S&PCORRECT:SF Community on FASB in SF Market Opinion.

Business Editors

(Editor's Note: The version of this article published earlier

today featured incorrect analytical contact information.

A corrected version follows.)

NEW YORK--(BUSINESS WIRE)--Standard & Poor's

July 30, 2002--While the majority of securitization professionals worldwide believe FASB's overarching goals of increased disclosure, transparency, and honesty in balance-sheet reporting are absolutely essential pursuits, most feel that the regulator's singular emphasis on special-purpose entity (SPE) consolidation as the main solution is inappropriate.

Instead, a stronger focus on risk disclosure and corporate integrity would be more suitable, market participants said.

In fact, according to the results of Standard & Poor's inaugural SF Market Opinion survey, which canvassed structured finance professionals globally regarding their views on the SPE consolidation project, more than 81% of respondents, or 247 individuals, believe that a requirement of 10% outside equity is simply not the best way to maintain the integrity of financial statements. Even more telling, perhaps, is that only 18% of participants thought that the final outcome of FASB's endeavors would be fair to all parties -- regardless of what the guidelines turn out to be -- and 60% are concerned that FASB's proposals will restrict the future growth of the securitization market in the U.S.

These statistics were underscored by a variety of pointed comments from respondents stating that increased disclosure is surely critical, but a focus on SPE consolidation is not the proper means of achieving it.

Market players offered many suggestions as alternatives, including improved disclosure of: guarantees, related-party transactions, compensation agreements, and detailed risk/return estimates; the appointment of an outside auditor that reports to the SEC; more of an emphasis on the recognition of the legal status of sold assets; a limiting of recourse obligations; verification of data by an independent third party; and harsher censure for accountants and chief financial officers who fail to act with integrity.

Surprisingly, a small number of constituents said that the 10% equity requirement, although the correct strategy, is actually too low a threshold to ensure improved corporate governance. It is clear, however, that the majority of those who completed the SF Market Opinion survey strongly believe that the salient issues of disclosure and accountability should not be confused with a need to consolidate SPEs back onto the balance sheet, and moreover, FASB's focus needs some fine-tuning.

"I think FASB has more than enough standards regarding off-balance-sheet treatment," said one respondent. "The current SPE consolidation issue is a red herring; the crisis now facing the investment community is one of outright fraud." Another market player said, "We need honesty, transparency, and less emphasis on rules -- more emphasis on principles and substance. And how about accountability of senior management -- they can't say they 'didn't know'!"

"Securitization should have additional checks and balances beyond default modeling, but I think a 10% outside equity mandate is at the other end of the extreme." However, a third individual in the structured finance market said, "I think we should require vehicles to hold more than 10% equity. Heck, you have to put 20% down on a house, so why not give businesses the same rules that the average consumer has to put up with?"

Survey Queries Market Participants on FASB Proposals

In Standard & Poor's first SF Market Opinion questionnaire, these types of sentiments, often divergent but generally reflecting a lukewarm or critical attitude toward the latest FASB proposals, were echoed throughout the responses received from structured finance players.

Consisting of both closed- and open-ended questions, SF Market Opinion is a recurring online survey covering hot topics pertinent to the structured finance community. This new program is intended to create valuable discourse and give individuals an opportunity to hear what their peers are saying on critical issues.

Using Standard & Poor's extensive database of global contacts, SF Market Opinion is an efficient means of gauging what investors, issuers, bankers, accountants, and others involved in securitization are thinking. Moreover, by sharing highlights of each survey with the securitization community, Standard & Poor's continues to promote communication within the industry and fulfill its role as the thought leader of the capital markets.

The first SF Market Opinion, launched via email on June 27, queried participants about their general views regarding the scope, potential impact, and fairness of FASB's proposals as they relate to securitized products. The survey happened to coincide with the release of the FASB Exposure Draft in late June.

A total of 305 participants responded to the survey, of which 247, or 81%, considered themselves at least "somewhat familiar" with the FASB proposals. As should be expected, more U.S. respondents than non-U.S. respondents considered themselves "very familiar" with the proposals (36% vs. 7%), though more non-U.S. participants actually completed the entire questionnaire.

CDO and ABCP Players Are Most Concerned

Although the latest incarnation of the FASB rules seems to offer hope that CDOs and ABCP conduits will ultimately be exempt from consolidation requirements, securitization players are still leery of the long-term effects of the new guidelines.

