Agencies Seek Comment on Proposed Regulatory Capital Standards Related to Adoption of Statements of Financial Accounting Standards No. 166 and 167
I. Background The agencies’ regulatory capital regime for banking organizations incorporates both leverage and risk-based measures. The leverage measure uses on-balance sheet assets as the basis for setting capital requirements that are intended to limit the degree to which a banking organization can leverage its equity capital base. The risk-based measures (the general risk-based capital rules and the advanced approaches rules) establish capital requirements intended to reflect the risks associated with on-balance sheet exposures as well as off-balance sheet exposures, such as guarantees, commitments, and derivative transactions. The agencies use generally accepted accounting principles (GAAP), as established by FASB, as the initial basis for determining whether an exposure is treated as on- or off-balance sheet for regulatory capital purposes. The GAAP treatment for structured finance transactions using a special purpose entity (SPE) generally has been governed by the requirements of Statement of Financial Accounting Standards No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities (FAS 140) and FASB Interpretation No. 46R, Consolidation of Variable Interest Entities (FIN 46(R)). Under FAS 140 (as currently in effect), transfers of assets to an entity that meets the definition of a qualifying special purpose entity (QSPE) are usually recognized as sales, which permits the transferor to remove the assets from its balance sheet. In addition, FIN 46(R) specifically excludes QSPEs from its scope despite the fact that many QSPEs would have otherwise been deemed variable interest entities (VIEs) subject to FIN 46(R) and possible consolidation. On June 12, 2009, FASB finalized modifications to FAS 140 and FIN 46(R) (the 2009 GAAP modifications) through Statement of Financial Accounting Standards No. 166, Accounting for Transfers of Financial Assets, an Amendment of FASB Statement No. 140 (FAS 166), and Statement of Financial Accounting Standards No. 167, Amendments to FASB Interpretation No. 46(R) (FAS 167). FAS 166 and FAS 167 are effective as of the beginning of a banking organization’s first annual financial statement reporting period that begins after November 15, 2009, including interim periods therein, and for interim and annual periods thereafter. As discussed in further detail below, the 2009 GAAP modifications, among other things, remove the concept of a QSPE from GAAP and alter the consolidation analysis for VIEs, thereby subjecting many VIEs that are not consolidated under current GAAP standards to consolidation requirements. These changes will require some banking organizations to consolidate the assets, liabilities, and equity of certain VIEs onto their balance sheets for financial and regulatory reporting purposes. II. The 2009 GAAP Modifications Under FAS 167, a VIE is an entity whose equity investment at risk is insufficient to permit the entity to finance its activities without additional subordinated financial support (for example, an entity with nominal common equity) and/or whose equity investors do not have rights or obligations with respect to the entity typical of equity investors. For example, a VIE generally exists when the administrators of an entity hold a nominal common equity interest, and debt holders hold the rest of the economic interests in the entity (which frequently are issued in various degrees of subordination). Similarly, an entity is a VIE if its equity holders, as a group, lack the right to make decisions about the entity’s activities; the obligation to absorb the expected losses of the entity, or the right to receive the expected residual returns of the entity. Thus, for example, an entity whose debt holders, rather than its common equity holders, have all essential voting rights and the rights to receive all revenue generated by the entity’s assets, generally would be a VIE. Determining whether a specific company is required to consolidate a VIE under FAS 167 depends on a qualitative analysis of whether that company has a ‘‘controlling financial interest’’ in the VIE. The analysis focuses on the company’s power over and interest in the VIE, rather than on quantitative equity ownership thresholds. A company has a controlling financial interest in a VIE if it has (1) the power to direct matters that most significantly impact the activities of the VIE, including, but not limited to, activities that impact the VIE’s economic performance (for example, servicing activities); and (2) either the obligation to absorb losses of the VIE that potentially could be significant to the VIE, or the right to receive benefits from the VIE that potentially could be significant to the VIE, or both. A company’s analysis of whether it must consolidate a VIE must incorporate the above criteria and take into account the company’s interest(s) in the VIE and the characteristics of the VIE, including the involvement of other VIE interest holders. FAS 167 also requires a company to conduct ongoing assessments using the above criteria to determine whether a VIE is subject to consolidation. FAS 166 amends FAS 140 by removing the QSPE concept from GAAP, strengthening the requirements for recognizing the transfer of financial assets to a third party, and requiring companies to make additional disclosures about any continuing involvement they may have in financial assets that they transfer. As a result, a company that transferred financial assets to an SPE that previously met the definition of a QSPE must now evaluate whether it must consolidate the assets, liabilities, and equity of the SPE pursuant to FAS 167. Furthermore, under the additional disclosure requirements in FAS 166, companies must detail in their financial statements their continuing involvement—through recourse or guarantee arrangements, servicing arrangements, or other relationships—in any financial assets that they transfer to an SPE (whether or not a company is required to consolidate the SPE following the transfer). These disclosure requirements apply as long as a transferring company is involved in financial assets that it has transferred. The 2009 GAAP modifications do not provide for the grandfathering of existing financial structures. Most banking organizations that will be required to consolidate and recognize on their balance sheets many previously unconsolidated VIEs due to the 2009 GAAP modifications will consolidate as of January 1, 2010. These newly consolidated entities will therefore be included in relevant regulatory reports of banking organizations, such as the bank Reports of Condition and Income (Call Reports), the Thrift Financial Report (TFR), and the bank holding company financial statements (FR Y–9C Report). A preliminary analysis of the 2009 GAAP modifications, as well as analysis derived from the agencies’ supervisory information, indicates that the categories of off-balance sheet exposures likely to be subject to consolidation on an originating or servicing banking organization’s balance sheet include:
Certain asset-backed commercial paper (ABCP) conduits;
Revolving securitizations structured as master trusts, including credit card and home equity line of credit (HELOC) securitizations;
Certain mortgage loan securitizations not guaranteed by the U.S. government or a U.S. government-sponsored agency;
Certain term loan securitizations in which a banking organization retains a residual interest and servicing rights, including some student loan and automobile loan securitizations; and
Other SPEs, such as certain tender option bond trusts that were designed as QSPEs.
