Today the Strategic Research Institute is hosting a one-day conference titled "The Future of Off-Balance Sheet Financing," smartly timed to capture the climax of accounting uncertainty, as it trails the final release of Financial Interpretation No. 46 by little more than a week.
In fact, as the Financial Accounting Standards Board subsequently delayed its final draft, SRI pushed back its conference.
That said, market players were still digesting FIN 46 through most of last week, and, prior to a conference call hosted by Credit Suisse First Boston on Thursday, sources were generally reluctant to say anything on the record.
Initial market impressions: It's manageable for most securitizations (reiterating the exemption for transactions structured through a FAS 140 qualifying SPE). The board, in fact, modified a stance it held in the "Christmas Eve" draft, which ruled there would be no exemption for a non-transferor variable interest holder in a QSPE if that holder would not have been entitled to derecognition of the assets had it been the transferor.
FASB has narrowed the definition, such that a non-transferor VI holder in a QSPE would only be subject to the interpretation if it has the "unilateral ability" to cause the SPE to liquidate or to "change the entity so that it no longer meets conditions" required by FAS 140 to receive QSPE status. This enterprise would only consolidate if it has the majority of the expected losses and residual returns, an industry accountant noted.
ABCP as you know it
All the same, it's pretty much a sure thing that assets held in multi-seller ABCP conduits, as presently structured, will be forced onto the sponsor bank's balance sheet. This is more or less what the market had anticipated, though actually having FASB's final guidelines in hand has sounded off a gun of sorts.
"It's not really a question of whether or not banks will restructure, it's how long it takes," said one bank researcher. "And it's a question of how long a loop hole will stay open before FASB comes in and plugs it."
According to one attorney following the developments closely, several parties he spoke to believed that, for existing vehicles, the deadline for "restructuring" would be Sept. 30, at the end of the third quarter, when in fact the deadline is at the start of the quarter. FASB states that the new interpretation applies to any public enterprise at the beginning of the interim or annual period (following June 15), and at the end of the period for non-public enterprises.
Shortly after FASB released its final interpretation, Standard & Poor's released a statement (and research) that essentially affirmed its current opinions on the financial strengths of the sponsoring banks, even if these assets were to be suddenly consolidated. Such an event would not have a material effect on bank ratings, even if tier-one capital ratios were impacted from a regulatory perspective.
"We knew that these things were out there and always a little bit opaque," said Tanya Azarchs, a fundamental bank analyst at S&P, and author of the report. S&P lists the industry's top sponsoring banks and each bank's total CP. Citigroup, which is the top sponsor bank, has nearly $56 billion in ABCP. Bank of America trails slightly at $54 billion. Total ABCP outstanding is currently at about $725 billion, though not all of that is held in multi-seller conduits.
"What I predict is that, in time, most sponsors will find a practical way to restructure; however, in no sense am I certain," said Jason Kravitt, of Mayer Brown Rowe & Maw. "While theoretically there are many different ways to restructure, what's important is if it will work in the real world. It may not work for everyone, but I think restructuring will work for a majority of the market."
Restructuring may open up the doors for third party asset managers not concerned with consolidation, according to venture hopeful FORE Partners Capital, which is pitching banks one potential solution. Without giving away too much, FPC principal Harry Forsyth described a vehicle that takes elements of the existing conduit structure, such as program-wide credit support and liquidity lines, and combines these with elements of a CDO, such as credit ratings based on asset composition, diversification, and with more than one bank involved.
"FASB has given us a blueprint of how a company like ours needs to operate," Forsyth said. "It's all about majorities.'"
During CSFB's conference call, Jim Mountain of Deloitte & Touche gave some other alternatives, such as adding equity to conduits, or syndicating expecting losses and fees. Some conduit sponsors may simply choose to consolidate and pare down their assets.
For single seller vehicles, the focus will be to restructure the vehicles to satisfy FAS 140 QSPE requirements. The thought was that arbitrage conduits would also be conducive to QSPEs - many are already, said CSFB's ABCP group head, Maureen Coen. Last week, FASB recently assumed control of what was previously the Emerging Issues Task Force 02-12, which dealt with the permitted activities of QSPEs that issue beneficial interests (concerning the liability side of the QSPE balance sheet). FASB will be issuing another Interpretation dealing specifically with this topic.
Researchers at UBS Warburg recently noted that if arbitrage conduits lost their allure, triple-A ABS spreads would widen, as the conduits absorb a substantial portion of triple-A paper.
With little restructuring, structure investment vehicles (SIVs) may be able to demonstrate enough equity to support their activities, and will probably be able to avoid consolidation to the sponsoring bank, analysts said.
So you're saying there's a chance...'
In its release, S&P also noted that certain assets contained in CDOs could wind up on banks balance sheets, though the agency was less willing to gauge the impact, as there's "no good estimate of the amount of CDO assets that require consolidation."
If balance-sheet driven structures, particularly cash and synthetic CLOs, no longer capture regulatory capital relief, it's possible these structures will lose their luster. Over the past year market players were talking about a shift to static deals to avoid consolidation. The challenges here are questions such as, if there's a workout situation, who makes the decisions in a static deal, and can positions be traded out of?
As noted a few weeks ago by Marty Rosenblatt of Deloitte & Touche, applying the expected losses and residual returns analysis to determine a primary beneficiary could result in a collateral manager being the primary beneficiary even if it owns little or none of the equity. This is the result of the guidelines incorporating management fees in the residual return analysis.
Because of this, an attorney suggested that CDOs might choose the voting rights analysis. As with conduits, asset managers that are not particularly concerned about consolidation, such as independent firms like Deerfield Capital Management, may have a significant competitive advantage, if banks and insurance companies shy away.
Is it worth the price?
In her analysis, Azarchs notes that "A major issue is whether the on-balance-sheet treatment of conduits will affect banks' appetite to continue to sponsor them."
Essentially, said Mark Adelson, head of ABS research at Nomura Securities, banks use the conduits as a means to lend cheaply to their corporate clients without tying up capital. This implies that ABCP is not really a financing mechanism for banks, but rather a balance sheet tool. Pulling the conduits on balance sheet would negate much of the economic advantages.
"This isn't a high enough return business for the banks for them to seriously restructure their capital," said one bank analyst. "The emphasis will be how do we get the stuff back off-balance-sheet, or else, how do we lessen our participation in this market."
If banks were to forgo restructuring, opting to bring the assets onto their balance sheets instead, these banks could reduce other low-risk weighted assets.
Whatever the outcome banks, Adelson, Azarchs and others have noted the potential borrowing for costs to rise for companies currently selling receivables into conduits. "If borrowing becomes more expensive, how much are you going to squeeze the borrower, and how does that hurt the economy at large?" asked Adelson. "Also, would this re-pricing of credit be a correction?"