"Regardless of how you structure them," says Turner, "the economics of the transactions need to end up in the financials. If that impacts the costs, then so be it; we need to make decisions based on real economics, not hidden gimmicks."
Synthetic Leases Expire
James Kent, vice president and treasurer of Chiron Corp., in Emeryville, California, says that in general, "financing alternatives priced on our creditworthiness have always been more attractive than a structured product." Kent says that in 1996, however, the biotech firm found that a synthetic lease on a new research facility "compared very favorably to a credit-based borrowing."
Six years later, the landscape has changed. Kent has made no decision about what to do when the lease comes up for renewal next July. Uncertainty as he waits for FASB to "clarify the ground rules" makes it impossible to evaluate costs, he says. More important, he adds, "we recognize that this is an area of significant current scrutiny." Wary of the "taint" of off-balance-sheet treatment, Kent notes that Chiron has plenty of alternatives, including $1.2 billion in cash — more than enough to buy back its less than $200 million research facility.
In fact, synthetic leases are likely to be all but wiped out by FASB's proposed revision of the SPE rules, which was released for comment this past summer. Expected to be final by year-end, the rules could be in effect as soon as second-quarter 2003. As proposed, they raise the outside equity ownership stake required to define an SPE as independent from 3 percent to a "rebuttable presumption" of 10 percent. The rules also are intended to ensure that the outside capital comes from a truly independent source that is truly at risk for that capital.
Where majority voting rights are difficult to determine, the rules create a complex set of criteria for establishing the "primary beneficiary" of the SPE. In most synthetic leases, companies set up an SPE to own a property and lease it back to them, with the lessee the primary beneficiary of the lessor SPE. So the rules would require the lessee to consolidate the lessor onto its balance sheet. There are exceptions if another party holds the majority voting rights or if the SPE is consolidated by a substantive business enterprise, but in general the proposed rules would nullify most synthetic leases.
Also potentially affected by FASB's proposal are asset-backed securitizations. Bradley Schwartz, a managing director at JPMorgan, says asset-backed securitizations are being used even by investment-grade companies to supplement or supplant traditional backup credit lines, particularly since they are shielded from corporate-event risk. Now, however, asset-backed paper issuance is declining as well, both because companies might have authorized more than they needed and because of the uncertainty generated by FASB's rulemaking. Ultimately, says Joanne W. Rose, executive managing director of global structured finance rating at Standard & Poor's, "I expect there will be more transparency and more disclosure around securitization and its effect on the balance sheet. That is positive for everybody."
Unless you badly need credit. A big potential drawback is the possibility that the enormous commercial paper (CP) conduits run by the banks themselves could be among the SPEs forced back on balance sheet. These conduits purchase the securitized assets from qualified SPEs. While the latter aren't subject to the provisions of the proposed rule, consolidation of CP conduits could severely curtail the ability of banks to lend. "If you apply the provisions to CP conduits, you could absolutely conclude that the banks should consolidate," says Michael Joseph, a partner with Ernst & Young. In that event, it's hard to see any result other than a credit crunch. "If the banks have to consolidate their CP conduits, that's going to be huge," says Joseph.
Guarding the Hen House
Banks are already requiring more from their corporate customers in terms of reporting, and that may make other capital costly, simply because the details of structured finance, and the debt it often masks, may become more apparent to ratings agencies, analysts, and investors. While banks insist they bore no responsibility for policing Enron's accounting, the damage it did has given them reason to take a renewed interest. "People are assailing our reputation," declares Feldstein. JPMorgan Chase and Citigroup — along with six other banks — also have been named as defendants in class-action lawsuits for their role in Enron's collapse.
In August, chairman and CEO Sandy Weill announced that Citigroup would no longer perform material structured financings for clients that won't record them on their balance sheet unless the clients agree to publicly disclose the impact to investors. Citigroup will require "prompt disclosure of the details of the transaction, including management's analysis of the net effect the transaction has on the financial condition of the company, the nature and amount of the obligations, and a description of events that may cause an obligation to arise, increase, or be accelerated." The bank also will require its clients to provide a complete set of transaction documents to the client's chief legal officer, independent auditors, and, oddly, the CFO.
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