Mutual

.J I
Leiter of Comment No:
File Reference: 1225-001
Washington
Mutual
October 10, 2005
Ms. Suzanne Q. Bielstein
Director of Major Projects and Technical Activities
Financial Accounting Standards Board
401 Merritt 7
P.O. Box 5116
Norwalk, Connecticut 06856-5116
File Reference No. 1225-001: Exposure Draft on Accounting for Transfers of Financial
Assets, an amendment to F ASB Statement No. 140, Accounting for Transfers and
ServiCing ofFinancial Assets and Extinguishments of Liabilities
Dear Ms. Bielstein:
Washington Mutual would like to take this opportunity to comment on the Exposure Draft
("ED") referenced above. Based on our consolidated assets at June 30, 2005, Washington
Mutual, Inc. (the "Company") was the largest savings institution and one of the largest
residential mortgage loan originators and mortgage loan servicers in the nation. The
Company actively sells mortgage loans and servicing rights in securitization transactions
and retains servicing responsibilities as well as senior and subordinated interests.
We understand the FASB's main objectives in developing the ED were to revise and
clarify the derecognition requirements for financial assets, the initial measurement of
interests related to transferred financial assets that are retained by the transferor as well as
permitted activities of Qualifying Special Purpose Entities. We believe that the objective
of these proposed changes is to amend certain provisions in FASB Statement No. 140,
Accounting for Transfers and Servicing of Financial Assets and Extinguishments of
Liabilities ("Statement 140"), that have resulted in inconsistent application of the
principles of that Statement, with the goal of improving the comparability of financial
statements. We support the efforts of the FASB in this initiative.
We would like to explain certain issues affecting the financial services industry related to
the application ofthe proposed ED.
Passive Derivatives held by Qualifying Special Purpose Entities
Under Statement 140, a transfer of financial assets to a trust or other legal entity that
meets the defmition of a Qualifying Special Purpose Entity ("QSPE") can be accorded
off-balance sheet treatment by the transferor, in which case neither the transferor nor its
affiliates would consolidate the assets and liabilities of the QSPE (paragraph 46).
Paragraph 35 states that a QSPE is a trust or other legal entity that meets certain
lof7
Washington
Mutual
requirements. One of those requirements is that a QSPE may only hold passive derivative
financial instruments (paragraphs 35(c)(2) and 40(a».
We agree with the proposal to amend paragraphs 35(c)(2) and 40(a) that would allow
passive derivatives in a QSPE to pertain to beneficial interests held by the transferor. We
believe that a transferor should be permitted to hold such beneficial interests upon the
establishment of the QSPE or through subsequent acquisition at a date following issuance.
This conclusion is based on our understanding of the underlying principle of the original
limitations prescribed in paragraphs 35(c)(2) and 40(a). Specifically, the intent of those
limitations was to prevent entities from circumventing the fair value requirements for
derivatives under FASB Statement No. 133, Accounting for Derivative Instruments and
Hedging Activities ("Statement 133"). Additionally, the Exposure Draft on Accounting
for Certain Hybrid Financial Instruments, an amendment to FASB Statements No. 133 and
140, would require derivatives that are not clearly and closely related to the host contract
to be bifurcated and marked-to-market through earnings. In particular, that proposed
Statement would establish a requirement to evaluate beneficial interests in securitized
financial assets to identify interests that are freestanding derivatives or hybrid fmancial
instruments requiring bifurcation.
Additionally, companies routinely securitize loans and sell the resulting securities to the
secondary market using an underwriter that is a wholly-owned subsidiary. [n its capacity
as underwriter and a registered broker-dealer, that affiliate may act as a market-maker for
such securities such that (without any option, commitment or obligation to do so of any
kind) the affiliate subsequently purchases securities issued by the QSPE and thereafter resells those securities in the secondary market. It is common industry practice for brokerdealers to make a market in the securities issued by QSPEs for which they are affiliated
with the transferor of the assets. The liquidity provided by this practice increases the
marketability of the securities. Because broker-dealers classify all such marketable debt
securities as trading and record them at fair value with changes in fair value recorded in
earnings immediately, and the period of time between repurchase of the beneficial
interests and subsequent sale is relatively brief (less than 10 days on average), we do not
believe that an affiliated broker dealer's subsequent repurchase of beneficial interests in a
QSPE that holds passive derivative financial instruments violates the intent of Statement
140.
As we have communicated above we support the FASB's proposal to amend paragraphs
35(c)(2) and 40(a) and would like to request early adoption of this modified language.
According to paragraph 5 of the ED:
20f7
Washington
Mutual
A public entity shall apply all other derecognition provisions, including those reflected in
paragraphs 8A, 9(b), 9(d), 9(e), 27, 27A, 27B, 35(c), 35(e), 39, 40, 41, 43, 45A and 80-83
of Statement 140 (as amended), to transfers offinancial assets occurring after the end of
the first fiscal quarter beginning after the issuance of this Statement.
We would like to request that the provisions in paragraph 35(c) and 40 be eligible for
early adoption during the quarter in which the final statement goes into effect.
