Tuesday, October 30, 2007
M-LEC Letter To Citi
This letter is in response to your inquiry on October 5th, 2007, regarding the regulatory capital treatment of the liquidity facilities to be provided to a structured finance vehicle, the Master Liquidity Enhancement Conduit.Somehow I feel the need to post a link to the Interagency Statement on Sound Practices Concerning Elevated Risk Complex Structured Finance Activities. Here it is in all of its pdf glory. Few appreciate the dry humor contained in some of these releases. Perhaps it is an acquired taste. Roll this quote around on your tongue:
As the Final Statement recognizes, structured finance transactions encompass a broad array of products with varying levels of complexity. Most structured finance transactions, such as standard public mortgage-backed securities and hedging-type transactions involving “plain vanilla” derivatives or collateralized debt obligations, are familiar to participants in the financial markets, have well-established track records, and typically would not be considered CSFTs for purposes of the Final Statement.This was released at the beginning of 2007. We have seen just how plain vanilla and understandable CDOs really are, haven't we? No need for any special procedures involving risk evaluations on those, right?
It's all completely safe, I guess. From the Citi letter, which was is not text-copyable so I have to retype all of this, which is making me even more bitchy than usual, the real issue:
Under the loan funding facility, a participating liquidity bank would make a 364 day commitment to lend to M-LEC. If M-LEC draws on the facility, the liquidity bank would be obliged to extend a term loan to M-LEC. The loan would rank pari passu with the ABCP and MTNs issued by M-LEC and would be backed by M-LEC's assets. If, at the end of 364 days, the liquidity bank chooses not to renew its commitment, M-LEC would have the option to draw on the loan commitment, resulting in a term loan to M-LEC with a maturity, for example, of three years.Now here is the decision:
Under the Capital Guidelines, the credit conversion factor for an eligible ABCP liquidity facility is based on whether the facility has an original maturity of one year or less. Under the Capital Guidelines and the Board's interpretation thereof, original maturity is the length of time between the date the commitment is issued and the date the commitment terminates or the earliest date on which 1) the Bank can, at its option, unconditionally (without cause) cancel the commitment and 2) the Bank is scheduled to (and as a normal practice, actually does) review the facility to determine whether or not it should be extended. Each liquidity facility you describe has an original maturity of 364 days, with an option that allows M-LEC to draw upon the facility and receive funding with a maturity of up to three years should the Bank providing the facility decide not to renew it. Under the Capital Guidelines and the Board's longstanding interpretations thereof, the term of any advances that can be made under a commitment is not taken into account in determining the commitment's original maturity. Thus, the M-LEC liquidity facilities would have an original maturity of one year or less for risk-based capital purposes. Therefore, the credit conversion factor that would apply to the notational amount of the M-LEC liquidity facilities would be 10 percent.It's all plain vanilla and there is no need to get all chocolate about it and invent complications.
This rounds up to 4 years in the real world, which is why the Fed will treat it as short-term for reserve requirements.
I found it interesting.
If it quacks like a 4-year loan, and Basel II ain't calling it a duck, I call shenanigans on this new, flexible, "spirit of the law" approach.
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