[Congressional Record Volume 141, Number 109 (Friday, June 30, 1995)]
[Extensions of Remarks]
[Pages E1369-E1371]
From the Congressional Record Online through the Government Publishing Office [www.gpo.gov]


                 SECURITIZATION ENHANCEMENT ACT OF 1995

                                 ______


                         HON. E. CLAY SHAW, JR.

                               of florida

                    in the house of representatives

                         Thursday, June 29, 1995
  Mr. SHAW. Mr. Speaker, today I, along with Congressman Rangel, am 
introducing the Securitization Enhancement Act of 1995. We are 
privileged to be joined by Representatives Zimmer, McDermott, Payne, 
Kennelly, Cardin, English, Sam Johnson, Hancock, Christensen, Neal, 
Crane, Thomas, Collins, Kleczka, Dunn, Houghton, Matsui, Nancy Johnson, 
Herger, Nussle and Portman in introducing this important legislation 
that will assist small business in gaining access to capital and 
promote safety and soundness in the Nation's banking system. It will do 
so by simplifying the tax rules governing the securitization of asset-
backed securities in a user-friendly fashion.
  We also have an additional piece of good news. Whenever the Congress 
considers tax legislation, one of the first questions asked is how much 
will this cost. Fortunately, this legislation is revenue neutral and 
will not add to our budget deficit. Indeed, the bill actually raises 
$87 million over 5 years, $92 million over ten, without raising any 
taxes.
  This bill builds upon the success of legislation enacted by Congress 
in 1986--the Real Estate Mortgage Investment Conduit [REMIC] provisions 
of the Tax Reform Act of 1986--which specified the tax rules for 
securitizing home mortgages.
  The legislation creates a new tax vehicle similar to a REMIC known as 
a Financial Securitization Investment Trust [FASIT]. Unlike REMIC, 
which applies only to home mortgages, FASIT is available to all forms 
of debt, including small business, consumer, student and auto loans, 
among others. Our experience with REMIC suggests that facilitating 
securitization for such loans will greatly expand credit availability.
  The Benefits of Securitization.--Securitization is the process 
whereby banks and other lenders package relatively illiquid loans and 
turn them into highly liquid marketable securities that relay for their 
creditworthiness solely on the underlying loans or on other guarantees 
provided by the private sector. Assistant Secretary of the Treasury 
Richard Carnell has described the securitization process as follows:

       By ``securitization,'' I mean the process of transforming 
     financial assets, such as loans, 

[[Page E1370]]
     into securities that in turn convert into cash over time. One converts 
     loans into securities by assembling a pool of loans and 
     selling them to a special-purpose entity, often a trust. That 
     entity then issues securities representing a debt or equity 
     interest in the loan pool. The cash flow generated by the 
     loans finances payments on the securities. (Statement of the 
     Honorable Richard S. Carnell, Assistant Secretary for 
     Financial Institutions, United States Department of the 
     Treasury, on the Administration's Views on the Loan 
     Securitization Provisions of the Community Development, 
     Credit Enhancement, and Regulatory Improvement Act of 1994, 
     Subcommittee of Telecommunications and Finance, Committee on 
     Energy and Commerce, United States House of Representatives, 
     June 14, 1994 at 1.)

  The advantages of securitization are several:

       First, because securitization increases the amount of 
     information investors have about the risks involved in 
     holding a pool of loans, investors become more comfortable 
     with those risks and more willing to invest in the pool.
       Second, securitization makes it possible to segment the 
     different categories or types of economic risk associated 
     with a pool of loans. As a result, it is often possible to 
     make a better match between various risks and the investors 
     that are most knowledgeable about undertaking those risks.
       Third, by converting a pool of loans into a marketable 
     security--even if that security is retained by the original 
     lender--the loans become more liquid and therefore more 
     valuable. Liquidity also makes for safer and sounder 
     financial markets.
       Fourth, by increasing information, risk segmentation, and 
     liquidity, securitization makes it easier for lenders and 
     investors to achieve appropriate diversification of their 
     portfolios. Diversification can also help prevent a localized 
     economic problem--such as a sudden change in the price of 
     energy, real estate, or other commodities crucial to a local 
     economy--from dragging down all of an area's local financial 
     institutions and potentially causing serious regional or 
     national financial problems.

