Yesterday, the Federal Reserve issued a report outlining the “potential impact of credit risk retention requirements on securitization markets.” The report was issued pursuant to Section 941(c) of the Wall Street Reform and Consumer Protection Act (Dodd-Frank Act), which requires the Federal Reserve “to conduct a study and issue a report not later than 90 days after the date of enactment on the effect of the new risk retention requirements to be developed and implemented by the federal agencies, and of Statements of Financial Accounting Standards Nos. 166 and 167 (FAS 166 and 167).”
The Dodd-Frank Act also requires the Federal Reserve and other federal agencies to issue joint rulemaking implementing “risk retention requirements for securitizers or originators of assets securitized through the issuance of asset-backed securities” within 180 days from the date of the report. The Section 941 requirement that the securitizer or the originator of the assets retain some percentage of the credit risk of the assets being securitized is intended to better “align the interest of key participants in the securitization process, notably securitizers and originators of the assets underlying an ABS transaction, with the interests of investors."
The Federal Reserve's report focuses on nine different asset classes and “highlights the significant differences in market practices and performance across securitizations backed by different types of assets”:
- nonconforming residential mortgages (RMBS);
- commercial mortgages (CMBS);
- credit cards;
- auto loans and leases;
- student loans (including both federally guaranteed and privately issued);
- commercial and industrial bank loans;
- equipment loans and leases;
- dealer floorplans; and
- asset-backed commercial paper (ABCP).
For each asset class, the report provides: (i) a discussion of the economics of the securitization, (ii) a summary of the underlying collateral and (iii) key differences in the “securitization ‘chain’ linking originators to investors." The report examines issuance activity before and after the recent financial crisis, noting in particular that, although the RMBS and CMBS securitization markets are still slow, consumer and business finance securitizations have “rebounded.” The report also describes a notable shift from the public market to the private market for such issuances. Especially with respect to credit card securitizations, the report notes that the adoption of the FAS 166/167 accounting standards has made securitizations a less desirable form of financing, since many credit card issuers are now required to retain almost all credit card deals on balance sheet.
The report describes certain mechanisms that failed to properly align incentives of market participants or to protect investors and presents various “statutory and regulatory recommendations for eliminating any negative impacts of the continued viability of asset-backed securitization markets and on the availability of credit for new lending identified by the study.” In conclusion, the report specifically recommends that rulemaking agencies consider some of the following:
- differences in asset classes “when developing risk retention requirements in order to achieve the objectives of the Dodd-Frank Act without unnecessarily impeding the availability of credit”;
- the potential effect of “credit risk retention requirements on the capacity of smaller market participants to comply an remain active in the securitization market";
- the potential for other incentive “alignment mechanism” to serve as either an “alternative or compliment to mandated credit risk retention";
- the “interaction of credit risk retention with both accounting treatment and regulatory capital requirements”; and
- that investors may require originators and securitizers to hold “alternate forms of risk retention beyond that required by the credit risk regulations.”
Late last month, the FDIC approved a final rule regarding its securitization safe harbor that included an explicit risk-retention requirement for securitizations by insured depository institutions. Last week the SEC proposed rules that would require additional disclosures regarding the use of representations and warranties in transaction documents for asset-backed securities (ABS) offerings pursuant to Section 943 of the Dodd-Frank Act.