As the commentary period for the Bank of International Settlements Proposal approaches its March 31 deadline, market observers are looking at the proposed 20% risk weight capital charge on loan commitments less than 365 days as most likely to incite a "bite" in asset-backed land.
The BIS proposal - a set of international banking guidelines - was issued last June by the Basel Committee of Banking Supervision. The section concerning securitization, however, is very similar to the domestic guidelines for risk based capital weighting published earlier last month.
"Of course the BIS is a much, much broader proposal, because it encompasses the entire risk-based capital framework, but it does have a very specific section on securitization," said a source. "And, not surprisingly, it looks exactly like the US proposal, for the very simple reason that the US regulators wrote it."
The principal difference between the U.S. and BIS proposal involves the added risk weight on loan commitments less than 365 days. This proposed change will have the most impact on asset-backed commercial paper.
Currently, with a commitment of less than 365 days, there's no charge, but for commitments over a year, there is a risk charge of 50%, which translates to 4 cents on the dollar.
The significance of this is that the loan commitments can be used to facilitate liquidity, for both the underlying borrowers and the commercial paper conduits. The change will have a significant impact on how banks will be able to price asset-backed commercial paper, the source said, because of the additional capital charge for the short term commitments that provide liquidity will cost more.
"You can use loan commitment a couple of different ways in these programs," the source said. "Each party that puts their receivables into the program usually has a fall-back loan commitment: that is if they can't put receivables in, the bank will lend them money. Similarly, there is oftentimes a liquidity facility applied to the conduit itself, in the event that the conduit cannot sell commercial paper for whatever reason."
In essence, the bank provides the conduit with liquidity through a loan commitment.
Among other significant issues, both the BIS and the domestic proposals describe a 20% risk weight for securitizations sold with an early amortization feature often found on credit card transactions, off-balance sheet CLOs, and, in some cases, home-equity lines of credit (Helocs).
"All that really means is that if a negative trend of losses and deliquencies develops, instead of the investors, the bank will take the losses," explained the source. "The regulators, in both the BIS proposal and the US proposal, are saying, okay if that's really as possible as it appears, these credit card banks should pay $1.60 in capital against $100, or 20% risk weight."
The effect will be minimal for the larger issuers like MBNA and CitiBank, because they are required by the rating services to maintain significant capital to support their securitizations. For the smaller and new credit card issuers, however, this is another hurdle, the source said.
"It might take some of the smaller issuers out of the credit card market, and it will make it more difficult for new banks to become securitizers of credit cards, because it's going to add costs," the source added.
Banking Book vs. Trading Book
Possibly one of the more elusive impacts of the BIS guidelines, though not the domestic, is associated with the market value approach of reducing risk weight, where banks place assets on their trading book, to get a lower capital charge.
An example would be when one bank gives a swap to wrap another bank's portfolio. This lowers the risk weight to 20% from 100%, because it becomes the first bank's obligation. Normally the bank would have to put the capital up itself, if it has that swap on its books. But if the bank puts it in its trading book and marks the exposure to market continuously, the bank qualifies for a lower capital charge.
On the BIS proposal, there is proposal to equalize the treatment of the banking and trading books, where the regulators might impose a liquidity standard on assets placed in the trading books.
This change will only affect the very large banks, the source said, because to qualify for the market value approach, the banks must meet rigid internal risk management standards.