A tax bill now before the House Ways and Means Committee could boost securitization of a wide range of loans and other financial assets by easing the tax restrictions on high-yielding debt.
The bill, formally entitled the Securitization Enhancement Act of 1995, would create a new tax vehicle called a Financial Asset Securitization Trust, or Fasit.
Under this structure, lenders could sell or transfer all forms of loans, including small-business loans, consumer loans, and student and automobile loans, to the Fasit, which in turn would sell pass-through securities to investors.
Donald B. Susswein, a tax lawyer with Thacher Proffitt & Wood in Washington, helped craft the bill. He said the legislation amounts to a "cookbook" on securitization for these loans and is the tax law complement to the Community Development Financial Institutions Act that passed last year.
"It's going to mean another, cheaper, more efficient way for banks and other loan originators to securitize their loans," he said. "It's almost like a tax cut for the banking system."
In particular, the bill allows lenders who set up Fasits to create higher-yielding, subordinated pass-through securities. The law in turn allows these securities to be sold publicly or privately placed with corporate buyers.
Under the treatment of current tax laws, credit enhancement is typically provided by a bank letter of credit which cannot be sold to other investors. The subordination feature under a Fasit structure accomplishes the same credit enhancement purpose.
But there are some important limitations on the ability to issue high- yield securities.
For one thing, the securities cannot pay a yield greater than 500 basis points over treasury securities of comparable maturity. In order to exceed this maximum, the Fasit must sell its securities directly to a corporate buyer, typically the originating bank or another lender.
Patterned after the 1986 legislation that created Real Estate Mortgage Investment Conduits, or Remics, the Fasit bill is intended to expand the amount of credit by encouraging lenders to sell the loans on their books and recycling the cash into new loans.
Rep. E. Clay Shaw Jr., R-Fla., a co-sponsor of the bill, told the Ways and Means Committee that introduction of Remics in 1986 helped securitizations in the home mortgage market balloon from 20% of the market to over 50% today, including nearly all of the fixed-rate mortgage market.
That legislation is also credited with helping foster a dramatic rise in the overall level of mortgage originations, from $2.5 trillion in 1986 to around $4 trillion today.
One of the stated goals of the new bill is to expand credit for small businesses. But some industry observers say that securitization of small business loans requires more than changing the tax code.
For one thing, Securitization in the mortgage, credit card and auto finance industries was built upon having homogeneous assets.
Also, lack of information and constant monitoring may stunt securitizations of small-business loans, according to Christopher Beshouri and Peter Nigro, financial economists at the Office of the Comptroller of the Currency who co-authored a November report on the topic.
As a result, securitization of small business loans will "be undertaken for special purposes rather than as a primary funding mechanism," they say.
But creation of Fasits is expected to add an important new level of certainty to the tax treatment of securitizations, which will in turn aid innovations already occurring in this market.
For instance, Money Store Inc. recently securitized the nonguaranteed portion its of Small Business Administration-backed loan portfolio by using its underwriting standards as the common element.
For the banking industry in general, the bill is expected to not only expand the amount of credit available, but also pass the risk of each loan out of the banking industry and into the hands of private investors.
Said Rep. Shaw: "Securitization makes it easier for lenders and investors to achieve appropriate diversification of their portfolios." And this will "help prevent a localized economic problem from dragging down all of an area's local financial institutions."
So far, the bill has support on the committee from members of both political parties.
Estimates are that the new mechanism will not cost anything to create, but will bring in $87 million over the next five years as lenders sell or transfer loans to Fasits.
Advocates feel this gives the bill as strong a chance of success as any measure currently before Congress.
"We believe the chances of this bill getting through the (Ways and Means) committee are as good as they are for any legislation out there," said Scott Spear, an aide to Rep. Shaw.