The 2009 GAAP modifications may also require banking organizations to recognize on their balance sheets certain loan participations and other exposures not related to asset securitization. In addition, banking organizations may need to establish loan loss reserves to cover incurred losses on the assets consolidated pursuant to the 2009 GAAP modifications. Each banking organization must determine which structures and exposures must be consolidated onto its balance sheet, and assess other appropriate adjustments to relevant financial reports, as a result of the 2009 GAAP modifications. Question 1: Which types of VIEs will banking organizations have to consolidate onto their balance sheets due to the 2009 GAAP modifications, which types are not expected to be subject to consolidation, and why? Which types are likely to be restructured to avoid consolidation? III. Regulatory Capital and the 2009 GAAP Modifications The agencies’ capital standards generally use GAAP treatment of an exposure as a starting point for assessing regulatory capital requirements for that exposure. For example, if certain assets of a banking organization are transferred to a VIE through a secured financing but remain on the banking organization’s balance sheet under GAAP, the VIE’s assets are risk-weighted like other consolidated assets. However, if the assets are securitized through sale to a VIE that the banking organization does not consolidate under GAAP, generally the banking organization is required to hold risk-based capital only against its contractual exposures to the VIE. The contractual exposures may take the form of on-balance sheet exposures such as asset-backed securities and residual interests, and off-balance sheet exposures such as liquidity facilities. The 2009 GAAP modifications generally would increase the amount of exposures recognized on banking organizations’ balance sheets. Accordingly, under the agencies’ current regulatory capital requirements, the 2009 GAAP modifications generally would result in higher regulatory capital requirements for those banking organizations that must consolidate VIEs. Under the agencies’ leverage capital requirements, tier 1 capital is assessed against a measure of a banking organization’s total assets, net of the ALLL and certain other exposures. Therefore, previously unconsolidated assets that now must be recognized on a banking organization’s balance sheet due to the 2009 GAAP modifications will increase the denominator of the banking organization’s leverage ratio. Although the 2009 GAAP modifications will also affect the numerator of the risk-based and leverage capital ratios, in many cases both the risk-based and leverage capital ratios of affected banking organizations will decrease following implementation of the 2009 GAAP modifications. The risk-based capital rules specify the components of regulatory capital and recognize variations of risk levels among different exposures through different risk-weight assignments. Although for many years the agencies have used financial information reported under GAAP as the starting point for banking organizations’ regulatory reporting requirements, the risk-based capital rules adjust GAAP balance sheet inputs where appropriate to capture an exposure’s risk or the ability of elements of capital to absorb loss. In their consideration of the 2009 GAAP modifications and the interaction of the modifications with the regulatory capital requirements, the agencies have determined that the qualitative analysis required under FAS 167, as well as enhanced requirements for recognizing transfers of financial assets under FAS 166, converge in many respects with the agencies’ assessment of a banking organization’s risk exposure to a structured finance transaction and other transactions affected by the 2009 GAAP modifications. In the case of some structures that banking organizations were not required to consolidate prior to the 2009 GAAP modifications, the recent turmoil in the financial markets has demonstrated the extent to which the credit risk exposure of the sponsoring banking organization to such structures (and their related assets) has in fact been greater than the agencies estimated, and more associated with non-contractual considerations than the agencies had expected. For example, recent performance data on structures involving revolving assets show that banking organizations have often provided non-contractual (implicit) support to prevent senior securities of the structure from being downgraded, thereby mitigating reputational risk and the associated alienation of investors, and preserving access to cost-effective funding. In light of this recent experience, the agencies believe that the broader accounting consolidation requirements implemented by the 2009 GAAP modifications will result in a regulatory capital treatment that more appropriately reflects the risks to which banking organizations are exposed. Additionally, the 2009 GAAP modifications require that a banking organization regularly update its consolidation analysis with respect to VIEs, and the enhanced requirements for recognition of asset transfers and ongoing disclosure requirements for financial assets with which the banking organization maintains some relationship. These requirements are consistent with the agencies’ view that the capital treatment of some previously unconsolidated VIEs does not reflect the actual risk to which the banking organization may be exposed. Question 2: Are there features and characteristics of securitization transactions or other transactions with VIEs, other SPEs, or other entities that are more or less likely to elicit banking organizations’ provision of non-contractual (implicit) support under stressed or other circumstances due to reputational risk, business model, or other reasons? Commenters should describe such features and characteristics and the methods of support that may be provided. The agencies are particularly interested in comments regarding credit card securitizations, structured investment vehicles, money market funds, hedge funds, and other entities that are likely beneficiaries of