  Avoiding Future Credit Crunches.--We all remember the credit crunch 
of the late eighties and early nineties that so hurt small businesses 
throughout the country. While this problem has receded somewhat, it 
remains a serious one. However, while small business was finding credit 
hard to come by, home buyers experienced unprecedented credit 
availability during this same period. For example, in 1986 the total 
size of the home mortgage market was approximately $2.5 trillion, with 
about $500 billion in home mortgages being securitized or sold in the 
secondary market. Six years later, in 1992, the size of the home 
mortgage market had grown to $4 trillion, over half of which was 
securitized. Virtually 100 percent of all fixed rate home mortgages are 
now sold in the secondary market.
  Since 1986, the total supply of home mortgage money has been steadily 
increasing, even though the portion supplied without reliance on 
securitization has been declining both as a percentage, and, most 
recently, as an absolute amount. Clearly, without securitization we 
would not have had the large increase in credit availability in the 
home mortgage market that occurred since 1986.
  REMIC may well be the most successful and perhaps the least known 
success emanating from the Tax Reform Act of 1986. Simply put, REMIC 
prevented the credit crunch from infecting the home mortgage market, to 
the everlasting benefit of millions of homeowners throughout the 
country.
  FASITs and Small Business.--FASITs can do for other forms of debt, 
particularly small business loans, what REMIC accomplished for home 
mortgages. Securitization of other forms of non-mortgage debt is 
virtually in its infancy. In 1992 only about $120 billion in non-
mortgage debt was securitized. Most of the debt involved revolving 
credit and auto loans. We know from experience with REMIC that there is 
almost a one-to-one ratio for increased securitization and increased 
credit availability.
  There is every reason to believe that the economic and business 
benefits of securitization will be seized upon by lenders and borrowers 
alike in these other areas. As the administration has pointed out, 
``[s]ecuritization benefits borrowers by making credit cheaper and more 
readily available. . . . Securitization could help make small 
businesses less susceptible to problems in the banking system insofar 
as it gives those businesses access to national and international 
credit markets, through banks or other financial institutions.'' 
(Carnell statement, supra at 2-3.)
  Last year Congress enacted the Community Development, Credit 
Enhancement, and Regulatory Improvement Act of 1994. That legislation 
made a number of changes in the securities laws intended to facilitate 
securitization of small business loans. When that legislation was 
introduced a provision was included authorizing Treasury to issue 
regulations regarding the tax rules for such securitizations. This 
provision was dropped, but the need for clear tax rules to guide small 
business and other nonmortgage securitizations remains.
  FASIT completes the unfinished business of the Community Development 
Bank Act. As the Administration noted in its 1994 testimony:

       We believe that securitization has the potential to 
     increase lending to small businesses. Offering loan 
     originators the opportunity to sell pools of small business 
     loans to investors should help free up resources that can be 
     used to make more such loans. By making small business loans 
     more liquid, securitization should make them more attractive 
     to originate and to hold. Securitization should also bring 
     new sources of
      funds to small- and medium-sized business lending by 
     enabling investors who do not lend directly to small 
     businesses--such as pension funds, insurance companies, 
     trust departments, and other institutional investors--to 
     invest in small business loans made by other financial 
     institutions, including banks that are effective 
     originators of such loans but that may not want to hold 
     all loans originated on their balance sheets. (Carnell 
     statement, supra at 6-7.)

  The administration further stated that:

       [S]ecuritization should reduce the cost of borrowing for 
     small businesses. Small business borrowers pay higher 
     interest rates for credit in part because their loans are 
     illiquid. If an active secondary market for small business 
     loans existed, interest rates in that marked would influence 
     rates in the loan origination market. If rates and yields 
     were high in the securitized loan market, banks and other 
     loan originators would be eager to have more loans to sell. 
     They would signal this interest to borrowers by slightly 
     lowering their interest rates to them, inviting borrowers to 
     seek more credit or permitting previously marginal borrowers 
     to afford credit. (Carnell statement, supra at 7.)

