At the American Securitization Forum (ASF) Sunset Seminar held last Wednesday, speakers were predicting the death of securitization because of the implementation of the Financial Accounting Standard Board’s (FASB) Financial Accounting Standards (FAS) No. 166, Accounting for Transfers of Financial Assets, an Amendment of FASB Statement No 140 and FAS No. 167,  Amendments to FASB Interpretation No. 46.
The Seminar tackled the impact and collateral consequences these changes might have on the overall securitization and credit markets.

Participants at the gathering also reacted to last Tuesday’s release by the Office of the Comptroller of the Currency (OCC), Board of Governors of the Federal Reserve System, Federal Deposit Insurance Corp., and the Office of Thrift Supervision (OTC) of a request for comment on the proposal to modify their general risk-based and advanced risk-based capital adequacy framework for eliminating the exemption of certain consolidated ABCP programs from risk-weighted assets.

The agencies also requested comment regarding the reservation of authority in their general risk-based and advanced risk-based capital adequacy frameworks to permit the agencies to require banking organizations to treat entities that are not consolidated under accounting standards as if they were consolidated for risk-based capital purposes commensurate with the risk relationship of the banking organization to the structure.

In the request for comment filed with the Federal Register, the agencies stated they are issuing this proposal and request for comment to better align capital requirements with the actual risk of certain exposures and to obtain information and views from the public on the effect on regulatory capital resulting from implementing FAS 166 and 167.

Jason Kravitt, senior partner at Mayer Brown, said that by implementing the recent NPR on regulatory capital in response to the accounting changes in FAS 166 and 167, the regulators are throwing “securitization into the water.”

He then proceeded to enumerate the benefits of securitization for the economy and discussed how each would be affected by the implementation of these changes.

The benefits of securitization, according to Kravitt, are that it provides efficient financing, facilitates the incremental creation of credit by allowing issuers to recycle capital, provides market liquidity, allows for the transfer of risk by individual banks into the capital markets and can create more widespread and cheaper consumer financing.

The new proposed regulatory capital rules will be tied to the new accounting rules. Kravitt said that with the new accounting rules, “it’s going to be very difficult to take the transactions off balance sheets.” As a result, banks will have to keep the same amount of capital against their securitizations as if they engaged only in secured financings. 

If you’re an analyst, you are going to have to work very hard to figure out how much risk is actually kept by banks because of the consolidation of so many SPEs.

He added that the old accounting rules where consolidation was based more on risk rather than control was a better proxy for capital. Using the new accounting to value that amount of risk held by an institution is not a reasonable proxy, Kravitt said.

With these new regulatory capital rules, Kravitt said that when the economy begins to grow again and consumers start to behave less conservatively, banks would be less able to recycle their capital so the important benefits from the securitization of incremental credit creation and transfer of risk would be materially reduced.

The problem with the accounting rules, according to speakers at the Sunset Seminar, is that  it might penalize non-mortgage issuers, rather than mortgage originators. So in effect, the new rules might just be “punishing the innocent” and letting the culprits get off scot free, the participants said.

Also, for credit card issuers for instance, the bank issuers that might have the deposit base would likely turn to that business instead of securitization. Since they have to shore up capital for these deposits — which have increased as consumers have saved up their money as a result of the financial crisis — these institutions might end up  being capital constrained. Thus, although these issuers might be able to protect their capital position, it’s not good for the macro economy because it does not stimulate growth, speakers said. Additionally, they said that depository institutions might walk away from securitization so the market is going to be left with Tier 2 or Tier 3 issuers.

Speakers also said that there should be a delay in the implementation of these rules, which should give issuers time to raise capital to deal with the increased cost. The problem is, speakers said, not only do institutions affected need to deal with raising capital, they also have to figure out how to be compliant with the rules, which would take more time to understand.

In terms of the ABCP market, speakers at the conference said that never in the 26-year history of the market have ABCP sponsors been required to hold as much capital against these deals. Under the proposed rules , the RWA required would be 100% by January 1, 2010, compared with the current 10%. This would put U.S. regulated banks at a disadvantage because non-U.S regulated banks, under Basel II, are only required to keep 7% to 20%.

For ABCP, the primary concern cited in the NPR that caused this change is, in the regulators’ view, the extent of banks’ credit risk exposure to off balance sheet structures with the recent market stress was more than these regulating agencies expected and more associated with non-contractual considerations than what these agencies had thought.

However, these concerns might be alleviated by the nature of ABCP programs. Even in the most stressed times in the ABCP market, speakers said that any support provided by multi-seller programs was contractual and explicit. Furthermore, speakers emphasized that multi-seller ABCP deals are structured to withstand difficult markets and have contractual features like liquidity. Any support provided already had regulatory capital held against it and purchases of commercial paper by the sponsor have resulted in additional regulatory capital as the liquidity capital charge would still be there.

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