non-contractual support. The banking agencies have carefully considered the probable effect on banking organizations’ regulatory capital ratios that will result from the 2009 GAAP modifications and the possible alignments between these effects and the risk-based principles of the risk-based capital rules. The agencies have also carefully considered the potential financial impact of the 2009 GAAP modifications on banking organizations. As part of this consideration, the agencies reviewed relevant data from banking organizations’ public financial filings and regulatory reports as well as information obtained from the supervisory process, including the results of the Supervisory Capital Assessment Program (SCAP). The SCAP evaluated the capital position of the nineteen largest U.S. banking organizations, which are also the banking organizations most involved in asset securitization. As part of the SCAP, participating banking organizations’ capital adequacy was assessed using consolidation assumptions consistent with standards ultimately included in FAS 166 and FAS 167. Having considered this information, including the SCAP results, the agencies do not, at this time, find that a compelling basis exists for modifying their regulatory capital requirements to alter the effect of the 2009 GAAP modifications on banking organizations’ minimum regulatory capital requirements. Furthermore, as discussed above, the banking agencies believe that the capital treatment of many exposures that would be consolidated under the new accounting standards aligns with risk-based capital principles and results in more appropriate risk-based capital charges. The agencies also believe that it is most appropriate for the leverage ratio to continue to reflect the total on-balance sheet assets of a banking organization, in keeping with its role as a supplement to the risk-based capital measure that limits the maximum degree to which a banking organization can leverage its equity capital base. Question 3: What effect will the 2009 GAAP modifications have on banking organizations’ financial positions, lending, and activities? How will the modifications impact lending typically financed by securitization and lending in general? How may the modifications affect the financial markets? What proportion of the impact is related to regulatory capital requirements? Commenters should provide specific responses and supporting data. Question 4: As is generally the case with respect to changes in accounting rules, the 2009 GAAP modifications would immediately affect banking organizations’ capital requirements. The agencies specifically request comment on the impact of immediate application of the 2009 GAAP modifications on the regulatory capital requirements of banking organizations that were not included in the SCAP. In light of the potential impact at this point in the economic cycle of the 2009 GAAP modifications on regulatory capital requirements, the agencies solicit comment on whether there are significant costs and burdens (or benefits) associated with immediate application of the 2009 GAAP modifications to regulatory capital requirements. If there are significant costs and burdens, or other relevant considerations, should the agencies consider a phase-in of the capital requirements that would result from the 2009 GAAP modifications? Commenters should provide specific and detailed rationales and supporting evidence and data to support their positions. Additionally, if a phase-in of the impact of the GAAP modifications is appropriate, what type of phase-in should be considered? For example, would a phase-in over the course of a four-quarter period, as described below, for transactions entered into on or prior to December 31, 2009, reduce costs or burdens without reducing benefits? Under a four-quarter phase-in approach, the amount of a newly-consolidated VIE’s assets that would be subject to the phase-in would be limited to the aggregate value of the assets held by the entity as of the last day of the fiscal year prior to its implementation of the 2009 GAAP modifications. For most banking organizations, the aggregate value would be calculated as of December 31, 2009. During such a phase-in, banking organizations would be required to hold capital (for purposes of calculating both the leverage and risk-based capital ratios) incrementally against 25 percent of exposures subject to consolidation due to the 2009 GAAP modifications for each of the first three quarters of 2010, and against 100 percent of the exposures thereafter. For example, if, as a result of the 2009 GAAP modifications, a banking organization would have to consolidate $10 billion of assets associated with transactions entered into on or before December 31, 2009, it would be required to include $2.5 billion of these assets in its regulatory capital ratios the first quarter 2010, $5 billion the second, $7.5 billion the third, and the full $10 billion of assets in the fourth quarter and future reporting periods. During such a phase-in period, the amount of capital that an institution holds against all of its exposures to a single VIE as of December 31, 2009, would not be reduced as a result of this phase-in. For example, if a banking organization is effectively required to hold risk-based capital against all exposures in a VIE due to a provision of implicit recourse, that capital treatment would continue throughout 2010. For another example, if in the first quarter of the phase-in the amount of capital required for a banking organization’s credit enhancements to a securitization on December 31, 2009, exceeds the amount of capital required for 25 percent (the first quarter phase-in amount) of the newly consolidated underlying assets, the banking organization would be required to hold the greater amount of capital. Regulatory capital rules establish only a minimum capital requirement. In all cases, banking organizations should hold capital commensurate with the level and nature of the risks to which they are exposed. Supervisors will review a banking organization’s securitization and other structured finance activities on an individual transaction