If enacted by U.S. regulators as currently drafted, the Simple Supervisory Formula Approach (SSFA) would require banks to give capital risk weightings to securitizations that are sharply higher than those assessed under the longstanding ratings-based approach, according to a presentation by Brian P. Lancaster, co-head of structured transactions at RBS, and John Jordan, from the bank’s financial institutions division.
The SSFA is meant to bring bank’s business practices into adherence with 939A of the Dodd Frank Act, which mandates that all federal agencies “remove reliance on credit ratings from their regulations and replace them with appropriate alternatives for evaluating creditworthiness.”
To calculate risk-weighted assets (RWA), the SSFA uses a formula based primarily on tranche ‘attachment’ and ‘detachment’ points, as well as on cumulative historical losses, the analysts said.
If put into effect in its current form, the proposal could lead to much higher RWAs for tranches where credit enhancement is already quite generous. “Because the approach is based on the concept of attachment and detachment points, the amount of ‘credit’ given for other forms of credit enhancement may be less than for the current ratings based approach, which could result in higher capital requirements for these structured products,” RBS said.
One example cited was a single-asset CMBS securitization with a very low LTV mortgage backing it. In the SSFA approach, the ‘attachment’ point of the investment grade tranches could be very low but the ratings very high. As drafted, the SSFA wouldn’t give credit for the equity behind the property, in contrast to the rating-based approach.
The SSFA’s focus on cumulative losses would also appear to make securitizations more costly. The analysts said that the cumulative losses approach could cause distortions so that even highly rated tranches with significant enhancement might end up getting hit with steep capital charges.
RBS said that Dodd-Frank has thrown a wrench in the process of U.S. banks advancing from Basel I to II/II.5 and III. While all U.S. banks have to observe Basel I rules for public filings, presently only those with over $250 billion in assets or over $10 billion in foreign assets must internally report and manage to Basel II requirements.