For instance, the aforementioned statistic that a mere 18% of participants feel the final outcome would be fair to all parties -- regardless of how the final FASB rules turn out -- points to a deep cynicism and concern on the part of structured finance players. Similarly, 60% of the participants said that the proposals might inhibit the growth of the securitization markets.

However, on a more encouraging note, 39% of the total respondents, or 119 participants, expect CDOs and ABCP to be exempted from consolidation; but only 23% think FASB's proposals will have a positive effect on the overall ABS market.

Judging by the vehement, impassioned comments of those involved in the CDO and ABCP industries, it is clear that these asset classes are the most at risk. Twenty-five percent of respondents believe that CDOs face the greatest risk, while 21% believe that ABCP is in the most danger. In addition, 21% of the participants said all areas of the market face risk equally, while only 9% thought that the general ABS market was at risk. "Obviously, FASB does not fully understand the ABCP market," said one participant. "At $750 billion in size, the ABCP market is integral to maintaining liquidity." Another survey participant said, "The proposals could take away some of an ABCP administrator's options in how to rectify a problem early on within an ABCP program."

According to survey results, the most likely consequences of SPE consolidation for the ABCP and CDO markets would be declining issuance. For ABCP, 44%, or 128 individuals, predict declining issuance to be the leading consequence, while 37% believe that increased cost to consumers is a likely effect. For CDOs, 45% considered declining issuance to be the No. 1 result, while 34% said that more innovation or new types of issuance vehicles would be one way the market copes with potentially deleterious SPE consolidation rules. For the general ABS market, 37%, or 108 people, thought increased cost to consumers was a potential consequence.

"The future treatment of ABS in financial statements will lead to risk sharing and increase of transaction costs in ABS structures," said one participant. "Arbitrage deals will decrease and economic risk reduction-driven deals will continue."

There's Got to Be a Better Way

According to SF Market Opinion results, FASB needs to change its basic strategy. Not only did 81% of respondents from both the U.S. and abroad say that 10% outside equity was not the best way to maintain the integrity of financial statements, but nearly half, or 46%, said that the consolidation of subsidiary SPE issuers of ABS would not lead to better risk evaluation of the corporate parent. Thirty-seven percent said that it would lead to better risk evaluation, while 17% chose the "Don't Know" option.

However, one theme was consistent throughout all of the responses: The only sensible measure that regulators can take is to promote disclosure and more stringent rules for transparency, but there are higher priorities than the consolidation of SPEs that need to be addressed. "FASB is missing the big picture and trying to come up with an accounting solution to an economic issue," said one respondent. "The focus should be on reporting economic risks -- not on how/when to consolidate. Accounting leverage is not a particularly good measure of economic risk." Another participant said, "The problem was people not following the rules. Why will changing the rules help?"

Indeed, increased disclosure is the key to the problem -- not consolidation -- especially if true risk transfer and legal isolation of assets has genuinely taken place. "There needs to be better disclosure of the benefits derived by outside parties to the SPEs, details of all financial commitments, leases, repurchase agreements, etc.," noted a survey participant. "These can have a far greater impact than the equity and liabilities shown on a balance sheet."

Another person suggested: "There must be disclosure on risks retained (e.g., moral recourse). 'What if' disclosure in footnotes would do more to promote understanding than anything FASB is proposing."

Interestingly, only one-third of respondents thought that international bodies should follow FASB's lead on SPE consolidation, and this opinion was consistent for both U.S and non-U.S. participants. Some people even suggested that a uniform global accounting rule would make the most sense. "To make this work, an international standard needs to be agreed upon and applied," noted one participant.

The overall message of SF Market Opinion feedback was that better disclosure is essential; however, consolidation of SPEs may not be necessary, and in fact, placing the items back on balance sheet may present further challenges to structured finance investors, as they would be assuming more "corporate" risk, as one respondent put it.

Ultimately, however, many of the comments reflected the belief that the securitization market will "tweak" its way around the FASB rules, even if they are applied in a conservative manner. One respondent summed it up best: "The proposal seems to be reactionary rather than proactive. The largest users of the current rules will not be impacted, so if the proposal is to change the way the largest entities operate, it will fail. Market leaders will always innovate."