and business-line basis, and may require a banking organization to increase its capital if they conclude that its capital position is not commensurate with its risk. IV. Asset-Backed Commercial Paper Programs The agencies propose to eliminate existing provisions in the risk-based capital rules that permit a banking organization, if it is required to consolidate under GAAP an ABCP program that it sponsors, to exclude the consolidated ABCP program assets from risk-weighted assets and instead assess the risk-based capital requirement against any contractual exposures of the organization arising from such ABCP programs. The agencies also propose to eliminate the associated provision in the general risk-based capital rules (incorporated by reference in the advanced approaches) that excludes from tier 1 capital the minority interest in a consolidated ABCP program not included in a banking organization’s risk-weighted assets. The agencies initially implemented these provisions in the general risk-based capital rules in 2004 in response to changes in GAAP that required consolidation of certain ABCP conduits by sponsors. The provisions were driven largely by the agencies’ belief at the time that banking organizations sponsoring ABCP conduits generally faced limited risk exposures to ABCP programs, because these exposures generally were confined to the credit enhancements and liquidity facility arrangements banking organizations provide to these programs. Additionally, the agencies believed previously that operational controls and structural provisions, as well as overcollateralization or other credit enhancements provided by the companies that sell assets into ABCP programs, could further mitigate the risk to which sponsoring banking organizations were exposed. However, in light of the increased incidence of banking organizations providing non-contractual support to these programs, as well as the general credit risk concerns discussed above, the agencies have reconsidered the appropriateness of excluding consolidated ABCP program assets from risk-weighted assets and have determined that continuing the exclusion is no longer justified. Under the proposal, if a banking organization is required to consolidate an entity associated with an ABCP program under GAAP, it must hold regulatory capital against the assets of the entity. It would not be permitted to calculate its risk-based capital requirements with respect to the entity based on its contractual exposure to the entity. V. Reservation of Authority The agencies expect that there may be instances when a banking organization structures a financial transaction with an SPE to avoid consolidation under FAS 166 and FAS 167, and the resulting capital treatment is not commensurate with the actual risk relationship of the banking organization to the entity. Under this proposal, the banking organization’s primary Federal supervisor would retain the authority to require the banking organization to treat the entity as if it were consolidated onto the banking organization’s balance sheet for risk-based capital purposes. Question 5: The agencies request comment on all aspects of this proposed rule, including the proposal to remove the exclusion of consolidated ABCP program assets from risk-weighted assets under the risk-based capital rules, the proposed reservation of authority provisions, and the regulatory capital treatment that would result from the 2009 GAAP modifications absent changes to the agencies’ regulatory capital requirements. Question 6: Does this proposal raise competitive equity concerns with respect to accounting and regulatory capital treatments in other jurisdictions or with respect to international accounting standards? Although the agencies believe that GAAP, as modified, should remain the starting point for calculating regulatory capital ratios and that the capital requirements resulting from the 2009 GAAP modifications generally will result in a more appropriate reflection of credit risk, the agencies recognize that the principles underlying the 2009 GAAP modifications—power, benefits, and obligation to bear losses—and the resulting consolidation treatment, may not in all situations and respects correspond to a treatment that would result from a more pure risk focus. Question 7: Among the structures that likely will be consolidated under the 2009 GAAP modifications, for which types, if any, should the agencies consider assessing a different risk-based capital requirement than the capital treatment that will result from the implementation of the modifications? How are commenters’ views influenced by proposals for reforming the securitization markets that require securitizers to retain a percentage of the credit risk on any asset that is transferred, sold or conveyed through a securitization? Commenters should provide a detailed explanation and supporting empirical analysis of why the features and characteristics of these structure types merit an alternative treatment, how the risks of the structures should be measured, and what an appropriate alternative capital treatment would be. Responses should also discuss in detail with supporting evidence how such different capital treatment may or may not give rise to capital arbitrage opportunities. Question 8: Servicers of securitized residential mortgages who participate in the Treasury’s Making Home Affordable Program (MHAP) receive certain incentive payments in connection with loans modified under the program. If a structure must be consolidated solely due to loan modifications under MHAP, should these assets be included in the leverage and risk-based capital requirements? Commenters should specify the rationale for an alternative treatment and what an appropriate alternative capital requirement would be. Question 9: Which features and characteristics of transactions that may not be subject to consolidation after the 2009 GAAP modifications become effective should be subject to risk-based capital requirements as if consolidated in order to more appropriately reflect risk? Question 10: Will securitized loans that remain on the balance sheet be subjected to the same ALLL