Anxiety's price: new regulations call into question the value of off-balance-sheet financing, if only because of their impact on bankers' fees - Special Report Banking

CFO: Magazine for Senior Financial Executives,  March, 2003  by Randy Myers

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One financial strategy that promises to become prohibitively costly for most companies involves synthetic leases, which are typically used to take such assets as real estate off corporate balance sheets. These deals almost always use SPEs that wouldn't qualify for nonconsolidation under FIN 46. "Instead of being done out of SPEs, they will have to be done out of substantive operating entities," says Kravitt, "which may reduce the volume of these transactions." Some companies, including Cisco Systems Inc., Silicon Graphics Inc., and Krispy Kreme Doughnuts Inc., have already ended their syntheticlease programs.

In addition to specifying when VIEs must be consolidated, FIN 46 adds disclosure requirements for certain VIEs that don't need to be consolidated. FIN 46 applies immediately to VIEs created after January 31 of this year; it applies in the fiscal year or interim period beginning after June 15, 2003, to VIEs started or acquired before February 1, 2003.

FASB is not the only organization requiring greater disclosure relating to SPEs. On January 22, the Securities and Exchange Commission implemented portions of the Sarbanes-Oxley Act of 2002 by requiring, among other things, that companies begin disclosing in their annual and quarterly SEC filings all material off-balance-sheet transactions and obligations with unconsolidated entities (see "Two Weeks in January," page 75).

Despite the added regulatory burden, George Miller, deputy general counsel for the Bond Market Association, predicts that the growth of structured finance will not be interrupted. "The world of securitization--the vast majority of that market, which has now grown to be quite significant in terms of its overall size and scope and importance--is going to continue in a very robust way, just as it has up until this time," he says.

Maybe. But consolidation and additional disclosure required by the regulators, in light of the increasing incidence of corporate bankruptcies, will inevitably raise questions about the legitimacy of many deals (see sidebar, page 67).

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The viability of deals that do pass muster will depend on just how much more expensive they become. Maureen Coen, managing director and head of asset-backed commercial-paper origination for Credit Suisse First Boston in New York, says that until now, conduit transactions have been priced to account for three costs: credit risk (the chance that the assets underlying the deal--that is, credit-card receivables-won't perform), liquidity risk (the risk that the bank sponsor or some other third-party entity may have to buy assets out of the conduit to ensure payment to investors in the deal), and administrative costs. Together, those three costs can vary tremendously from deal to deal, ranging from as little as 25 basis points to perhaps 200, depending primarily on the deal's credit and liquidity risk.

If banks are forced to bring conduit assets onto their books, Coen says, they will have to factor a fourth cost component into their deals: that of the additional regulatory capital they would have to hold against those formerly offbalance-sheet assets. Currently, they hold only a minimal amount against their conduits, she says.