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CDO Managers Challenge FASB Proposal


Existing collateralized debt obligations will not be grandfathered under the Financial Accounting Standards Board's proposal to raise the required equity in CDOs from 3% to 10%, much to the dismay of CDO managers, who may have to consolidate these off- balance sheet transactions on the balance sheet. FASB is seeking to implement the new rule in July and rating agency analysts and managers are still unclear of the potential impacts or feasibility of restructuring past transactions. But the initial take is not good. "It's not a viable option," said Andrew Dickey, managing director at MassMutual subsidiary, David L. Babson, regarding the idea of an equity overhaul.

"We do not want to consolidate," stated Bill Jaume, senior v.p at Harbourview Asset Management. Jaume explained the FASB proposal unfairly includes traditional cash flow arbitrage deals--the most popular structure used-- under the umbrella of all special purpose entities, even though CLO managers buy assets in the open market. "Investors know signing up that they only have recourse to the assets," he said, noting that the purchased assets are already reflected on the balance sheet as investments. "It's accounting 101: a liability means recourse to the company," he continued, explaining that moving arbitrage deals onto the balance sheet will merely confuse regulators and analysts when looking at the financial statements. "Our business would change radically. It warps your ratios."

Elizabeth Russotto, an analyst at Fitch Ratings, said concern is also mounting for managers because it is unclear if such a change will result in high capital charges related to holding capital against the assets. On the equity option, Russotto said such a change will be a drag on deal economics as equity is the most expensive form of capital. "Why should FASB blindly require 10% when the rating agencies require equity based on the quality of the assets?" questioned Jaume. Dickey, remaining optimistic, thinks regulators will not require capital as the collateral on arbitrage CDOs is bought in the open market and is non-recourse. Both Dickey and Jaume agree that the new requirements will impact industry players equally, but will require a backlog of accounting work for all funds.

Ray Simpson, product manager at FASB, explained that right now FASB is working on an exposure draft to come out next month, outlining the new proposal. The board will draft a final document that may include changes reflecting concerns by CDO market players after review of the exposure draft. Jaume says many bankers and managers are currently working to challenge the board.

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