Definition of Participating Interests
For purposes of defining a participating interest, the definition of recourse is an important
consideration when applying Paragraph SA(c) of the ED. According to Paragraph SA(c):
Participating interest holders have no recourse to the trallsferor (or its consolidated
affiliates or agents) or to each other, and no participating interest is subordinated to
another. That is, no participating interest holder is entitled to receive cash before any
other participating interest holder. The rights of each participating interest holder
(including the transferor if it retaills a participating interest) have the same priority, alld
that priority does not change in the event of bankruptcy or other receivership of the
transferor, the original debtor, or any participating interest holder.
One factor that is typically given significant weight in the legal isolation analysis is
whether the transferor or the transferee bears the risk of losses arising out of defaults on
the financial assets being transferred. The allocation of risk of loss often involves the
question of whether the transferee has "recourse" against the transferor.
The concept of "recourse" considers recourse relating to the failure of an obligor, as a
result of the lack of creditworthiness of that obligor, to make payments owed under an
obligation for the payment of money. This is consistent with "full recourse" or "partial
recourse" as those terms are applied in Paragraph 113 of Statement 140:
In a transfer of receivables with recourse, the transferor provides the transferee with filii
or limited recourse. The transferor is obligated under the terms of the recourse provision
to make payments to the transferee or to repurchase receivables sold under certain
circumstances, typically for defaults up to a specified percentage.
This notion of "credit recourse" is also referred to in the glossary in Statement 140 under
part (a) of the definition:
30f7
Washington
Mutual
The right of a transferee of receivables to receive payment from the transferor of those
receivables f or (a) failure of debtors to pay when due, (b) the effects ofprepayments,
or (c) adjustments resulting from def ects in the eligibility of the transferred receivables.
Additionally, the concept of recourse can contemplate recourse which is unrelated to the
collectibility of payment obligations or the creditworthiness of the debtors ("non-credit
recourse"). Common examples of non-credit recourse include obligations arising from
breaches of transferor representations regarding enforceability of the transferred
obligations and duties of the transferor to indemnify the transferee for offsets and defenses
relating to the transferor's conduct. This notion of non-credit recourse is also referred to
in the glossary in Statement 140 under part (c) of the definition:
Th e right of a transferee of receivables to receive payment from the transferor of those
receivables f or (a) failure of debtors to pay when due, (b) the effects ofprepayments,
or (c) adjustments resulting (rom defects in the eligibility ofthe transferred receivables.
With respect to the treatment of participations under Paragraph SA( c), we suggest that
recourse be limited to the concepts used in Paragraph 113 and part (a) of the definition of
recourse in the Statemcnt 140 glossary. It should exclude non-credit related recourse, as
we believe such an approach would be consistent with the concept of legal isolation
(which primarily considers credit recourse). We also believe that if recourse, as referred
to in paragraph 8A(c), were to be defm ed in accordance with the Statement 140 glossary
(thereby including part (c» then no instruments would meet the definition of a
participating interest, since all sales of beneficial interests (i.e. loan syndications) typically
involve the transferor making certain industry standard representations or warranties in
one form or another.
Demonstration of Legal Isolation - Legal True Sale vs. FDIC Receiversbip Opinion
The F ASB has indicated that one of the goals of the ED is to clarify the derecognition
requirements for financial assets. The proposed amendments to Statement 140 strive to
clarify the requirements necessary for a transfer of financial assets to achieve legal
isolation. Based on our review of the ED we believe there are some areas that will benefit
from further clarification. For example, paragraph 9(a) (as amended) states:
The transferred finan Cial assets have been isolated from the transferor-put
presumptively beyond the reach of the transferor and its creditors, even in bankruptcy or
other receivership. Transferred fin anCial assets are isolated in bankmptcy or other
receivership only if the available evidence provides reasonable assurance that the
transferred financial assets would be beyond the reach of the powers of a bankruptcy
trustee or other receiver f or the transf eror or any consolidated affiliate of the transf eror
40f7
Washington
Mutual
that is /lot a special-purpose corporation or other entity designed to make remote the
possibility that it would enter bankruptcy or other receivership (bankn,ptcy-remote entity)
(paragraphs 9(d), 9(e), 27, 27A, 27B, 28, and 83(c)).
The paragraph above seems to indicate the form of evidential matter necessary to
demonstrate legal isolation is dependent on th e type of entity under analysi s. For
example, Washington Mutual Bank ("WMB"), a subsidiary of the Company, is a federal
savings association that is regulated by the Office of Thrift Supervision, the deposits of
which are insured within applicable limits by the Federal Deposit Insurance Corporation
("FDIC"). In the event of its insolvency, the FDIC would be appointed as receiver or
conservator under, and its receivership would be administered by the FDIC pursuant to,
applicable provisions of the Federal Deposit Insurance Act ("FDIA") and the FDIC's rules
and interpretations thereof. In such a situation, the most appropriate form of evidence
used to demonstrate legal isolation with respect to qualifying securitization transactions
within the meaning of the applicable FDIC rule would be an FDIC receivership opinion
covering the transferred assets, since a federal savings association is not subject to U.S.
bankruptcy laws in the event of insolvency. In this regard, we would note that the typical
FDIC opinion provided to WMB states that if the FDIC were appointed as conservator or
receiver for WMB, the FDIC would not reclaim , recover, or recharacterize as property of
WMB the transferred assets that have been transferred by WMB to the transferee in
connection with the specified securitization transaction pursuant to the FDIA. The
applicable FDIC rule applies only to securiti zation transactions and does not apply to nonsecuritization transactions (e.g. whole loan sales).
