[Federal Register Volume 78, Number 183 (Friday, September 20, 2013)]
[Proposed Rules]
[Pages 57928-58048]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2013-21677]
[[Page 57927]]
Vol. 78
Friday,
No. 183
September 20, 2013
Part II
Department of the Treasury
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Office of the Comptroller of the Currency
Federal Reserve System
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Federal Deposit Insurance Corporation
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Federal Housing Finance Agency
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Securities and Exchange Commission
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Department of Housing and Urban Development
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12 CFR Parts 43, 244, 373, et al.
17 CFR Part 246
24 CFR Part 267
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Credit Risk Retention; Proposed Rule
Federal Register / Vol. 78 , No. 183 / Friday, September 20, 2013 /
Proposed Rules
[[Page 57928]]
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DEPARTMENT OF THE TREASURY
Office of the Comptroller of the Currency
12 CFR Part 43
[Docket No. OCC-2013-0010]
RIN 1557-AD40
FEDERAL RESERVE SYSTEM
12 CFR Part 244
[Docket No. R-1411]
RIN 7100-AD70
FEDERAL DEPOSIT INSURANCE CORPORATION
12 CFR Part 373
RIN 3064-AD74
FEDERAL HOUSING FINANCE AGENCY
12 CFR Part 1234
RIN 2590-AA43
SECURITIES AND EXCHANGE COMMISSION
17 CFR Part 246
[Release Nos. 34-70277]
RIN 3235-AK96
DEPARTMENT OF HOUSING AND URBAN DEVELOPMENT
24 CFR Part 267
RIN 2501-AD53
Credit Risk Retention
AGENCY: Office of the Comptroller of the Currency, Treasury (OCC);
Board of Governors of the Federal Reserve System (Board); Federal
Deposit Insurance Corporation (FDIC); U.S. Securities and Exchange
Commission (Commission); Federal Housing Finance Agency (FHFA); and
Department of Housing and Urban Development (HUD).
ACTION: Proposed rule.
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SUMMARY: The OCC, Board, FDIC, Commission, FHFA, and HUD (the agencies)
are seeking comment on a joint proposed rule (the proposed rule, or the
proposal) to revise the proposed rule the agencies published in the
Federal Register on April 29, 2011, and to implement the credit risk
retention requirements of section 15G of the Securities Exchange Act of
1934 (15. U.S.C. 78o-11), as added by section 941 of the Dodd-Frank
Wall Street Reform and Consumer Protection Act (Dodd-Frank Act).
Section 15G generally requires the securitizer of asset-backed
securities to retain not less than 5 percent of the credit risk of the
assets collateralizing the asset-backed securities. Section 15G
includes a variety of exemptions from these requirements, including an
exemption for asset-backed securities that are collateralized
exclusively by residential mortgages that qualify as ``qualified
residential mortgages,'' as such term is defined by the agencies by
rule.
DATES: Comments must be received by October 30, 2013.
ADDRESSES: Interested parties are encouraged to submit written comments
jointly to all of the agencies. Commenters are encouraged to use the
title ``Credit Risk Retention'' to facilitate the organization and
distribution of comments among the agencies. Commenters are also
encouraged to identify the number of the specific request for comment
to which they are responding.
Office of the Comptroller of the Currency: Because paper mail in
the Washington, DC area and at the OCC is subject to delay, commenters
are encouraged to submit comments by the Federal eRulemaking Portal or
email, if possible. Please use the title ``Credit Risk Retention'' to
facilitate the organization and distribution of the comments. You may
submit comments by any of the following methods:
Federal eRulemaking Portal--``Regulations.gov'': Go to
http://www.regulations.gov. Enter ``Docket ID OCC-2013-0010'' in the
Search Box and click ``Search''. Results can be filtered using the
filtering tools on the left side of the screen. Click on ``Comment
Now'' to submit public comments. Click on the ``Help'' tab on the
Regulations.gov home page to get information on using Regulations.gov.
Email: [email protected].
Mail: Legislative and Regulatory Activities Division,
Office of the Comptroller of the Currency, 400 7th Street SW., Suite
3E-218, Mail Stop 9W-11, Washington, DC 20219.
Fax: (571) 465-4326.
