‘Quantum physics’ in ABS as IFRS 9 hurts investment
IFRS 9 accounting rules are cutting certain investors out of some ABS asset classes all together, with auto lease ABS likely to be hardest hit, according to panellists speaking at Global ABS on Tuesday.
The new accounting rules landed in January this year, but their effects are only now rippling through the market – with potential damage for asset classes which can’t meet a test called the “SPPI” – meaning loans consist of ‘solely payments of principal and interest’.
Most vanilla products, such as many mortgages and straightforward consumer lending, qualify, but lease contracts may not, since they can include residual value risk. Ways to hedge the risk, such as residual value put options, may run into other accounting problems, such as losing sale accounting.
If an asset class doesn’t meet the SPPI test, investors applying IFRS 9 might have to mark to market, even if it’s held in the banking book. That leaves bank treasuries, often keen buyers of senior tranches in vanilla products like auto leases, taking far more P&L volatility than before.
Harry Noutsos, global head of ABS at ING, told the Global ABS conference that for him, the SPPI test was “binary” – if an asset class couldn’t meet it, he wouldn’t.
But, according to Noutsos, it’s not even as clear as that implies. He said that ING’s accountants had decreed that all but two of the bank’s Spanish RMBS investments failed the test, while for other prospective investments, the originator’s accountants said it met the test, but ING’s said it failed.
“How can something both meet the test and not meet the test at the same time?,” said Noutsos. “It’s quantum physics in the ABS world.”
The SPPI test, according to John Kent, partner at Deloitte, is also very prescriptive about the interest rates used to calculate payments. The Spanish RMBS that failed ING’s test had mortgages linked to a backward looking Bank of Spain rate, rather than to Euribor.
This could be a further headache for the market as it seeks solutions for the likely end of Libor and Euribor rates in 2021.
If the solution chosen by the market and by regulators fails to meet the SPPI test, this could mean major P&L volatility for existing holders of ABS.