Anxiety’s Price

New regulations call into question the value of off-balance-sheet financing -- if only because of their impact on bankers' fees.

The Financial Accounting Standards Board’s new rules for off-balance-sheet financing may not prevent another Enron, but they could very well increase the cost of capital for more honest companies.

For one thing, companies that have to consolidate off-balance-sheet entities will report higher leverage than before, which, all things being equal, may increase the cost of new public-debt offerings for them. Other companies, forced to greater lengths to keep their entities off the books, could find such financing more expensive because of the extra legal and banking work involved.

Cost is clearly an issue for finance executives. MBNA America Bank issues asset-backed securities through such arrangements, says Vernon Wright, executive vice chairman and chief corporate finance officer, “because securitizations serve as a stable, long-term source of cost-effective funding.” The new accounting rules, coupled with closer scrutiny, raise doubts that such financing will continue to serve as such.

Some observers contend that the increased cost will be offset by the resulting gain in investor confidence. “Further negative surprises are not something we want right now,” says Anthony Sanders, an Ohio State University finance professor and an adamant proponent of consolidation. “We need to have confidence in the marketplace, and I think the general principle of having people consolidate and declare what risk exposure they have is incredibly valuable to the economy.”

In essence, the rules FASB issued in January say assets held by special-purpose entities (SPEs) — or what FASB is calling variable-interest entities (VIEs) — must be put back on a sponsor’s own books if it retains a controlling financial interest in them. But even if a sponsor doesn’t have to consolidate the VIEs, it has something to worry about, because the banks that arrange them may have to do so or go to considerable lengths not to. Either possibility will mean at least some extra cost for the companies that are their customers.

Extra Players

In fact, U.S. banks that operate huge asset-backed securitization conduits, through which they issue asset-backed commercial paper for multiple corporate clients, are most likely to be affected by the consolidation requirement. These banks typically provide both liquidity and credit enhancements to deals executed through their conduits. According to a report by Standard & Poor’s credit analyst Tanya Azarchs, this could, under a rule known as Interpretation No. 46 (FIN 46), require the conduit sponsors to bring the assets and liabilities involved onto their balance sheets.

It’s possible, to be sure, that banks could restructure their conduits to qualify for nonconsolidation under the new rules, but at this point most structured-finance experts are uncertain how exactly that might be done. The new rules do not apply to VIEs considered to be “qualifying” SPEs (QSPEs) under FAS 140, which generally include most SPEs created to facilitate issuance of asset-backed securities other than asset-backed commercial paper or collateralized debt obligations (CDOs) — essentially, bonds backed by other bonds. But those are precisely the types of securities that many corporate borrowers have come to depend on.


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