provisioning process, including comparable loss rates, as similar loans that are not securitized? If the answer is no, please explain. If the answer is yes, how would banking organizations reflect the benefits of risk sharing if investors in securitized, on-balance sheet loans absorb realized credit losses? Commenters should provide quantification of such benefits, and any other effects of loss sharing, wherever possible. Additionally, are there policy alternatives to address any unique challenges the pending change in accounting standards present with regard to the ALLL provisioning process including, for example, the current constraint on the amount of provisions that are includible in tier 2 capital? Commenters should provide quantification of the effects of the current limits on the includibility of provisions in tier 2 capital and the extent to which the 2009 GAAP modifications and the changes in regulatory capital requirements proposed in this NPR affect those limits. VI. Regulatory Analysis Regulatory Flexibility Act The Regulatory Flexibility Act, 5 U.S.C. 601 et seq. (RFA), generally requires that, in connection with a notice of proposed rulemaking, an agency prepare and make available for public comment an initial regulatory flexibility analysis that describes the impact of a proposed rule on small entities. Under regulations issued by the Small Business Administration, a small entity includes a commercial bank, bank holding company, or savings association with assets of $175 million or less (a small banking organization). As of June 30, 2009, there were approximately 2,533 small bank holding companies, 385 small savings associations, 749 small national banks, 432 small State member banks, and 3,040 small State nonmember banks. As a general matter, the Board’s general risk-based capital rules apply only to a bank holding company that has consolidated assets of $500 million or more. Therefore, the proposed changes to the Board’s capital adequacy guidelines for bank holding companies will not affect small bank holding companies. Other than the proposed modifications to the risk-based capital rules that would no longer allow banking organizations to exclude consolidated ABCP programs from risk-weighted assets, the proposed rule does not impose any additional obligations, restrictions, burdens, or reporting, recordkeeping or compliance requirements on banks or savings associations, including small banking organizations, nor does it duplicate, overlap or conflict with other Federal rules. The agencies expect that the proposed modifications to the general risk-based capital rules would not materially affect small banking organizations because they do not sponsor ABCP programs. Paperwork Reduction Act In accordance with the requirements of the Paperwork Reduction Act of 1995(44 U.S.C. 3506), the agencies have reviewed the proposed rule. The Board reviewed the proposed rule under the authority delegated to the Board by the Office of Management and Budget. The agencies note that instructions related to ABCP conduits in schedule RC–R of the Consolidated Reports of Condition and Income (OMB Nos. 7100–0036, 1557–0081, and 3064–0052; FFIEC 031 and 041) and schedule HC–R of the Consolidated Financial Statements for Bank Holding Companies (OMB No. 7100–0128; FR Y–9C) would need to be revised under the proposal. The agencies, however, do not believe that there would be any additional burden associated with these instructional changes as they would be in accordance with GAAP. OCC/OTS Executive Order 12866 Executive Order 12866 requires Federal agencies to prepare a regulatory impact analysis for agency actions that are found to be ‘‘significant regulatory actions.’’ Significant regulatory actions include, among other things, rulemakings that ‘‘have an annual effect on the economy of $100 million or more or adversely affect in a material way the economy, a sector of the economy, productivity, competition, jobs, the environment, public health or safety, or State, local, or Tribal governments or communities.’’ The OCC and the OTS each determined that its portion of the proposed rule is not a significant regulatory action under Executive Order 12866. OCC/OTS Unfunded Mandates Reform Act of 1995 Determination The Unfunded Mandates Reform Act of 1995 29 (UMRA) requires that an agency prepare a budgetary impact statement before promulgating a rule that includes a Federal mandate that may result in the expenditure by State, local, and Tribal governments, in the aggregate, or by the private sector of $100 million or more (adjusted annually for inflation) in any one year. If a budgetary impact statement is required, section 205 of the UMRA also requires an agency to identify and consider a reasonable number of regulatory alternatives before promulgating a rule. The OCC and the OTS each have determined that its proposed rule will not result in expenditures by State, local, and Tribal governments, in the aggregate, or by the private sector, of $100 million or more in any one year. Accordingly, neither the OCC nor the OTS has prepared a budgetary impact statement or specifically addressed the regulatory alternatives considered. Solicitation of Comments on Use of Plain Language Section 722 of the GLBA required the agencies to use plain language in all proposed and final rules published after January 1, 2000. The agencies invite comment on how to make this proposed rule easier to understand. For example:
Have the agencies organized the material to suit your needs? If not, how could they present the rule more clearly?
Are the requirements in the rule clearly stated? If not, how could the rule be more clearly stated?
Do the regulations contain technical language or jargon that is not clear? If so, which language requires clarification?
Would a different format (grouping and order of sections, use of headings, paragraphing) make the regulation easier to understand? If so, what changes would achieve that?
Is this section format adequate? If not, which of the sections should be changed and how?
What other changes can the agencies incorporate to make the regulation easier to understand?
