
Bankers argue that securitizations with significant subordination, overcollateralization or other form of credit enhancement, where typically other investors absorb a sizeable portion of defaults before the bonds held by banks are impacted, should be subject to lower assessments. Otherwise, banks will be penalized for holding those assets.
The new assessment rule only impacts a relatively small circle of large banks that are dominated by the likes of Citibank, JPMorgan, Wells Fargo and Bank of America. The precise impact on the ABS held by these institutions remains unclear, but the Federal Deposit Insurance Corp. (FDIC) is currently discussing the issue with banks and their representatives.
"We don't have any kind of quantification of the volume [impacted], but it would be significant," said Tom Deutsch, executive director of the American Securitization Forum (ASF), which began discussions on the issue last fall. "It is ultimately one more price disadvantage for banks to hold ABS on their books, as compared to other financial products."
A top securitization banker at one of the largest U.S. banks said the deposit insurance assessment rule makes sense when applied to subprime and other risky loans outright.
"But what it doesn't do is distinguish between banks holding loans outright and investing in securitizations that have a 45% credit enhancement, so the subordinated portions take the first 45% of hits," the banker said.
The assessment provision impacting securitizations was a part of the FDIC's original proposal in April 2010 that applied the assessment fee to a bank's assets minus its Tier 1 capital, rather than its deposits, or liabilities. The intent was to make the deposit insurance assessment fairer, since large banks now tend to use fewer deposits to fund their activities.
The securitization appears to have been overlooked by banks until recently amidst the barrage of other regulations they currently must contend with. Numerous comment letters to the original proposal suggested postponing the rule so that it could be melded with requirements anticipated to arrive from the then-pending Dodd-Frank Act.
The FDIC complied and in November 2010 reissued the proposal, which included some adjustments but largely retained the same multi-faceted scorecard approach to determine the assessment. A final rule was issued Feb. 25, 2011, that became effective April 1 of last year.
Problems with Call-Report Format
The assessment issue pertaining to ABS hadn't yet rung any alarms. However, when the new rule requirements filtered down to the bank staff responsible for call reports, they realized their systems did not collect the data in the correct format and would have to be changed, according to sources familiar with discussions between the regulator and banks. The FDIC agreed to allow banks to continue providing the data according to the current call-report format until they adjusted their systems appropriately. The new deadline for reporting the data in the format required by the FDIC's rule is April 1.
The call-report issue appears to have triggered banks' recognition of the assessment rule's impact on securitizations. An FDIC spokesman said no final decisions have been made about whether changes are warranted to the existing rule and what form they would take.
The ASF met with FDIC officials in November to discuss the issue."The FDIC hasn't made any changes to the rule since our meeting with them, though we do expect them to make some adjustments," Deutsch said. "It's not clear whether their adjustments will really account appropriately for credit enhancements in securitizations."
Unlike the Federal Reserve Board's scheduled meetings, the FDIC board meets as needed, so it remains to be seen whether it will take up the assessment issue before April 1. Any changes it does make to the rule would have to be proposed and issued for public comment.
According to the rule, larger banking institutions with at least $10 billion in assets must determine assessments by applying a complicated scorecard approach that combines a performance score and a loss-severity score. The performance score comprises a bank's CAMEL rating, or the supervisory rating of its overall condition, as well as its ability to withstand funding stress and asset stress.
The securitization issue is only one component of a bank's ability to withstand asset stress. However, if more than half of a securitization's assets fit into one of the four defined categories, including subprime and leveraged loans, then the full securitization is included in the asset stress test, and that can raise the overall assessment rate.
In terms of the actual assessment, the FDIC has defined four risk categories for banks with less than $10 billion in assets and a total base-assessment rate ranges for each category. A fifth category for "large and highly complex institutions" imposes a total base assessment rate ranging between 2.5 basis points and 45 basis points, depending on the riskiness of a bank's assets as determined by the rule's methodology.
Steve Twersky, senior vice president in FTN Financial's portfolio strategies group, said that while he had yet to crunch the precise numbers.
"My sense is the securitization issue on its own would not cause a major jump in the assessment rate," because it comprises only 35% of the asset stress test, and that test is only one portion of the performance score, he said. "Of course, that doesn't mean it couldn't be a significant amount for a large bank in pure dollars." Proposals to implement the Basel Committee guidelines in the U.S. could also hinder banks' participation in the securitization market because they, too, ignore credit enhancements. The U.S. banking regulators issued a proposal Dec. 16 that implements amendments to Basel II, commonly referred to as Basel 2.5, that also do not recognize securitizations' risk-reducing features when calculating regulatory capital.
The December proposal looks at four metrics to determine the capital charge. One is including cumulative lsses to date, and once those losses reach a specified threshold, the capital charge is no longer risk weighted and instead becomes dollar for dollar.