Patterned after an approach taken by the Basle Committee on Banking Supervision, the U.S. federal regulators are introducing for commentary a new "sliding" risk-based capital charge against revolving securitizations with early amortization provisions.
While this development is not totally surprising, the timing raised some eyebrows. Apparently the proposed rules - or at least the idea of them - are embedded in the interim guidelines on risk-based capital for ABCP conduit sponsors impacted specifically by FIN 46, the consolidation criteria written into rule in January by the Financial Accounting Standards Board. Last week, a draft of those rules, believed to be in near-final form, was circulating the market. The ruling was distributed by the Federal Deposit Insurance Corp. to other members of the Federal Financial Institutions Examination Council (FFIEC).
"This is the beginning of harmonizing the U.S. regulations with the proposed Basle guidelines," said one industry source. "This is a slow moving event, but it is definitely on the horizon."
As for the early amortization issue, monoline credit card issuers would likely bear the brunt of these changes, however slight. As proposed, the capital charges only kick in if a securitization is approaching early amortization associated with performance-based measures, namely three-month average excess spread.
According to the chief financial officer at a major credit card issuing bank, these rules are only potentially threatening to banks that manage high volatility portfolios, many of which have already faced
regulatory enforcement in the past few years. In a sense, with a sliding capital charge, the regulators are automating what might have earlier been an enforcement order.
For the purposes of the proposal, the FDIC uses a 450 basis point excess spread differential (ESD), as a threshold where risk-based capital requirements would kick in for the banking originator (if there is no performance-based spread trapping account). For securitizations with spread accounts, the ESD would be broken into quartiles, with the differential based on the difference between the "spread trapping point" and the early amortization trigger (presumably three months of negative excess spread). In those quartiles, the FDIC proposes the issuer hold capital against the off-balance sheet portion of the securitization (the issuer already holds dollar-for-dollar against the residuals) according to the following conversions per quartile: 5%, 10%, 50%, 100%.
Significantly, the issuer would never be forced to hold more capital against the deal than it would if it had retained the entire portfolio on-balance sheet. So if the retained interest is more than 8% - which is the capital charge the bank would face had it kept the credit cards on its balance sheet - the sliding measures are no longer applicable.
Liquidity and ABCP
The FDIC draft also outlines its capital charges on liquidity support provided to ABCP conduits. As expected, it appears that the regulators will require a 20% conversion factor on liquidity support commitments under one year, and 50% for commitments over one year. The support would then be weighted again against the underlying asset to which the liquidity is provided.
According to a securitization attorney in Washington, the regulators have long been eying liquidity support - which has been viewed as credit enhancement in disguise.
"Some have called it trick or structured liquidity, where in reality they were funding against bad assets as well as good assets," the attorney said. "If you're funding against the whole deal, it borders on credit enhancement.
Also as anticipated, the regulators are not requiring sponsor banks to hold capital against ABCP conduit assets brought on balance sheet solely as a result of FIN 46 implementation. The interim rule stands through April 1, 2004, at which point the final rule would take effect. According to the draft circulated last week, the final rule will permanently eliminate ABCP assets from inclusion in the risk-based capital calculation.
According to the FDIC, the regulators believe that "the consolidation of ABCP program assets onto the balance sheets of sponsoring banking organizations would result in risk-based capital requirements that do not appropriately reflect the risks faced by organizations involved with these programs."
This bias was first confirmed in May by Gregory Coleman of the Office of the Comptroller of the Currency on a panel at a Standard & Poor's conference in Florida.
Following the announcement, the "race to restructure," or rather the tempered panic roving the market in the face of rapidly shifting capital adequacy ratios, slowed considerably. Still, many sponsors are equally concerned with asset leverage ratios and return on equity. The regulatory relief is independent of GAAP financial reporting.