Two and a half years in the making, guidelines for financial asset securitization investment trusts (Fasit) have finally been issued. While market observers are surprised the U.S. Treasury Department even issued these long-awaited guidelines, they have been drawn to two or three specific areas of the proposed regulations.

Congress first passed legislation in August 1996 creating the new securitization structure, which was an attempt to apply the real estate mortgage investment conduit (Remic) structure to other non-real-estate asset classes, particularly credit-card receivables and construction loans. However, because the legislation was an addendum to a minimum-wage bill, it is believed the Treasury was never really enthusiastic in providing guidelines for the structure, and presented these guidelines to answer criticism of their delay.

"Possibly because the Fasit legislation was hastily grafted onto the minimum- wage increase bill in August of 1996, Treasury never really got a handle on what Fasit was all about, and needed this extra time to get comfortable with issuing regulations," said Stephen Whelan, chairman of the corporate department at the law firm of Thacher Proffitt & Wood.

In addition, the original legislation left many questions unanswered, and these guidelines were an attempt to address them, said Mark Leeds, capital markets partner at Deloitte & Touche. The proposed regulations are currently in an open comment period until May 8, and a comment hearing will take place May 15.

"Because it was a whole new regime, and because it wasn't as nice and tidy as mortgage-backed securities, they instructed us to write regulations to cover whatever issues may write up," said a source from the Treasury department.

The 89-page regulation provide information covering all aspects of the Fasit structure, including: how to form one; the effect of forming it; how to make the election; how the investors, the entity itself and the owner are treated; how to get out of the transaction; what kind of securities it could hold; and how to transition from a prior asset-backed vehicle to a Fasit.

The Remic Rule

Among those areas of particular interest is the new rule for Remics. "The new Remic rule is extremely important," Leeds said.

This rule, according to a source at the Internal Revenue Service, states that the tax on phantom income must be paid when transferring interest to a third party. "If the present value of what you pay out is more than what you get back, something's wrong," the source said.

"The theme certainly seemed to be focused on anti-abuse," said Michael Decker, vice president for research and policy analysis at the Bond Market Association. "In general, we agree with the notion people shouldn't use the Fasit structure for abusive transactions, so the extent that the IRS is focusing on anti-abuse, is appropriate."

The source from the Treasury noted that the anti-abuse rule is the only portion of the regulations that is effective immediately. The rules state that "if you're trying to use one of these new Fasit vehicles for purposes other than securitization, the commissioner can step in and recharacterize the transaction," according to the source.

"It's very broad, it gives the Treasury a lot of latitude," Leeds said. "Rather than going with hard-and-fast rules, they went with a regimen that allows them to address all types of transactions. They give themselves broad power to enforce the underlying purpose of the rules."

"There was some really good news that lines of credit are a permissible Fasit asset," Leeds added. "I thought that was pretty important."

The Taxable Gain Formula

There was one pleasant surprise in the regulations, according to one source, relating to the taxable gain that would have to be recognized on transfer of the assets to a Fasit. "If the assets are worth $100 million, and because of the advantageous securities the Fasit can issue, the Fasit would pay $110 million to the originator for those assets; that's a taxable gain," said the source. "Whereas in a typical debt deal, that $10 million increase can be amortized over the life of the securities."

The formula for figuring out taxable gain, however, will only be used on assets originated by the originator. If instead of making a loan directly some independent third party makes the loan and then sells that loan to the originator of the Fasit, then the formula will not have to be used.

Foreign-Tax Credits and Liability

One area that the Treasury did not take into account in 1996 and have since revisited concerns foreign tax. "When Congress initially enacted the Fasit regulations, they were not thinking of cross-border securitizations and the implications on the allowance of foreign-tax credits," the Treasury source explained.

"We understand there were a number of transactions the Treasury was aware of...that were foreign-tax credit plans, and they're specifically addressed here," said Deloitte's Leeds. "The foreign-tax credit strategies that had been thought about in connection to Fasit had been shut down. There have been other cross-border strategies that were addressed here that they were quite well aware of."

An area of concern, however, involves the Fasit's tax liability. "Apparently, the Treasury wants to make the Fasit itself liable secondarily. If the owner of the ownership interest doesn't pay taxes on the income of the Fasit, then the Fasit would have to pay it," said a source. "That would be a dramatic change in the law." The source said this is "unpleasantly surprising" because of the Fasit's three types of interest: regular debt interest, high-yield interest and ownership interest.

Any Deals in the Works?

When Fasit legislation first passed Congress in 1996, a deal by Nomura Securities and Freddie Mac was the first public deal to be conducted under the Fasit structure, and only a few have been done since. While there has been no requirement that transactions could not take place until regulations were issued, many waited.

And because of changes in financial policy since 1996, particularly Financial Accounting Statute No. 125 and the check-the-box' regulation, people have been able to structure deals so that the desired tax and accounting treatment is much easier to obtain, giving today's Fasit structure a struggling start.

"So paradoxically, whereas initially Fasit was designed to provide certainty in an uncertain world, for the early users of Fasit, they will be injecting uncertainty - because Fasit is still something that's new - in a world that has been characterized by a comfortable level of certainty for originators and investors," Whelan said.

"We're able to do deals that get us pretty much optimal economic treatment," added another source.

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