  FASIT's and Safety and Soundness Concerns.--Although facilitating 
asset securitizations will, as the SEC 
noted, help small business gain access to needed capital, this 
legislation will also be of direct benefit to the taxpayer. We need 
only look back to the recent thrift crisis to see the tremendous costs 
to the taxpayer that can come about as a result of Federal deposit 
insurance.
  Had REMIC or FASIT been in place in the late seventies, it is 
unlikely that the taxpayer would ever have had to bail out thrift 
depositors. In the last seventies, thrifts found themselves holding low 
interest rate mortgages at a time when their cost of funds was 
skyrocketing. To counteract these financial pressures, thrifts sought 
additional powers to engage in potentially more profitable, but also 
more risky activities. When these efforts proved to be unsuccessful, 
many thrifts failed, and the taxpayer had to finance a bailout costing 
billions.
  Simply put, if banks can sell off their loans to the secondary 
market, the risk that the loans may possibly default is assumed by the 
capital markets rather than the taxpayer through the deposit insurance 
system. Had thrifts been able to sell off their low interest rate 
mortgages in the seventies, the mismatch between their earnings and 
cost of funds would have been avoided, and the taxpayer spared much 
later expense. FASIT, by facilitating securitization of non-mortgage 
debt, will allow for a much safer and sounder banking industry, and, at 
the same time, reduce the potential exposure now borne by the taxpayer 
in the event that such loans go bad.
  The Tax Treatment of Asset Securitization.--In many ways the FASIT 
legislation is the tax code counterpart to the SEC's actions to promote 
asset securitization. Like the SEC's actions, FASIT would eliminate 
much of the disparity in tax treatment between certain selected classes 
or types of assets, which are currently allowed to obtain direct access 
to the capital markets through statutorily sanctioned vehicles, and 
other types or classes of assets which do not yet enjoy that treatment 
under the tax law. FASIT accomplishes this through a generic rule, like 
the SEC's approach, which allows all types of loans to be securitized 
as long as appropriate structural limitations and safeguards are in 
place.
  By moving to a generic approach, FASIT represents a first step 
towards rationalizing the various pass-through vehicles that now exist 
in the Internal Revenue Code, including REMICs, REITs, RICs, and the 
like. Once the market becomes familiar with FASIT, it may well be 
possible, eventually, to do all forms of securitizations under the 
FASIT umbrella. However, given the already large markets that exist in 
these other areas such as REMIC, we believe it would be far preferable 
and much less disruptive to move gradually rather than precipitously to 
a one size fits all model.
  Current Law Tax Treatment of Asset Securitization.--To understand 
exactly what FASIT does, and why it is beneficial, it is necessary to 
understand a little about the way asset securitizations are structured 
under current tax law.
  Securitization of loans depends on the ability to pass through to 
investors all or a significant portion of the interest income that is 
earned on a pool of loans without the imposition of an intervening 
corporate tax. As a tax matter, this is essentially what occurs when a 

[[Page E1371]]
bank makes loans with funds that it has obtained from deposits or other 
borrowings. Corporate taxes are paid by the bank only on the portion of 
the interest income received that is not paid out as interest to its 
depositors or other creditors.
  Traditional securitizations typically involve the use of a special 
purpose financing vehicle as the holder of the loans, and issue debt 
securities instead of raising funds from bank deposits, but the tax 
principle is the same. That is, assuming that the financing vehicle is 
a corporation, corporate taxes are paid only on the portion of the 
interest income received that is not paid out to the holders of debt 
instruments issued by the entity. As a result, the key tax issue is 
determining how best to structure the transaction so that the 
securities qualify as
 debt, rather than as an ownership interest in the special purpose 
entity.

