Capital Rules Are Pressuring Funding Units
Scrambling to avoid increased capital requirements, a number of huge banks are revising how they guarantee billions of dollars in off-balance-sheet assets.
Citicorp has just finished arranging new guarantees, First Chicago Corp. is midway through the process, and other banks are in various stages, according to market sources.
At issue are asset-backed commercial paper programs set up by banks to provide financing for corporate customers. The special funding vehicles enable banks to maintain customer relationships without having to expand their balance sheets.
Banks have usually ensured the creditworthiness of these special-purpose corporations by issuing some type of guarantee.
Regulators require banks to set capital aside for so-called credit enhancements -- such as letters of credit -- that are used to guarantee that assets raised by the funding units will be repaid by the borrowing corporation.
A Change in the Rules
Some banks that used a hybrid type of guarantee had been setting aside less capital than needed for a letter of credit. But earlier this year, regulators clarified the rules, saying that banks should treat such hybrid guarantees the same as letters of credit.
The hybrid backups function both as credit enhancements, which clearly required capital to be set aside, and as liquidity facilities, which do not require capital.
Banks that used hybrid backups now need to restructure their backups so that less capital is required, or else add new capital - an expensive alternative.
"If you've got a facility being used for liquidity and credit, it's going to be counted as credit -- and capital assessed accordingly," said David Halsted, a managing director at Continental Bank Corp.
Citicorp Obtains Backups
As of last week, Citicorp had obtained new backups for five asset-backed commercial paper programs.
The company purchased a surety bond to provide credit enhancement to a $680 million program, set up a cash collateral account to back a $1.04 billion program, and obtained two letters of credit for a $1.5 billion program, according to a Citicorp official.
Earlier, it obtained new backing for its two biggest programs, which together have about $13.1 billion in assets.
First Chicago, whose largest special-purpose corporations had $5.2 billion in assets at the end of the third quarter, is in the process of obtaining new liquidity backups.
"We're bringing in more liquidity providers from outside," said Steven Johnson, senior vice president and head of asset-backed markets at First Chicago.
He said the Illinois bank has paid others to provide new backups for roughly 30% of the various programs' assets. A source close to the bank said First Chicago expects to have all the new backups it needs by the end of March 1992.
At First Chicago
Mr. Johnson contended that First Chicago was paying other banks for backups because it wanted to limit its own exposure to any single client's assets, not because of any change in the capital requirements associated with the backups.
He said the bank started to revamp the backing of the programs well in advance of any discussion with regulators.
But he said when First Chicago allocates capital to the hybrid backups, "I would guess that a standby letter of credit gets more capital."
An Inopportune Time
The scramble for other sources of guarantees has come at an inopportune time for many banks. Few would-be providers of guarantees have managed to hold onto top credit ratings over the past two years - a key requirement for a provider.
As a result, top-rated banks are setting fees for credit enhancements at roughly 80 basis points of the underlying asset when they provide backup credit, or $8 for every $1,000 of assets. A year ago, those fees would have been closer to 45 basis points, or $4.50 for every $1,000 of assets.
The high cost of replacement backups could eventually make some special-purpose corporations too expensive to maintain.
For now, banks can pass on the cost to the clients that use the special-purpose corporations, according to First Chicago's Mr. Johnson.
But eventually, other sources said, those clients could object, leaving the high-cost replacement backups to be paid for by the banks originating the special-purpose corporations.