It's fitting that the Financial Accounting Standards Board (FASB) released its proposed changes to Statement 140 and Interpretation 46 (R) the week the Lehman Brothers bankruptcy news broke.
These FASB proposals, market participants fear, will further exacerbate the capital and liquidity constraints now being experienced in the ABS sector.
"The current language of the FASB proposals does not allow consolidation into a QSPE even if the party in the deal took on the residual interests in the transaction," said Lisa Filomia-Aktas, a partner and global on-call advisory services group leader at New York City-based Ernst & Young. "Depending on the power you have over the assets in the deal or whether you could benefit from the transaction, the transferee might end up having to consolidate the assets on to its balance sheet. There might be ramifications upon consolidation in terms of the financial ratios, debt covenants, and regulatory compliance for banks. The market now needs to understand what these ramifications are."
ABS players went as far as to say that this rule change might cause trouble for institutions such as Fannie Mae and Freddie Mac, as the new rules might swell these institutions' portfolios even further.
Issuers now have to ask the questions: Which programs will have to come back on balance sheet as a result of these proposals, and how much would that cost in terms of the capital that issuers have to hold against these assets?
But these are not only concerns for the issuers. Investors will be affected as well, specifically CMBS investors.
"We share similar concerns with the larger ABS market, although our specific issue is what these changes mean for CMBS investors," said Brendan Reilly, senior vice president in government relations at the Commercial Mortgage Securities Association.
He explained that CMBS investors that buy B-pieces, i.e. the first-loss piece, they usually own 2% of the transaction. However, with the way the current FASB proposals are drafted, these investors would now have to place 100% of the transaction on their balance sheet if they also serve as the special-sevicer. "This sets a series of events into motion - investors now have to raise capital, might technically default on their debt covenants and might have to renegotiate these agreements, and might be financially strained to make future investments. This should negatively affect liquidity in the market."
Although he acknowledged that this is a problem for securitization issuers, they might have more of a way out because the Federal Reserve could change capital requirements. This option is not available to CMBS investors that might be forced to consolidate.
Most in the securitization world agree that the QSPE is now a thing of the past. This is why alternative approaches to balance sheet consideration are now being touted by various securitization players and trade groups.
The most prominent thus far is the "linked presentation" concept. This would allow the parties in a transaction to show the liabilities issued in a securitization on the asset side of the balance sheet, as a deduction from the amount of securitized assets under a single caption. Parties would also make parallel presentations on income and cash flow statements.
Whether it's linked presentation or some other concept, the FASB and the securitization industry have to find a replacement for the QSPE. This alternative should not cause a tremendous amount of dislocation to a market that has already suffered from the absence of liquidity and unparalleled volatility.
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