Fitch: U.S. Credit Card Performance Measures Mixed as Chargeoffs Drop 29 Oct 2009 11:54 AM (EDT)
Fitch Ratings-New York-29 October 2009: U.S. credit card performance measures exhibited mixed results last month with chargeoffs declining for the second time in three months while delinquencies resumed their upward trends according to the latest Credit Card Index results from Fitch Ratings. The results come as consumers continue suffer from high unemployment rates and a lack of credit availability.
'U.S. consumer credit quality measures remain pressured and chargeoffs will stay high until we see some improvement in employment conditions and in delinquency trends,' said Managing Director Michael Dean.
Despite the ongoing unfavorable trends, Fitch continues to expect current ratings of senior credit card ABS tranches to remain stable given available credit enhancement and structural protections afforded investors. The outlook for subordinate tranches remains negative. Fitch expects the U.S. unemployment to peak at 10.3% in second-quarter 2010 and remain above 10% throughout 2010.
During the month, Fitch's Credit Card Chargeoff Index declined 77 basis points (bps) to 10.75%, marking just the third month-over-month improvement. Despite pulling back from last month's record high, the chargeoff index remains 71% above year-earlier levels.
Measured by Fitch's 60+ day delinquency index, late payments rose 16 bps to 4.22% after a 20 bp dip last month. Late stage delinquencies are running 33% higher on a year-over-year comparison. Early stage late payments increased for the month as well, with 30+ day delinquencies rising 13 bps.
'While somewhat seasonal, the rise in delinquencies provides further evidence that chargeoffs will remain elevated in the coming months,' said Senior Director Cynthia Ullrich.
Monthly payment rate (MPR) remains stronger than earlier this year at 17.98%. MPR is well above the historical average of 15.98% and remains above the 2009 average of 17.37%. MPR has remained consistent year-over-year as current MPR is 9 bps higher than it was during October 2008.
During October, gross yield decreased 27 bps to 19.39%. However, gross yield continues to be strong relative to historical data as a result of discount options and repricing initiatives in various trusts. Compared to last year, gross yield is up 254 bps or 12%.
Three-month average excess spread increases 50 bps this month to 5.75%., its highest level since the February 2009 period. This increase is driven by the one month excess spread increasing to 5.99% this month. The increase in three-month average excess spread has enabled trusts that were trapping excess spread to release all or part of the trapped amount.
Contact: Michael Dean +1-212-908-0556 or Cynthia Ullrich +1-212-908-0609, New York.
Media Relations: Sandro Scenga, New York, Tel: +1 212-908-0278, Email: sandro.scenga@fitchratings.com.
Additional information is available at 'www.fitchratings.com'
October 7, 2009
Debt-Market Paralysis Deepens Credit Drought
By JENNY ANDERSON
A year after Washington rescued the big names of American finance, it’s still hard to get a loan. But the problem isn’t just tight-fisted banks.
The continued disarray in debt-securitization markets, which in recent years were the source of roughly 60 percent of all credit in the United States, is making loans scarce and threatening to slow the economic recovery. Many of these markets are operating only because the government is propping them up.
But now the Federal Reserve has put these markets on notice that it plans to withdraw its support for them. Policy makers hope private investors will return to the markets, which imploded during the financial crisis.
The exit will require a delicate balancing act, government officials said.
“You do it incrementally, where and when you think you can, and not sooner,” said Lee Sachs, a counselor to the Treasury secretary, Timothy F. Geithner.
The debt-securitization markets finance corporate loans, home mortgages, student loans and more. In good times, they enabled banks to package their loans into securities and resell them to investors. That process, known as securitization, freed banks to lend even more money.
Many investors have lost trust in securitization after losing huge sums on packages of subprime mortgages that had high default rates. The government has since spent more than $1 trillion trying to restore the markets, with mixed success.
Until more of the securitization market revives, or some new form of financing takes its place, a wide range of loans needed to secure a lasting economic recovery will remain elusive, experts said.
“Given the imperative for securitization markets to fuel bank lending, we won’t have meaningful economic growth until securitization markets are re-established,” said Joseph R. Mason, a professor of banking at Louisiana State University. Mr. Sachs agrees: “It’s very important these markets come back to get credit to businesses and families who need it, and also as a sign of confidence.”
Enormous swaths of this so-called shadow banking system remain paralyzed. Depending on the type of loan, certain securitization markets have fallen 40 to 100 percent.
A once-thriving private market in securities backed by home mortgages has collapsed, from $744 billion in 2005, at the peak of the housing boom, to $8 billion during the first half of this year.
The market for securities backed by commercial real estate loans is in worse shape. No new securities of this type have been issued in two years.
“The securitization markets are dead,” said Robert J. Shiller, the Yale University economist and housing expert who predicted the subprime collapse. The government is supporting them, he said, but it’s unclear what will happen when it extricates itself. “We’re stuck,” he said.
