In its final iteration of its ABCP risk-based capital guidelines, the Federal Deposit Insurance Corp. lowered the eligible liquidity conversion factor to 10% from the 20% it proposed last fall. Industry pundits were pushing for 7%. Also, the FDIC has decided not to include final guidance on capital against securitized revolving credits with early amortization provisions (such as credit cards), but will readdress this issue through the implementation of Basel II.

A final draft of the rules was circulated during a discussion in Washington last Monday. The rest of the U.S. regulators, collectively the Federal Financial Institutions Examination Council (FFIEC), are expected to follow course. The rules, which have yet to be published to the Federal Register, will take effect Sept. 30.

As in the initial proposal, for rated assets, the liquidity facility will be converted against the underlying asset, such that a facility supporting a triple-A exposure will be converted to 10%, per the new rules, and "assigned to the 20% risk weight category" for the underlying triple-A.

Perhaps most significant, the FDIC also modified the criteria for eligible liquidity facilities, which have been - and may still be - viewed as too stringent (see ASR 6/14). First, the regulators have extended the past-due asset quality test, which determines how long an asset can be past due before it is written down and no longer fundable by liquidity. Eligible liquidity will be able to fund assets 90 days past due, as opposed to the 60 days proposed last fall. Also, assets with embedded government guarantees, such as FFELPS student loans, are not subject to the past-due asset quality test.

"The 90 days past-due test does not comply with industry practice and likely will create some difficulties," said one industry source.

Also troubling for some, the regulators are holding firm on the "non-investment-grade" restriction, which precludes eligible liquidity from funding a rated asset/security that has been downgraded below investment grade. As with the asset quality test, government-guaranteed credits are subject to this rule.

"We're waiting for the industry to respond, because we've indicated that the arbitrage conduits could not continue to be rated without some sort of adjustment," said Tom Fritz, head of ABCP at Standards & Poor's. "We will have to look for some other sort of enhancement for conduits that hold rated securities, if they want to convert to eligible liquidity."

Essentially, if liquidity facilities were unable to fund these assets, the conduit would have to draw on credit enhancement, which would have to be sized up to take on this additional risk.

The eligible liquidity requirements do not become effective until Sept. 30, 2005, noted Jason Kravitt, of Mayer, Brown, Rowe & Maw. "The industry has time to have further discussions with the regulators."

Eligible facilities with maturities greater than one year are subject to a 50% risk conversion. Noneligible facilities are considered a recourse obligation or a direct credit substitute, and subject to 100% risk conversion.

Last fall's notice of proposed rulemaking (NPR), which provided interim guidance, was viewed by some as a relief package to the conduit industry, as it excluded conduit assets consolidated as a result of FIN 46 (now FIN46R) from the risk-based capital analysis.

However, if a bank sponsor is including the assets and liabilities of the ABCP on its balance sheet, and is including these in its risk-based capital analysis, liquidity facilities associated with the conduit would not be subject to capital risk weighting.

Copyright 2004 Thomson Media Inc. All Rights Reserved.

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