Longer paper routes: banks have gone to greater lengths to keep assets off their balance sheets. That means higher prices for commercial paper - banking - restructuring conduit assets

CFO: Magazine for Senior Financial Executives,  Oct, 2003  by Hilary Rosenberg

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Will customers accept such a cost increase? Bankers think so, if only because many of their ABCP clients are loan clients as well. "Marginally increased costs won't cause them to pull out," Durham says. At least one corporate finance executive agrees. Although "we never like costs to go up," says General Motors's assistant treasurer, Sanjiv Khattri, the company recently used a restructured conduit that is "slightly more expensive" to refinance the office space it leases in Detroit's Renaissance Center.

But some observers point out that returns on the subordinated notes, and thus costs of conduits restructured through their use, will have to exceed 25 percent if expected losses exceed 20 percent, which is likely for assets whose credit quality is less than stellar.

"I'd be willing to bet that those now paying 200 basis points to participate in a conduit will pay a lot more," says Jeff Wallace, a principal in Greenwich Treasury Advisors, in Greenwich, Connecticut.

The question of whether conduits mill remain worthwhile may come down to whether they will continue to be less expensive than such alternatives as revolving credit. That depends on whether the banks also boost their pricing on revolvers and the like to maintain the current cost advantage of conduits. The answer to that question at this point is unclear.

RELATED ARTICLE: One out of three ain't bad.

BANKS HAVE EXAMINED three different means of restructuring their conduits:

THE SILO METHOD. Bank of America reportedly used this technique to restructure about $6 billion of its roughly $22 billion in conduit assets. In this arrangement, companies that have sold assets into the pool consolidate the assets and liabilities on their own books, with each set of assets being a "silo." Such an arrangement isn't really asset-backed lending, but more of a traditionally collateralized loan. And the participants in the new entity already consolidated the assets and liabilities, This technique will not become more common unless other companies are willing to do the same, and so far there's little sign of that.

JOINT VENTURE. A few banks reportedly are attempting to form a joint venture for purposes of restructuring their conduits, although they hadn't completed the transaction at press time. The concept: If three or more conduit sponsors combine their conduits, no one of them could be the primary beneficiary--and thus all would escape the confines of FIN 46. Each sponsor would provide liquidity and credit enhancement, and the commercial paper would be backed by all of the conduit assets. The trouble with this approach, besides its complexity, is that "you are exposed to the credit risk of a competitor's clients and the underwriting of a competitive sponsor," says Deborah Seife, managing director at Fitch Ratings.

EXPECTED-LOSS TRANCHE. By far the most popular method for restructuring ABCP conduits, this carries the greatest ongoing cost to corporate customers. The concept here is that a third-party investor in the conduit covers the majority of the expected losses (before the bank's credit enhancement), which by FIN 46's definition makes it, not the bank, the primary beneficiary. The bank has to estimate the expected losses from the pool, construct a subordinated note worth more than that amount (leaving room for the conduit to growl, and pay an interest rate high enough to sell that note to an investor willing to consolidate the conduit's assets and liabilities on its own balance sheet. Critically, the bank's credit enhancement does not make it the primary beneficiary under FIN 46. * H.R.