WASHINGTON — The Federal Deposit Insurance Corp. is ready to clarify today how it will treat securitized assets at a failed bank — a move that would have significant implications for investors if the agency laid claim to such assets.
Under current policy, the FDIC does not touch assets that a failed bank has isolated from its books through securitization. But starting next year, an accounting rule change will force banks to move these assets back on the balance sheet, raising questions about how the FDIC will adjust its policy.
The implications are potentially dramatic; investors would be expected to rethink their participation in such securitizations if they feared the FDIC would later take them.
"If there isn't further clarification of the FDIC's safe harbor, there would likely be significant downgrades of existing credit card" asset-backed securities, "thereby appreciably decreasing the value of those securities," said Tom Deutsch, the deputy executive director of the American Securitization Forum.
The FDIC has not said how it plans to address the issue. The agenda for its board meeting today says it will take up a proposal dealing with the agency's "treatment … as conservator or receiver of financial assets transferred … in connection with a securitization." (The board is also expected to complete rules that would force banks to prepay premiums and require licensing for mortgage originators.)
FDIC action on securitizations is required after the Financial Accounting Standards Board decided in June that banks must move securitized assets onto their balance sheets next year.
Traditionally, institutions doing securitizations have been able to set up special-purpose vehicles that are isolated from the rest of the company's operations and reporting. Banks originated loans and transferred them to the vehicles, where they were formed into securities. These assets were then be sold to investors, who collect the interest income from the loans and maintain rights over the collateral.
In light of the breakdown last year in the mortgage securitization market, FASB has required banks to present those transactions — as well as the underlying loans — in a more transparent way. The change is expected to force banks to hold more capital against these assets. "The thought is that, if it's more prominently on your balance sheet, it's going to be more prominent in people's mind, and they're more likely to try to figure out what is the credit quality of all these loans that you made," said Brian Bushee, an accounting professor at the Wharton School.
But some people worry that, the more these assets are tied in to a bank's balance sheet, the greater the potential for the FDIC to have a legal claim over them in a failure. Typically, few assets are exempt from the agency's authority. But the FDIC's ability to assume control of, and sell off, assets is crucial now as it tries to mitigate its skyrocketing resolution costs.
Observers said that, if the FDIC policy does not continue to make it clear it will not claim securitized assets, ratings agencies might downgrade the securities and investors would fear they might be denied access to collateral if loans default.
"Asset-backed securitization is premised on investors' rights to the underlying asset in the event the payments of principal and interest cease," said Karen Shaw Petrou, the managing partner of Federal Financial Analytics Inc. "They need to make clear they will not exert receivership rights over the underlying collateral in the asset-backed securities, or they'll shoot securitization in the head."
Observers said the issue could particularly affect credit card issuers, who have been among the most active securitizers. Some sources are optimistic that the FDIC will reaffirm its existing policy — established in 2000 — and view securitizations as other asset classes that enjoy special status in receiverships are viewed, for example, the collateral backing Federal Home Loan Bank advances.
"I think they're just going to say: 'Even if it's on the balance sheet, if they appear to be sold' " to investors, " 'they'll be treated like a secured borrowing,' " said Ralph "Chip" MacDonald, a partner in the Jones Day law firm in Atlanta.
Industry representatives are also closely watching the agency as it completes its much anticipated rule to charge the industry in advance for insurance premiums. In September, the agency proposed raising $45 billion to help pay for failures by having institutions pay three years' worth of premiums.
The move was generally supported by the industry. The prepayment would let institutions expense the added charges over time when the assessments would normally be charged rather than taking the immediate hit of another one-time special assessment.
Though the rule is not expected to change significantly from an earlier proposal, some institutions want help to absorb the prepayment. Suggestions have included shortening the prepayment period from three years to two and letting institutions fill out separate invoices for each year's worth of premiums, which would qualify banks for added tax deductions.
"I don't expect big changes," said James Chessen, the chief economist for the American Bankers Association. "We're certainly hoping that there will be some beneficial tax treatment of the prepayment."
The board is also expected to finalize a proposal issued jointly by the regulators in June that would require banks to register their mortgage originators and servicers with a national licensing registry. The proposal, which would implement a 2008 law, came under some criticism for including in the registry servicers that only work on modifications, and do not originate loans.