Hand Delivery/Courier: 400 7th Street SW., Suite 3E-218,
Mail Stop 9W-11, Washington, DC 20219.
Instructions: You must include ``OCC'' as the agency name and
``Docket Number OCC-2013-0010'' in your comment. In general, OCC will
enter all comments received into the docket and publish them on the
Regulations.gov Web site without change, including any business or
personal information that you provide such as name and address
information, email addresses, or phone numbers. Comments received,
including attachments and other supporting materials, are part of the
public record and subject to public disclosure. Do not enclose any
information in your comment or supporting materials that you consider
confidential or inappropriate for public disclosure.
You may review comments and other related materials that pertain to
this proposed rulemaking by any of the following methods:
Viewing Comments Electronically: Go to http://www.regulations.gov. Enter ``Docket ID OCC-2013-0010'' in the Search
box and click ``Search''. Comments can be filtered by agency using the
filtering tools on the left side of the screen. Click on the ``Help''
tab on the Regulations.gov home page to get information on using
Regulations.gov, including instructions for viewing public comments,
viewing other supporting and related materials, and viewing the docket
after the close of the comment period.
Viewing Comments Personally: You may personally inspect
and photocopy comments at the OCC, 400 7th Street SW., Washington, DC.
For security reasons, the OCC requires that visitors make an
appointment to inspect comments. You may do so by calling (202) 649-
6700. Upon arrival, visitors will be required to present valid
government-issued photo identification and submit to security screening
in order to inspect and photocopy comments.
Docket: You may also view or request available background
documents and project summaries using the methods described above.
Board of Governors of the Federal Reserve System: You may submit
comments, identified by Docket No. R-1411, by any of the following
methods:
Agency Web site: http://www.federalreserve.gov. Follow the
instructions for submitting comments at http://www.federalreserve.gov/generalinfo/foia/ProposedRegs.cfm.
Federal eRulemaking Portal: http://www.regulations.gov.
Follow the instructions for submitting comments.
Email: [email protected]. Include the
docket number in the subject line of the message.
Fax: (202) 452-3819 or (202) 452-3102.
Mail: Address to Robert deV. Frierson, Secretary, Board of
Governors of the Federal Reserve System, 20th Street and Constitution
Avenue NW., Washington, DC 20551.
[[Page 57929]]
All public comments will be made available on the Board's Web site
at http://www.federalreserve.gov/generalinfo/foia/ProposedRegs.cfm as
submitted, unless modified for technical reasons. Accordingly, comments
will not be edited to remove any identifying or contact information.
Public comments may also be viewed electronically or in paper in Room
MP-500 of the Board's Martin Building (20th and C Streets, NW) between
9:00 a.m. and 5:00 p.m. on weekdays.
Federal Deposit Insurance Corporation: You may submit comments,
identified by RIN number, by any of the following methods:
Agency Web site: http://www.FDIC.gov/regulations/laws/federal. Follow instructions for submitting comments on the agency Web
site.
Email: [email protected]. Include RIN 3064-AD74 in the
subject line of the message.
Mail: Robert E. Feldman, Executive Secretary, Attention:
Comments, Federal Deposit Insurance Corporation, 550 17th Street NW.,
Washington, DC 20429.
Hand Delivery/Courier: Guard station at the rear of the
550 17th Street Building (located on F Street) on business days between
7:00 a.m. and 5:00 p.m.
Federal eRulemaking Portal: http://www.regulations.gov.
Follow the instructions for submitting comments.
Instructions: All comments will be posted without change to http://
www.fdic.gov/regulations/laws/federal, including any personal
information provided. Paper copies of public comments may be ordered
from the Public Information Center by telephone at (877) 275-3342 or
(703) 562-2200.
Securities and Exchange Commission: You may submit comments by the
following method:
Electronic Comments
Use the Commission's Internet comment form (http://www.sec.gov/rules/proposed.shtml); or
Send an email to [email protected]. Please include
File Number S7-14-11 on the subject line; or
Use the Federal eRulemaking Portal (http://www.regulations.gov). Follow the instructions for submitting comments.
