NEW YORK - With the deadline for conduit restructuring having come and gone, some of the banks still on the restructuring pike - and apparently there are many - may rather be working to deconsolidate the assets they'll take on for the reporting period ended June 30, as well as to avoid consolidating new assets originated between now and Sept. 30.
As has been a story over the last month or so, temporary capital relief from the federal regulators took most of the urgency out of the deadline for several players. Still, others were less worried about capital relief than the impact of consolidation on leverage ratios, something closely watched by equity analysts, among others.
"[Our] view on nonconsolidation was really more focused on the leverage ratios," confirmed Jon Bottorff, head of the ABS effort at HSBC, during a Strategic Research Institute conference last week, which was entitled ABCP Post FIN-46. HSBC was one of a small handful of banks that successfully restructured by deadline. Bottorff explained that HSBC was not comfortable with "the premise of putting assets on balance sheet and then pulling them off."
The SRI event, held at the Helmsley Hotel, drew more than 100 market participants.
All said, it was learned that as many as six banks are pursuing the yet-to-emerge joint venture approach to FIN 46, where at least two, or maybe three banks partner to co-sponsor a conduit, separately originating assets for their clients into a common CP issuing vehicle, with the calculated expected loss distributed equally among the participants. This structure has several components, including a credit and oversight committee. Obvious challenges include teaming up with the competition, commercial risk and exposure to another entity's underwriting standards.
Apparently, Credit Suisse First Boston is looking down the joint venture avenue as a possible solution, although details beyond that, such as whom CSFB would partner with, were not disclosed. The bank is also considering an expected loss tranche. CSFB and some other non-U.S.-based banks have more time to pursue solutions, if they need to at all. CSFB does not become U.S. GAAP compliant until Jan. 1, 2004.
To date, four banks have visibly restructured, three of which have used the expected loss tranche approach, which will continue to be the most popular solution to FIN 46, panelists said. Most recently, Mellon Bank sold off an expected loss tranche associated with its Three Rivers Funding conduit.
The other three banks that have completed FIN 46-related restructurings are Citibank, HSBC - both selling expected loss - and Bank of America, launching a conduit employing the silo approach, where the individual sellers book their own assets. BofA still plans to use the expected loss tranche in its other conduits, but acknowledges that some level of consolidation will be unavoidable.
It's expected that more successful restructurings will surface over the next few weeks, although the next crunch date seems to be Sept. 30. Interestingly, it is understood that all of the successful restructurings so far involved the same auditor, KPMG.
FASB on the mind
Since the Financial Accounting Standards Board released its proposed amendment to FAS 140, which would essentially nullify the possibility of a conduit achieving QSPE status, sponsors with existing securities arbitrage conduits have begun more seriously looking at the expected loss approach (see ASR 6/23), if they hadn't been already.
This area has concerned the industry for a while, as securities arbitrage conduits are a significant provider of liquidity to the term ABS market. If the economics change substantially, it could have an impact on primary market pricing.
FASB announced last week that, on Aug. 28, it would hold a roundtable discussion on the commentary received by the July 31 deadline. FASB is posting comment letters on its Web site at www.fasb.org. The deadline to register for the roundtable is Aug. 7.
Another offshoot of FASB's proposed amendment to 140, however, is that credit card master trusts that currently have the ability to issue directly into the CP market, will likely have to surrender that feature to remain off-balance-sheet. This was roughly touched upon at SRI's conference. However, the issue of whether subsequent series from a master trust constitutes what FASB considers re-issuance was only briefly alluded to as a hot topic to watch from the term perspective. Again, reminiscent of the release of FIN 46 in January, the market is concerned with vague definitions, unclear objectives and unintentional consequences of broad sweeping accounting changes.
Referring to FIN 46, one panelist commented that "FASB has provided no real guidance since it released the issue... in fact, some FASB members have indicated surprise that anyone would try to restructure."
It comes down to pricing
ABCP pros believe that securities arbitrage conduits can be re-jiggered to issue expected loss tranches fairly easily, as the math required would be based on portfolios of highly rated securities, as opposed to the unrated warehousing and trade receivable-type assets found in multiseller vehicles, which have already proven the feasibility of expected loss notes.
According to Randy Harrison, head of ABCP at Citigroup, between $70 billion and $80 billion of outstanding ABCP is tied to U.S. banks or corporate-sponsored securities arbitrage conduits currently structured as QSPEs.
Several panelists at the conference noted there are sufficient interested parties with cash to absorb the market's universe of expected loss needs, mostly from private equity and LBO-type investors. Panelists said that even when different approaches were taken to measure the expected loss, the results from various entities were in line with each other.
Apparently, the investment size is in the range of 10 to 20 basis points, and the return profile can be near 25%. One audience member asked, "Should I stop buying CDO equity and buy ABCP equity instead?"
According to one official at a bank that successfully restructured, the expected loss tranches can be measured against the committed size of the conduit, rather than current outstanding (which might be less) or the authorized amount (which would be greater). If a conduit's commitments were $1.5 billion, and the expected loss was sized at 15 basis points, the investment would theoretically be about $2.25 million. For that 25% return, however, the investor takes onto its balance sheet the conduit's assets. The theory is that the investor is either not concerned with or does not publicly file GAAP financial statements.
Still, while there appears to be a population of interested investors, the need for expected loss investment is based on the size of the conduit, so a growing conduit would need to issue subsequent subordinate notes as time goes by. In a sense, the market's growth is held captive by the appetite for this type of investment, just one more characteristic of the new reality in ABCP.
"Can the structure survive in good and bad times?" asked one panelist. "If things start to go bad, the negotiations will begin to get tough."
Clearly the economics for the conduits have changed, and, at this point, it's not exactly clear who will bear the brunt of the higher cost of business. As noted above, for arbitrage conduits, it's possible that the term market will see a decline in bid for the type of assets that generally end up in conduits. Borrowers in multiseller conduits could end up paying higher fees, though banks will still need to compete.
"People have become more focused on who their customers are and how you can leverage that relationship across different product lines," one banker said, arguing the corporate borrower probably won't see significantly higher costs.
Lisa McMillan of Banc of America Securities argued that the expected loss tranche is the cheapest in terms of upfront costs - and the easiest solution for existing conduits - though least cost-efficient over time. The silo approach, which is more specialized and only works with a specific client set, is quite costly upfront, as it is nearly impossible to accomplish without launching a new vehicle. However, it is "very high in operational efficiency." The joint venture approach seems to fall in the middle, McMillan said.
Whit McDowell, who heads BofA's ABCP business, commented that in today's environment, there are more borrowers willing to keep their financed assets on their own balance sheets, as the stigma associated with SPEs and off-balance sheet structures may outweigh the benefits.