On August 28, 2013, six federal financial services agencies issued a notice revising a proposed rule to implement Section 941 of the Dodd-Frank Act, which requires sponsors of securitization transactions to retain at least five percent credit risk in such transactions. By requiring securitizers to retain an economic interest in the credit risk of assets they securitize, regulators hope to incent securitizers to underwrite their transactions soundly and abandon volume originations. The proposed rule would provide asset-backed securities sponsors with several alternatives to satisfy the credit risk retention requirements.
Some of the major differences between the original proposed rule and the new proposed rule are:
- Under the Dodd-Frank Act, “qualified residential mortgages” (QRMs) are exempt from the credit risk requirements. The re-proposed rule aligns QRMs with the underwriting requirements for “qualified mortgages” adopted by the Consumer Financial Protection Bureau as a part of its “Ability to Repay” regulation, including a 43 percent maximum debt-to-income ratio. The new QRM definition does not include the loan-to-value ratio or credit history requirements that were included in the original proposal, nor does it include a down-payment requirement. In the re-proposal, the issuing agencies also solicit feedback about an alternative approach for defining QRMs by utilizing the qualified mortgage requirements but adding a loan-to-value ratio and other criteria. In particular, the proposed rule does not include private mortgage insurance as an alternative to risk retention but the government sponsored enterprise (GSE) exemption continues.
- For assets that are not exempted from risk retention, the securitizer would be required to retain five percent of the securitization transaction, calculated on the basis of fair value rather than par value, as in the original proposal, and determined on the day on which the price of the asset-backed security to be sold to third parties is determined.
- The premium capture cash reserve account requirement has been eliminated, given the increase in the value of the retained interest due to the change to a fair value calculation of the retained five percent.
- The rule as re-proposed permits a securitizer to hold any combination of vertical and horizontal first-loss interests that together represent five percent of the fair value of the securitization. The original rule required that retention be held only as all vertical, all horizontal, or as an L-shaped 50/50 combination. The revision provides for the same level of risk retention in a manner more aligned with current market practice. Additionally, the representative sample option has been eliminated.
- The proposed rule would permit commercial, commercial real estate, and automobile loans that qualify for exemption from risk retention to be combined in asset pools with non-qualifying loans of the same asset class subject to the full five percent risk retention. These blended pools would be eligible for reduced, but not less than two-and-a-half percent risk retention.
- For open market collateralized loan obligations, the new rule would allow sponsors to satisfy the risk retention requirements if the lead arrangers of loans purchased by the collateralized loan obligation retained the risk. This option would align the incentives of the lead arranger, which is the party most involved with the credit quality of the loans, with the interests of investors.
- The new proposal includes expiration timeframes on restrictions prohibiting transfer or sale and hedging of required risk retention.
This is a very complex proposed rule, which requests comments on over 100 aspects of the proposed rule and is over 500 pages long.
A number of other changes are included as well, including certain modifications to defined terms, provisions regarding underwriting for qualifying commercial, commercial real estate, and automobile loans, exemptions for special types of securitizations, and transaction specific retention options for resolving asset master trusts, asset-backed commercial paper conduits, commercial mortgage backed securities, government sponsored enterprises, open market collateralized loan obligations, and municipal bond repackaging transactions.
Finally, it is unclear how the proposed rule would interact with the various proposed GSE legislative reform proposals currently on the table. Clearly, it is imperative to restart the private securitization market before diminishing the role of the GSEs. It remains unclear whether this proposed rule will do so.
The agencies have requested comments on the revised proposed rule by October 30, 2013.