Several CDO bank researchers are quite positive on the direction that the Financial Accounting Standards Board (FASB) seems to be heading on the issue of SPE consolidation.
According to Banc One Capital Markets' new CDO monthly, should the exposure draft indeed reflect developments at FASB's latest meetings, the third and fourth quarters of 2002 could see added "pent-up" CDO volume from entities who were concerned about future consolidation issues.
Banc One's new CDO researcher Rusell Hurst, who joined from Wachovia Securities in February, notes that cash CDO volume in May, at $9 billion, was more than twice that seen during the same month in 2001, perhaps reflecting an overall improved sentiment. During the peak of accounting uncertainty earlier in the year, CDO issuance was depressed while professionals waited for the tentative guidelines to develop, reported IFR Markets.
Writes CDO strategist Lang Gibson in Banc of America Securities weekly, "In our opinion, FASB's intent all along has not been to penalize CDOs, but rather to put a stop to the creation of Enron-like SPEs."
Though acknowledging that there is still a fair amount of uncertainty, Gibson believes that "most CDOs will remain unscathed by the accounting bodies in the U.S."
On the ABCP front
This week, FASB's Emerging Issuers Task Force is meeting to discuss issue 02-12, which deals with permitted activities of a QSPE issuing beneficial interests, so the market will be closely watching developments on that front and how they interact with the anticipated consolidated exposure draft.
Again, should FASB's exposure draft criteria (and final criteria) resemble tentative the guidelines laid out in the minutes of the June 5 FASB meeting, ABCP professionals see multi-seller conduits as faring the best, easily tweakable so that there would be less likelihood of consolidation with the program administrator.
Should the individual silos qualify as financial SPEs (and themselves satisfy the non-consolidation criteria for sellers of assets to multi-seller ABCP programs), the conduit administrator bank might be required to satisfy two of three conditions of a financial SPE to avoid consolidation as well. The first condition, which is associated with the administrator's discretion to add/remove assets from the financial SPE (the conduit), may be satisfied for the administrator's benefit by having definitive standards in the documentation as to add/remove pool decisions. At the FASB meeting it was also suggested that there might be more flexibility granted to add/remove criteria in programs than what is presently found under SFAS 140.
The second condition, which addresses guarantees and liquidity facilities, would be more difficult to structure around. "Every bank sponsor in the market provides these facilities to their conduits and it will be a difficult provision to work around," said an industry source.
To satisfy the third condition, which is associated with the fees that administrators derive from their ABCP programs, the administrator would need to demonstrate that its fees are market based. Importantly, the FASB excluded from this the fees that administrators may receive from their provision of back-up lines and guaranty lines, such as credit enhancement facilities. What this leaves is the program administration fee which, according to industry sources, is usually a flat spread over the CP issuance cost. Since most administrators charge a flat administrative fee, there is an argument to be made that it is a market-based fee. To the extent that this fee looks more like a variable fee tied into performance of individual deals in conduits, it may be more difficult to pass the test.
Single-seller conduits and securities arbitrage conduits, on the other hand, may have a more difficult time qualifying for the financial SPE analysis (pending the final guidelines) based on the three factors raised by the FASB.
Sources believe EITF 02-12 will more closely examine issues related to a QSPE's discretion, such as determining durations of beneficial interests.
"The FASB discussion regarding consolidation, as well as regarding permitted activities of a QSPE issuing beneficial interests, both seem to be going in the right direction," said Carol Histelberger, partner at Mayer Brown Rowe & Maw. "Depending on the actual language of the final draft, there may be aspects that would give rise to practical difficulties for the day to day management of a typical asset-backed commercial paper conduit. However, we expect that we'll be able to iron those out in the long run."