New U.S. accounting rules may derail consumer lending

Oct 12, 2009

Fri Oct 9, 2009 4:18pm EDT

By Nancy Leinfuss – Analysis

NEW YORK (Reuters) – The Federal Reserve’s program to revive the markets for U.S. securitized debt may be disrupted and credit to consumers choked off if planned accounting changes are implemented in 2010.

New rules by the Financial Accounting Standard Board, in the form of FAS 166 and 167, will force banks to put securitized debt back on balance sheets and retain continued exposure to the risks related to transferred financial assets, by eliminating the concept of a “qualifying special-purpose entity.”

The amount of capital available for making new loans to consumers for credit cards and mortgages may be restricted as a result.

“There are potentially huge consequences of the FASB changes. There are concerns over whether bank balance sheets will be stretched to the breaking point because of the amounts recorded on balance sheets,” said John Arnholz, partner at law firm Bingham McCutchen.

Used as a crucial funding tool for issuers in the asset-backed market, securitization allows lenders to remove existing debt from their books, package the loans and later sell them as securities to investors. This allows the flow of credit to continue to consumers.

“If you get off-balance sheet treatment, that provides a more efficient use of your balance sheet and has been the foundation of the structured finance market. Bringing it back on balance sheet would have an impact on all your various financial ratios,” said Mike Kagawa, portfolio manager at Payden & Rygel.

The American Securitization Forum recently asked U.S. bank regulatory agencies for a six-month moratorium relating to any changes in bank regulatory capital requirements resulting from the implementation of FASB’s 166 and 167.

“We believe that this action is necessary to avoid a potentially severe capital and credit shock to the financial system as of January 1st, when the new accounting rules generally take effect,” said the ASF.

The role that securitization has assumed in providing both consumers and businesses with credit is striking with currently over $12 trillion of outstanding securitized assets, including mortgage-backed securities, asset-backed securities and asset-backed commercial paper, the ASF said.

Industry experts said the accounting changes threaten to setback the huge strides made by the Fed’s emergency loan program, the Term Asset-Backed Securites Loan Facility, known as TALF, launched earlier this year.

Through the program, the Fed was able to bolster consumer lending and reopen the securitization market for consumer ABS, nearly shutdown by a deep credit crisis in 2008. The program also drove the high costs of funding dramatically lower.

However, issuance under the program may suffer a sharp setback if banks retrench from making new consumer loans amid capital constraints created by heavier debt loads and new accounting and administration costs. The increased costs to banks are likely to filter down to the consumer in the form of higher borrowing costs, as well.

“Despite shifts in supply and demand, it is clear that reducing direct access to the capital markets would pinch consumers’ access to credit,” said John McElravey, analyst at Wells Fargo Securities.

“The balance sheets of banks and other lending institutions would likely only partially compensate for reduced ABS activity. This would be even more difficult if lenders were trying to raise additional capital,” said McElravey.

William Bemis, portfolio manager at Aviva Investors said he expects asset back securities issuance to decline as a result of the new rules.

“Credit card issuance will decline going forward, primarily because the debt will be going on balance sheet now. The attractiveness of being able to get financing and remove assets off balance sheet will be less now,” said Bemis.

While banks may still opt to lend, some may not meet the ratings criteria under TALF, which requires top ratings from credit agencies, as they carry heftier debt loads.

“This could really stifle issuance under the program because you need two ‘AAA’ ratings to issue under TALF. The accounting rules have the potential to reduce lenders’ access to TALF, which the Fed has devoted $1 billion in funds to,” said another industry source.

Meanwhile, as the deadline looms closer, market participants are expecting the Federal Deposit Insurance Corp. to weigh in with further clarification on off-balance sheet rules for securitizations.

“People are getting discouraged because the clock is ticking and this is going to help dry up money that would be available for consumer lending. The Fed knows how important it is to keep credit flowing but it seem that’s not getting through to the FDIC.” said the industry source.

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