The Federal Deposit Insurance Corporation has proposed a statement of policy to clarify how it will treat securitizations and loan participations if appointed receiver or conservator of an insured depository institution. The FDIC intends the proposal to allay concerns whether an insured institution's transfer of assets in a securitization or loan participation will be treated as a sale under the Financial Accounting Standards Board's Statement of Financial Accounting Standards No. 125. The proposed statement provides that, subject to certain conditions, the FDIC will not use its statutory repudiation power to try to recover assets transferred by a failed institution in a securitization or loan participation. Comments on the FDIC's proposal are due by March 1, 1999.
Background
A securitization or loan participation typically depends for its success on the characterization of the transfer of the applicable assets as a "true sale" rather than a secured financing. Sale treatment of the transfer allows lower cost financing by effectively separating the credit risk of the assets from the credit risk of the originating business. It also permits the originating business to remove the transferred assets from its balance sheet, thereby reducing risk-based capital requirements. Under FASB 125, issued in June 1996, a transfer of financial assets is accounted for as a sale if the transferor has "surrendered control over transferred assets," which in turn depends in part on whether the "transferred assets have been isolated from the transferor -- put presumptively beyond the reach of the transferor and its creditors, even in bankruptcy or other receivership."
The Federal Deposit Insurance Act authorizes the FDIC, as conservator or receiver for any insured depository institution, to disaffirm or repudiate any of the institution's contracts that it deems burdensome to the institution as long as the repudiation or disaffirmance promotes the orderly administration of the institution's affairs. Parties involved in securitizations and loan participations have questioned whether any transfer by an insured institution could qualify for sale treatment under FASB 125 in light of the FDIC's broad statutory powers to repudiate and disaffirm the contracts of failed institutions and, potentially, to recover transferred assets. Indeed, the FASB recently said that transfers by insured depository institutions in securitizations or loan participations will not qualify for sale accounting treatment under FASB 125 unless the FDIC clarifies its policy.
Proposed Statement of Policy
In response to these concerns, the FDIC's proposed statement of policy provides that "the FDIC will not attempt to reclaim, recover, or recharacterize as property of the institution or the receivership estate (i) in the case of a securitization, the financial assets transferred by the insured depository institution to a special purpose entity in connection with the securitization, or (ii) in the case of a loan participation, the undivided interest transferred to a participant in connection with the loan participation." The proposed statement is subject to four qualifications:
- The policy addresses only the exercise of the FDIC's statutory repudiation power for securitizations and loan participations.
- The policy applies only to securitizations or loan participations where the criteria for sale accounting under generally accepted accounting principles have been satisfied, the documentation evidencing the transaction reflects the intent of the parties to treat the transaction as a sale and the institution received adequate consideration for the transfer at the time it was made.
- The FDIC reserves the right to exercise its statutory authority to repudiate or disaffirm, but in so doing will not attempt to reclaim, recover or recharacterize as property of the institution or the receivership estate any financial assets or undivided interests transferred by an institution in connection with a securitization or a loan participation.
- The FDIC does not waive any other rights, remedies or powers it may have, including those regarding fraudulent transfers and transfers made in contemplation of insolvency.
Because the FDIC issued its proposed statement in response to FASB concerns and with input from the FASB, any transfer by an insured institution that comes within the safe harbor provisions of the proposed policy will almost certainly be accorded sale status under FASB 125 if the policy is enacted and all other FASB 125 conditions are met. Thus, a transfer of "financial assets" to a "special purpose entity" in connection with a securitization, for example, would be accounted for as a sale under FASB 125. For purposes of the policy, "financial assets" is defined very broadly and "special purpose entity" means a trust, corporation or other entity with standing at law distinct from the insured institution. Although the FDIC's proposal seemingly resolves issues related to FASB 125, it should be noted that the policy is limited, in that it does not alter the FDIC's ability to recover assets on grounds other than repudiation and disaffirmance.