12/11/2009

Accounting Relief Seen in Conduit Tweak

Companies that rely on commercial-paper conduits for funding are getting innovative in a late-year scramble to make sure their receivables continue to receive off-balance-sheet treatment.

The efforts represent some of the latest maneuvers stemming from the Financial Accounting Standards Board's FAS 166 and 167 rules, which among other things will force banks that run conduits to bring those vehicles' assets onto their books beginning Jan 1. Now businesses that draw financing from those entities are awakening to the possibility that they too may face balance-sheet impacts.

Their response is to propose changing the way they supply credit enhancement for asset pools sold to conduits, mainly trade receivables.

Take a $1 billion batch of receivables as an example. Right now, a company that wants to sell those assets to a conduit while kicking in enhancement of, say, 10%, would hand over the full $1 billion portfolio while getting back $900 million of up-front funding. The remaining $100 million would protect conduit investors as over-collateralization.

Under current FASB guidelines, the over-collateralization would remain on the seller's books while the rest would come off its balance sheet via a so-called true sale. But the new rules would essentially treat the funding as a loan, while negating the seller's true-sale status and possibly forcing it to keep all $1 billion of assets on its books.

The suggested work-around is to still get the $900 million up-front, while replacing the over-collateralization with a junior non-participating note. The move would lessen the seller's exposure as a supplier of credit enhancement, while preserving its true-sale status via a "deferred-payment" arrangement. The upshot is that only the note would have to be carried on the seller's balance sheet, at least in the view of some accountants.

The proposals are coming mainly from small, privately held companies in the manufacturing, industrial and financial sectors.

Larger publicly traded businesses with big financing divisions - say, a Ford, GE Capital or John Deere - face greater regulatory scrutiny and in many cases have already given up on off-balance-sheet treatment for conduit assets. Still, virtually every conduit operator in the U.S. has found itself in the position of deciding whether to allow the maneuvers. "It's pretty much any company that sells receivables to a conduit," the head of one bank's asset-backed commercial paper group said.

Some of the agreements have already been inked, and negotiations are expected to heat up in coming weeks as the deadline for complying with the new FASB rules approaches. That reflects a situation in which many sellers have managed to remain unaware of their exposure to the accounting change until now, even though the revised procedures have been in the works for years. "If you're some chemical company selling your trade receivables to a conduit, and you like being off-balance sheet, you're just waking up to realize this, and it's a rude awakening," one conduit administrator said.

The implications for sellers could be extensive. Financial institutions, for example, would have to hold regulatory capital against on-balance-sheet assets. With more liabilities on their books, companies of all types could also risk violating debt-to-equity limitations in other lending agreements. That could lead to higher overall borrowing costs, and reduce the businesses' borrowing power.

Whether a switch in credit-enhancement methods would have the desired outcome is far from settled, however. Certain conduits are allowing the moves, sometimes on a case-by-case basis, while others are holding out until they hear back from regulators.

"It's a small, technical difference, so I don't think that [regulators will allow] it," another bank's conduit head said. He said it's possible government authorities will invalidate the approach once word gets out. Still, his institution is giving the go-ahead to clients that want to make the change.

The leader of yet another bank's conduit division said he is approaching certain customers to suggest such an arrangement. "We're bringing it up as a marketing issue," he said. "It gives us a competitive advantage if we can put one of these together for a client."

For conduit operators, the larger impact of the new FASB rules may be the emergence of yet another reason for clients to seek alternatives to securitization. "That's the big fear," said one bank's conduit chief. "It will affect the balance of who securitizes and who doesn't."

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