  With REMICs, or similar entities structured under the tax law as 
fixed investment trusts of partnerships, the task of securitizing loans 
becomes much easier because 100 percent of the income paid out to 
investors is passed through without the imposition of an intervening 
corporate tax. This complete pass-through treatment is available 
regardless of whether the securities are classified as debt or as 
equity. Thus, the problem of determining how best to structure a 
security so that it satisfies the business objectives of the parties 
and still qualifies as debt for tax purposes is eliminated.
  FASITs and Asset Securitization.--Like the REMIC provisions before 
it, the FASIT legislation will help make loan securitization easier by 
creating a new pass-through structure specifically designed for loan 
securitization. Unlike REMICs, FASITs will be available for all types 
of loans or other instruments treated as debt for Federal income tax 
purposes.
  Although the FASIT itself will not be subject to any tax, its net 
income will be included in the United States income tax return of its 
owner or owners, and thus will, in virtually all cases, be subject to 
corporate income tax. The only exception is a provision intended to 
facilitate small business loan securitizations, which allows businesses 
operated as partnerships or S corporations to retain ownership of 
FASITs used to securitize loans to their customers, such as trade 
receivables.
  Loans will be transferred or sold to the FASIT so that it can issue 
securities backed by loans it has acquired. As with REMICs, FASITs will 
be permitted to issue securities that qualify as debt of the FASIT for 
Federal income tax purposes even though they are issued in non-debt 
form for State law purposes. This latter point reflects the fact that 
the assets of the FASIT are the sole source of payments on the 
securities, and that any risk of loss on the assets that is borne by 
the owners of the FASIT has been limited to a reasonably estimable 
amount. At the same time, treating such certificates as debt of the 
FASIT for tax purposes means that the portion of FASIT income passed 
through to the holders of the certificates is not included in the FASIT 
income that is passed through to the corporate owners of the FASIT.
  The FASIT legislation makes the rules for qualifying securities as 
debt, based upon their economic substance, clearer and more 
straightforward. In so ding, FASIT makes the tax rules governing the 
most advanced type of securitization structures more accessible to a 
wider variety of issuers and their tax counsel, thus creating a more 
liquid and more efficient marketplace.
  In addition to making the applicable legal rules and standards
   more accessible, FASIT will also ease some of the common law rules 
that are generally perceived as governing these types of transactions.

  Under current case law, securities purporting to qualify as debt for 
tax purposes generally must have a high investment grade rating of 
``A'' or better. Under the FASIT legislation, debt securities can be 
issued as long as they do not have a yield that is more than 5 
percentage points higher than the yield on Treasury obligations with a 
comparable maturity, which will permit more subordinated debt 
securities to be issued. Even debt securities at the top end of that 
yield limitation are still fundamentally debtlike, as the 5 percentage 
point standard is borrowed from current tax law rules governing when 
certain high yield discount bonds will be subject to special rules 
deferring accrued interest deductions. (See, section 163(e)(5), 
Internal Revenue Code of 1986.) These rules effectively assume that 
obligations yielding 5 points more than Treasury bonds could and do 
qualify as debt. Thus, FASIT legislation will not be authorizing the 
issuance of debt securities that are fundamentally different from debt 
securities that are currently outstanding in the markets.
  The yield limitation, which limits how much income can be passed 
through to the holders of FASIT debt instruments, is important because 
all remaining income--the income associated with the true equity like 
risk of investing in a pool of loans--will be taxable to the U.S. banks 
or other U.S. corporations that retain or acquire the ownership 
interests of the FASIT.
  Securitization has been driven by economic, not tax considerations. 
Consequently, we have exercised great care to ensure that this 
legislation contains no loopholes or gimmicks. Strong antiabuse 
provisions are also included to prevent any gamesmanship.
  Not only is this legislation devoid of any loopholes, it actually 
raises $92 million over 10 years. When a loan or an asset is 
transferred by the bank to the FASIT, there is an immediate recognition 
of gain. For example, assume that a loan will generate $10 of income 
each year over a 10-year period. When the loan is transferred to the 
FASIT, the present value of the entire $100 of income generated by the 
loan is recognized. In effect, this phenomenon is identical to an 
acceleration of estimated taxes, and the result is that the revenues 
lost by relieving the burden of the corporate level tax on the entity 
level is more than offset.
  Mr. Speaker, this FASIT legislation promises to be a great benefit to 
the Nation's small businesses, which often have difficulty gaining 
access to needed capital. We have seen the tremendous success of REMIC 
in developing a secondary market for
 home mortgages. If FASIT is even half as successful as REMIC, we will 
have enacted the most important legislation in history for small 
business.

  In addition to helping small business and others gain access to 
capital, this legislation protects the taxpayer from being forced to 
finance possible future bailouts for the banking industry. This 
legislation will promote safety and soundness of the banking system and 
spread the risks of loans throughout the capital markets rather than 
allowing them to be concentrated in one area, with the Federal 
Government the ultimate guarantor.
  This legislation also simplifies the tax rules governing 
securitization of asset-backed securities and creates a single vehicle 
available for all forms of non-mortgage debt and, eventually, FASITs 
may even supplant REMICs as the vehicle of choice for all 
securitizations.
  Finally, unlike many worthy tax measures which seem beyond our grasp 
because of budgetary constraints, this legislation actually raises 
money without raising taxes.
  I am proud to have introduced this fine piece of legislation, and I 
urge my colleagues to join with me to see that FASIT is enacted in 
1995.


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