Despite the running problems, federal officials hope to start weaning the securitization markets off government support next spring. The Federal Reserve has spent about $905 billion buying government-guaranteed mortgages in an effort to keep mortgage rates low. It will continue buying until it reaches its target of $1.25 trillion.
Complicating the Fed’s plan, banks — the other source of credit next to the securitization markets — continue to rein in lending, according to data from the Federal Reserve. And next year, banks face accounting rule changes and capital requirements that could further restrict their ability to make loans.
To be sure, certain corners of the securitization market are percolating again, thanks to the government’s Term Asset-Backed Loan Facility, or TALF, which provides attractive financing for investors who buy the securities.
Bonds backed by consumer debt — credit card debt, auto loans and some student loans — are being issued at costs close to those before the financial crisis, an indication that the market is functioning again.
But the program applies only to borrowers with stellar credit. It does not cover credit card debt or auto loans for people with blemished credit histories.
“The market is coming back, but a lot of it is because of TALF,” said Hyun Song Shin, a Princeton economist who studies securitization. “The big question is, Will the private issuance market stand on its own two feet without TALF, or has there been a fundamental change in the market that it is somehow hobbled permanently?”
That question is hard to answer as long as the government is dominating certain securitization markets. So far, the Fed has been most aggressive in supporting the market for mortgage-backed securities, which plays a crucial role in housing finance. The Fed is virtually the only buyer for these instruments, purchasing about $905 billion worth of government-guaranteed mortgage-backed securities through mid-September. Industry analysts estimate that is about 80 to 85 percent of the market.
“This is public support,” said George Miller, executive director for the American Securitization Forum, which represents the industry. “At the end of the day, the mortgage risk is held by the taxpayer.”
Investors are particularly concerned about the commercial real estate market. A big worry is that $50 billion of securitized commercial property loans are due to be refinanced in the next year. If that can’t be done, a toxic mix of declining property prices and maturing loans could lead to fresh losses at many banks.
“If there’s no mechanism, those properties will default,” said Arnold Phillips, who oversees mortgages and structured securities for the $50 billion in fixed-income investments managed by the California Public Employees' Retirement System.
As long as the market remains closed, banks will be reluctant to make loans for commercial real estate, since they would have to hold on to them, rather than package them into securities.
Meanwhile, the programs the government has started have not changed securitization practices that many investors say were a cause of the financial crisis. Lawmakers remain concerned that when securitization comes back, it does so in a way that doesn’t put the financial system at risk.
“Our challenge is to have a robust securitization process that adds value to the economy and doesn’t undermine it,” said Senator Jack Reed, Democrat of Rhode Island and chairman of the Banking Subcommittee on Securities, Insurance and Investment. He plans to hold a hearing on securitization next month to find out why consumers and businesses are still having so much trouble getting loans.
Accounting for Structured Transactions Forcing System Overhauls
August 17, 2009 John Hintze
Financial firms engaged in structured transactions--all the rage over the last decade--face recent accounting changes that could dramatically increase their capital requirements and more immediately require major operational changes in their asset-tracking systems, as well as books and records.
Some structured financial transactions such as mortgage-backed securities (MBS) and securitizations of credit card receivables, have become mainstream and others are highly esoteric. Brokers such as Goldman Sachs and Morgan Stanley, major banks including Bank of America and Wells Fargo, as well as asset-managers like Blackrock have noted the significant effects the new accounting is likely to have--not just on their financial statements but, in the short term, on their operations and technology staff.
Many of those firms will, for the first time, have to bring onto their financial statements a large portion and perhaps a majority of assets and liabilities now parked off-balance sheet in the independent trusts that issue the securities.
"They have to set up internal control processes over hundreds or even thousands of entities that they never had conceived they would need to account for," says Michael Gullette, vice president of accounting and financial management at the American Bankers Association.
Gullet adds that not only will firms have to review transactions to determine whether to consolidate them, but now the review process must be done quarterly. Before, this was done at the birth of the transaction and thereafter only if a major event occurred. In addition, now they will have to establish general ledgers for each of the trusts issuing the securities, integrate those ledgers with central books and records and create reserves for losses on the individual loans parked in each of the vehicles.
Much of that work must be analyzed by staff and the data manually inputted into firms' systems. Systems also must be adjusted to accommodate the new information.
In the works for more than a year, the overhauling of systems began in earnest June 12, when the Financial Account Standards Board (FASB), based in Norwalk, Conn., two standards affecting structured transactions: Financial Accounting Statements No. 166 (FAS), Accounting for Transfers of Financial Assets, and FAS 167, Amendments to FASB Interpretation No. 46(R).
FAS 166 requires disclosures for structured transactions that will be new for private companies but have mostly been required for public companies since the end of 2008.
FAS 167 is by far the bigger challenge. This standard is anticipated to bring billions of dollars of assets and liabilities onto financial firms' balance sheets, ballooning their capital requirements at a time when capital is in short supply, unless regulators change rules by year-end.
