NEW YORK - Asset-backed professionals are hoping that the federal bank regulators will grant relief against consolidated securitized assets for purposes of computing capital adequacy.
Should that happen, the regulators would arguably be diverging from the newly updated generally accepted accounting principles (GAAP), via Financial Interpretation No. 46. As reported last week by ASR, Standard & Poor's does not anticipate changing its core ratings on banks as a result of conduit consolidation, reflecting the view that consolidation on its own does not alter the risk profile.
More than 300 less-than-happy conference goers gathered last week at the Marriott Marquee for a series of panels themed The Future of Off-Balance Sheet Funding, a Strategic Research Institute event specifically targeting the new consolidation guidelines.
Professionals, including a representative from the Office of the Comptroller of the Currency, weighed the impacts on the cost of capital for banks that will adhere to the recently published guidelines.
While there is nothing currently in the works, National Bank Examiner Gregory Coleman of the OCC said during a panel that the regulators "would have to consider" reexamining the treatment of these assets "if it happened that the U.S. banks lost their competitive advantage."
This emerged as a general concern throughout last week's one-day event. Essentially, the playing field would otherwise be tilted in favor of European banks that are not subject to U.S. GAAP accounting. Apparently, Basel encourages risk transfer and diversification, and will maintain a stance that accounting does not drive capital requirements, said speakers on a European panel.
At least one accounting pro is skeptical that the U.S. regulators would take a diverging view, citing past disasters, such as the savings & loans crisis of the 1980s, when relief was used as a stimulus.
However, if the Federal Financial Institutions Examination Council (FFIEC) were to share S&P's opinion that the risk profile of a bank hasn't changed as a result of a GAAP-tinkered balance sheet, than the purpose of the new guidelines - at least in terms of commonplace securitization vehicles - becomes even murkier. Are these purely for the benefit of disclosure? Of course, this is subject to the debate on how much risk banks actually take when they are ABCP conduit sponsors, likely a topic the regulators will tackle over the next several months.
Would a bank be made to hold cash against conduit assets as well as the liquidity and/or credit support?
Some panelists were concerned that less savvy equity analysts will simply "plug in the numbers," arriving at significantly different valuations from previous quarters on companies that might not have been substantively changed. If the assets are taken onto a bank's balance sheet it will be projecting less return on equity.
Not on my balance sheet...
As a special treat, members of the audience last week were allowed a "grill session" with a very brave Ronald Lott, project manager at the Financial Accounting Standards Board and author of the recently published Financial Interpretation No. 46.
"The board put more energy in this than I have ever seen them put into a project," Lott noted. The project's immediacy was a direct response to the balance-sheet abuse and loopholes exploited by Enron Corp. in 2001. In addition to turning it out in record time, this was the first instance of FASB releasing a final ruling on its Web site. "For them to give this one away is significant," Lott said.
To that, Jason Kravitt, conference chair and securitization attorney at Mayer Brown Rowe & Maw, replied, "I think we would rather have paid for a different one."
While generally cordial (these were mostly accountants, after all), participants asked some tough questions, most of which Lott was able to answer (see below).
As noted last week, one of the greatest concerns with FIN 46, is that its "calculus" for expected loss is not applicable for real-life structures.
"As a side note," started Jerry Marlatt, a partner at Clifford Chance, "I have an undergraduate degree in physics. I look at the definition of expected losses, and I'm at a complete loss."
According to Lott, the original ARB 51, which FIN 46 interprets, was published in 1959 by the predecessor of the predecessor of FASB.
Perhaps more significant, only one board member was active when FAS140 was published two years ago, and the current staff is not "too fond" of that standard. FASB has assumed as its own project what was formerly Emerging Issues Task Force 02-12 - which sought to describe the permitted activities of a FAS 140 QSPE. FASB intends to explore:
If an existing special-purpose entity (SPE), or its designee or agent, has discretion to determine the terms of beneficial interests issued after its inception, whether that power is consistent with the requirements in paragraph 35 of Statement 140 that a qualifying SPE's activities be "significantly limited" and "entirely specified."
Whether certain transfers can meet the criteria for sale under paragraph 9 (and related implementation guidance) and therefore can be derecognized from consolidated financial statements if the transferor or any consolidated affiliate of the transferor guarantees the transferred assets or provides liquidity support for the transferee's beneficial interests. (Source: FASB)
The uncertain outcome, and the current bias of FASB against FAS 140, has dampened the discussion to structure securities arbitrage conduits as QSPEs.
* As mentioned, parties are concerned that European banks not conforming to GAAP will be better positioned than U.S. banks to acquire receivables. This has economic ramifications that the federal regulators may try to curb via capital relief, panelists said.
* Also, noted one panelist, "There is a temporary advantage for non-U.S. banks because they don't have to focus on restructuring over the next six months."
* Panelists expressed concerns about economic impact on sellers, if liquidity dries up. Further, there is potential for ratings action on sellers who no longer have this cheaper access to funding, and may choose to issue unsecured debt or borrow through a loan.
* One investor noted the risk of adverse selection if the better borrowers move out of ABCP and into other forms of funding.
* Investors also voiced concerns about a shrinking supply market. In conforming to investment guidelines, consolidated conduits will bear the name risk of the sponsor bank, while before these were treated - by some guidelines - as credits' independent of the sponsor.
* If several parties are performing the analysis individually, it's possible that more than one entity will consolidate the same pool of assets.