On August 28, 2013, the Board of Governors of the Federal Reserve System, Federal Deposit Insurance Corporation, Office of the Comptroller of the Currency, Department of Housing and Urban Development, Federal Housing Finance Agency, and Securities and Exchange Commission (the “Regulators”) issued a second notice of proposed rulemaking to implement the credit risk retention requirements in Section 941 of the Dodd-Frank Act.1 The re-proposal replaces the first notice of proposed rulemaking issued by the Regulators in 2011. The Dodd-Frank Act generally mandates that a securitizer retain at least 5% of the credit risk for the assets that are packaged in an asset-backed security issued by the securitizer, and requires the Regulators to draft rules to implement the requirement. Here are some highlights of the re-proposal.

  • The amount of required risk retention for non-Qualified Residential Mortgages (“QRM”) or other assets not exempt from risk retention would remain at 5%, but the required amount would be calculated using the fair value of the securitization transaction on the date it is priced, rather than par value as initially proposed. The fair value would be calculated in accordance with GAAP.
  • Based on the change to the use of fair value accounting, which would increase the dollar amount of credit risk retained, the requirement that securitizers hold a premium capture cash reserve account has been eliminated.
  • Risk retention can still be structured as a 100% vertical or 100% horizontal slice, but the requirement in the original proposal that any hybrid risk retention be split 50/50 between vertical and horizontal slices has been dropped. In its place, any combination of horizontal and vertical slices would be acceptable, so long as the total 5% credit risk retention requirement is met.
  • Qualifying and nonqualifying commercial, CRE and auto loans could be blended in a single pool with the credit risk retention requirement being reduced proportionally to the percentage of qualifying loans in the pool, provided that the risk retention requirement would not drop below 2.5%.
  • For securitizations where all the assets are residential mortgages, the prohibition on the sale, transfer or hedging of risk retention positions would expire after five years from the date of issuance, by which time delinquencies have peaked historically, provided that the principal balance of the loans securitized has been reduced to no more than 25% of the principal balance at closing. After seven years, the prohibition would be dropped regardless of the amount of the principal balance. Other requirements would apply to other asset classes.
  • The definition of QRM would generally mirror the definition of a “qualified mortgage,” or QM, recently adopted by the Consumer Finance Protection Bureau (“CFPB”). The basic QRM definition would be identical to the QM definition. However, the Regulators have proposed an alternative QRM exception, referred to as “QM-plus,” which would require a mortgage loan to meet the core QM criteria, cover a one-to-four-family dwelling used as the borrower’s primary residence, be a first lien, satisfy certain credit history requirements and have a LTV ratio at time of closing of not more than 70%.
  • For open market CLOs, the CLO manager/sponsor would be able to satisfy the risk retention requirement if the lead arrangers of the loans purchased for the CLO retain the required credit risk.
  • As in the original proposal, the re-proposal would require the appointment of an Operating Advisor for all CMBS transactions in which a qualifying third-party purchaser acquires a horizontal first-loss position. The re-proposal would allow up to two third-party purchasers of the horizontal first-loss position and would establish additional requirements regarding the Operating Advisor.

The Regulators have asked that public comment on the re-proposal be submitted by October 30, 2013.