Bank of America, for example, estimated in its second-quarter financial statements the need to bring $150 billion in structured transactions onto its balance sheet under the new accounting standard. Citigroup's estimate was $157 billion. Those numbers represent thousands of transactions that previously were held off-balance sheet and now must each be represented by their own general ledgers and integrated with a firm's books and records system.
The more immediate challenge is finding the resources to analyze and consolidate the appropriate assets as well as adapt operations and systems to handle not only the initial consolidation but quarterly monitoring of the transactions.
Complying with the new accounting will ultimately be more complex for the nation's largest banks, given they have multiple units, each dealing in different types of structured transactions that must be analyzed separately under the new standards. Then the data must be consolidated in the central books and records, a requirement that, by definition, never applied to the off-balance sheet transactions.
Smaller financial firms may have fewer transactions to deal with, but also fewer resources to deal with them. For example, Crystal River Capital, a New York-based real estate investment trust, says in its recently issued quarterly statement that it anticipates consolidating the underlying trusts for at least some of its commercial mortgage-backed securities (CMBS) and that the implementation of the standards "requires us to make major operational and systems changes."
Because of "the magnitude and complexity of the operational and system changes that we are making and the limited amount of time available to complete and test our systems development, there is a risk that unexpected developments could make it difficult for us to implement all of the necessary system changes and internal control processes by the January 1, 2010 effective date," the company maintained.
Crystal River did not respond to inquiries about the precise nature of those changes. The director of accounting policy at a large national bank with significant West Coast operations (and underwent major structural changes in last year's financial mayhem) says the firm has mostly finished deciding which transactions to consolidate.
But, "we're just beginning to look at the operations side now, and how we're going to proceed with that," he says. He adds "It's a challenge for all of us who have to consolidate large numbers of structures to determine how we're going to get access to the necessary data on the real-time basis and get it into our systems, so we can begin consolidating."
The first problem, he says, is getting the data and then feeding it into the loan systems of the bank's multiple business units that may deal with transactions ranging from MBS to CMBS to credit card receivables to highly complex lease transactions.
"If I have a loan system, how do I adjust it to capture these additional attributes that I have to continue to monitor?" says Bob Walley, principal at Deloitte & Touche, adding that another challenge will be connecting the data source--often a third-party loan servicer--to the bank's general accounting system. "So the two systems are sharing information," Walley says.
The banker adds that MBS tend to be plain vanilla and fairly static. Other transactions, however, may be actively managed-trading loans in an out of the trust--by a third-party record keeper which simply may not produce the required data to do quarterly assessments on a timely enough basis.
Existing structured investment vehicles (SIVs), for example, may only legally be required to provide data once a year. "Who's going to put up and pay for a reporting structure to track those assets to be able to close the books monthly? Operationally, this is a big deal," he says.
The head of accounting policy at another major U.S. bank based in the Northeast said the institution has been reviewing the transactions, know as variable-interest entities (VIEs), for the past year and still has numerous "miscellaneous structures" to look at.
"The key thing is to determine what new accounts we need operationally," she says, noting that each legal entity requires a column in the consolidated spreadsheets and a new reporting line. The new information also passes through to the cash-flow and income statements, where new items such as interest income and interest expenses will appear.
Numerous complications must be resolved. For example, some VIEs only issue notes and have no equity. "So you have the perplexing question of how do you provide consolidation of a vehicle that has no equity. We're working that through, and figuring out the proper journal entries, says the accounting chief of the Northeastern bank, who spoke on background because of the sensitive nature of the changes.
That's important from a systems standpoint, because transaction data must ultimately move up the chain to the bank's electronic books and records system. Much of that data will be inputted manually at first--the accounting policy chief at the Western bank says his firm is currently maintaining data on spreadsheets before entering it into the books and records system. Manual input increases errors, however, so the goal will be to automate the process as much as possible.
By year-end, a bank's IT staff will have had to create accounts for all the new entities and add new fields to accommodate data that may vary greatly, depending on the underlying asset. "We have to give IT people numbers and account descriptions, and they also have to set up controls to determine who can look at the accounts," the bank accounting chief at the East Coast-based bank says, adding, "Everything has to be compliant with Sarbanes-Oxley," the 2002 federal act which heightened regulation of corporate accounting practices.
She says the bank has developed a working group of executives from departments across the firm, including the tax department and the corporate reporting group, to evaluate the VIEs. Each of the bank's reporting units are listing all of their transactions, "So we know how many new entities there are and how much capacity we must build into the consolidation system that's a part of books and records," she says, adding, "We're going to need capacity for several hundred new vehicles."
In addition, the new on-balance sheet transactions will now have to be approved by various committees, such as the bank's capital management policy committee, and layers of management, requiring adjustment to the firm's workflow system. "All transactions will have to meet approval by several layers," she says, adding there was an approval process when the bank "first became involved" with the VIEs, "So now that process will have to grow to meet the new requirements. I can't exaggerate how big an effort this is."