FASIT primer.

• Author: Donadio, Anthony
• Position: Financial asset securitization investment trust

The Small Business Job Protection Act of 1996 (SBJPA) contains legislation introducing the financial asset securitization investment trust (FASIT). The FASIT provisions are elective miles intended to facilitate securitizations of nonmortgage assets in the same way that the real estate mortgage investment conduit (REMIC) legislation has spurred the growth of the market for mortgage-backed securities. Securitization is the process that allows a "sponsor" to repackage a receivable into a more marketable security and thereby obtain greater cash or other benefits from the new security than those available from a direct sale of the underlying receivable.

The FASIT legislation was enacted with the expectation that it would be a revenue-raising provision. The assumption is that the marketplace will be willing to pay the additional tax cost for using FASITs in exchange for structuring flexibility and tax certainty. The benefits of a FASIT election can only be determined by comparative analysis; FASITs may not be a panacea for all types of securitizations. Among the expected beneficiaries of FASITs are credit card trusts, which will receive tax certainty as to entity and debt classification and the enhanced ability to sell subordinated interests.

Even if certain issuers determine that the tax cost of a FASIT negates the benefits of the FASIT election for their current securitization models, the flexibility inherent in FASITs may give rise to modifications to current structures and foster the creation of new structured finance debt instruments. Not only may new, more efficient versions of existing securitization models arise, but completely new instruments may be created.

The FASIT legislation is effective on Sept. 1, 1997. Securitizations in effect before Sept. 1, 1997 (pre-effective date FASITs) may elect into the FASIT rules, subject to special gain recognition provisions (which may be beneficial).

Qualification as a FASIT

An entity may elect to be taxed as a FASIT if five requirements are met.

1. A FASIT election must be made. The election applies for the year in which it is made and for all subsequent years unless revoked with IRS consent. if the election is made after the entity's initial year, all of the entity's assets are deemed contributed at that time; any gain (but not loss) on such assets will be recognized immediately. A FASIT election may be made for an entity regardless of its legal form (corporation, partnership, trust or segregated asset pool).

2. All of the interests in the FASIT must be either an "ownership interest" or "regular interest"

   One of the distinct advantages of a FASIT is that a regular interest is treated as debt for all purposes regardless of its characterization in the absence of the FASIT election. A regular interest is an interest in the FASIT that meets all of the following criteria:

   * It has a specified principal amount that is unconditionally payable.

   * Interest payments, if any, are at a fixed or a qualifying variable rate.

   * The interest has a maturity of 30 years or less.

   * The issue price does not exceed 125% of stated principal amount.

   * The yield to maturity is less than the sum of the yield on Treasury obligations with comparable maturities plus 5%.

   A FASIT may also issue a subclass of regular interests referred to as high-yield regular interests. This interest has the same criteria as a regular interest, except it does not meet one or more of the above requirements. (If it fails the coupon requirement, it must meet certain "specified portion" requirements that generally relate to stripped bonds.) The high-yield regular interest rules allow a FASIT to issue interest-only (IO) strips, etc.; however, special restrictions apply to high-yield regular interests. A high-yield regular interest may only be held by a domestic C corporation, another FASIT or (in certain other cases) a dealer in securities. Also, the FASIT rules exact a toll charge for the tax certainty of debt treatment for high-yield regular interests: net operating losses (NOLs) or other "outside" deductions of a permitted holder may not offset the interest income on the high-yield regular interest.

   Ownership interests in a FASIT are interests in the FASIT that are not regular interests. The ownership interest in the FASIT is most often treated as evidence of ownership in the underlying assets.

3. There is only one class of ownership interest and 100% of such class is directly held by a single eligible corporation (that is, by my domestic C corporation other than a regulated investment company, a real estate investment trust, a REMIC or certain cooperatives).

4. As of the close of the third month beginning after the day of its formation and at all times thereafter, "substantially all" of the assets consist of "permitted assets." Permitted assets include cash and cash equivalents, most debt instruments (qualified debt instruments), swaps or certain other reasonably required hedging assets, credit enhancement assets (such as insurance and guarantees), REMIC regular (but not residual) interests and regular interests in other FASITs, and certain foreclosure property. Accordingly, FASITs may include a very broad spectrum...