Paragraphs 27 A and 27B(a), which were both inserted into the ED, further explain the
requirements specified in paragraph 9(a) for detennining legal isolation. We believe that
paragraphs 27 A and 27B(a), as amended, raise additional questions as to the requirements
necessary to achieve legal isolation. Paragraph 27 A states:
A transfer of a financial asset, a group offinancial assets, or a participating interest in an
individual financial asset (which are referred to collectively in this Statement as
transferred financial assets) is considered to have isolated the transferred financial assets
only if a legal analysis would support the follOWing conclusions under the laws in the
applicable jurisdiction:
a. The transfer is legally a sale.
b. In the event of bankruptcy, receivership, or other insolvency of the transferor or any
consolidated affiliate of the transferor that is not a bankruptcy-remote entity, the
transferred asset would not be deemed to be part of the estate of the transferor or its
consolidated affiliate.
50f7
Washington
Mutual
Paragraph 27B(a) provides a definition of a legal true sale opinion:
Under Us. law, a true sale opinion is an attorney's conclusion that the transferred
financial assets have been sold and are beyond the reach of the transferor's creditors and
that a court would conclude that the transferred assets would not be included in the
transferor's bankruptcy estate. That opinion should relate to the transferor and transferee
and should also consider the provisions ofparagraphs 9(d) and 9(e).
Based on our interpretation of paragraph 27 A, the amended language seems to indicate
that a transferor would need to evidence that the transfer qualifies for a legal true sale and
also ensure that the assets would be isolated from the transferor, in the event of
bankruptcy, receivership, or other insolvency. We believe evidence in the form of a legal
true sale opinion, for securitization transactions, would not be necessary for a federal
savings association, such as WMB, which is not subject to U.S. bankruptcy laws. We
believe this position is consistent with the intent of paragraph 9(a) and those practices
currently being applied by many other mortgage banking companies.
Additionally, the American Institute of Certified Public Accountants publication: AU
9336, Using the Work of a Specialist: Auditing Interpretations of Section 336, provides
examples of acceptable audit evidence to demonstrate legal isolation. According to AU
9336 (paragraphs 13 and 14), a legal true sale opinion is only one means of evidencing
legal isolation. An FDIC receivership opinion may also be used to evidence legal
isolation, as long as the opinion meets the requirements of AU 9336. We believe that in
the event the transferor (e.g. , a bank) was subject to insolvency proceedings outside of the
Bankruptcy Code (i.e. FDIC receivership), alternative forms of evidence of legal isolation
would be acceptable outside of a legal true sale opinion (which would apply to entities
subject to the bankruptcy code). Accordingly, to provide more clarity to constituents we
would propose that both 27 A and 27B(a) ofthe ED be amended to read as follows:
27A. A transfer of afinancial asset, a group offinancial assets, or a participating interest
in an individual financial asset (which are referred to collectively in this Statement as
transferred financial assets) is considered to have isolated the transferred financial assets
only if a legal analysis would support the following conclusions under the laws in the
applicable jurisdiction:
a. The transfer is legally a
ballkruptcy code).
sale~
(ollly applicable to trallsferors subject to the U.S.
b. III the event of bankruptcy, receivership, or other insolvency of the transferor or any
consolidated affiliate of the transferor that is not a bankruptcy-remote entity, the
transferred asset would not be deemed to be part of the estate of the transferor or its
consolidated affiliate. For a ballkillg elltity 1I0t subject to the U.S. ballkruptcy code all
60f7
Washington
Mutual
FDIC receivership opinion would serve as acceptable evidence of legal isolation for
securitization transactions in place of a legal true sale opinion.
27B(a). Under u.s. law, <'l A true sale opinion is an attorney's conclusion that, under
U.S. bankruptcy law or the Federal Deposit b,surance Act, as applicable, the
transferred financial assets have been sold and are beyond the reach of the transferor's
creditors and that a court would conclude that the transferred assets would not be
included in the transferor's bankruptcy estate. That opinion should relate to the transferor
and transferee and should also consider the provisions ofparagraphs 9(d) and 9(e).
We believe that these amendments would more accurately reflect the principals of legal
isolation under Statement 140.
Summary
We appreciate the opportunity to provide the foregoing comments in response to the ED.
Wc continue to be available for further discussions and assistance in identifying real-life
examples for the Board to use as a "field test" of its conclusions.
Should you have any questions or desire any clarification concerning the matters
addressed in this letter, please do not hesitate to contact me at 206.377.3684; or Marc
Malone, Financial Accounting Controller-Home Loans Group at 206.490.1349.
Very truly yours,
Lawrence R. Gee
Senior Vice President and Deputy Controller
70f7