Paper Comments
Send paper comments in triplicate to Elizabeth M. Murphy,
Secretary, Securities and Exchange Commission, 100 F Street NE.,
Washington, DC 20549-1090
All submissions should refer to File Number S7-14-11. This
file number should be included on the subject line if email is used. To
help us process and review your comments more efficiently, please use
only one method. The Commission will post all comments on the
Commission's Internet Web site (http://www.sec.gov/rules/proposed.shtml). Comments are also available for Web site viewing and
printing in the Commission's Public Reference Room, 100 F Street NE.,
Washington, DC 20549, on official business days between the hours of
10:00 a.m. and 3:00 p.m. All comments received will be posted without
change; we do not edit personal identifying information from
submissions. You should submit only information that you wish to make
available publicly.
Federal Housing Finance Agency: You may submit your written
comments on the proposed rulemaking, identified by RIN number 2590-
AA43, by any of the following methods:
Email: Comments to Alfred M. Pollard, General Counsel, may
be sent by email at [email protected]. Please include ``RIN 2590-
AA43'' in the subject line of the message.
Federal eRulemaking Portal: http://www.regulations.gov.
Follow the instructions for submitting comments. If you submit your
comment to the Federal eRulemaking Portal, please also send it by email
to FHFA at [email protected] to ensure timely receipt by the agency.
Please include ``RIN 2590-AA43'' in the subject line of the message.
U.S. Mail, United Parcel Service, Federal Express, or
Other Mail Service: The mailing address for comments is: Alfred M.
Pollard, General Counsel, Attention: Comments/RIN 2590-AA43, Federal
Housing Finance Agency, Constitution Center, (OGC) Eighth Floor, 400
7th Street SW., Washington, DC 20024.
Hand Delivery/Courier: The hand delivery address is:
Alfred M. Pollard, General Counsel, Attention: Comments/RIN 2590-AA43,
Federal Housing Finance Agency, Constitution Center, (OGC) Eighth
Floor, 400 7th Street SW., Washington, DC 20024. A hand-delivered
package should be logged in at the Seventh Street entrance Guard Desk,
First Floor, on business days between 9:00 a.m. and 5:00 p.m.
All comments received by the deadline will be posted for public
inspection without change, including any personal information you
provide, such as your name and address, on the FHFA Web site at http://www.fhfa.gov. Copies of all comments timely received will be available
for public inspection and copying at the address above on government-
business days between the hours of 10 a.m. and 3 p.m. at the Federal
Housing Finance Agency, Constitution Center, 400 7th Street SW.,
Washington, DC 20024. To make an appointment to inspect comments please
call the Office of General Counsel at (202) 649-3804.
Department of Housing and Urban Development: Interested persons are
invited to submit comments regarding this rule to the Regulations
Division, Office of General Counsel, Department of Housing and Urban
Development, 451 7th Street SW., Room 10276, Washington, DC 20410-0500.
Communications must refer to the above docket number and title. There
are two methods for submitting public comments. All submissions must
refer to the above docket number and title.
Submission of Comments by Mail. Comments may be submitted
by mail to the Regulations Division, Office of General Counsel,
Department of Housing and Urban Development, 451 7th Street SW., Room
10276, Washington, DC 20410-0500.
Electronic Submission of Comments. Interested persons may
submit comments electronically through the Federal eRulemaking Portal
at www.regulations.gov. HUD strongly encourages commenters to submit
comments electronically. Electronic submission of comments allows the
commenter maximum time to prepare and submit a comment, ensures timely
receipt by HUD, and enables HUD to make them immediately available to
the public. Comments submitted electronically through the
www.regulations.gov Web site can be viewed by other commenters and
interested members of the public. Commenters should follow the
instructions provided on that site to submit comments electronically.
Note: To receive consideration as public comments,
comments must be submitted through one of the two methods specified
above. Again, all submissions must refer to the docket number and title
of the rule.
No Facsimile Comments. Facsimile (FAX) comments are not
acceptable.
Public Inspection of Public Comments. All properly
submitted comments and communications submitted to HUD will be
available for public inspection and copying between 8 a.m. and 5 p.m.
weekdays at the above address. Due to security measures at the HUD
Headquarters building, an appointment to review the public comments
must be scheduled in advance by calling the Regulations Division at
202-708-3055 (this is not a toll-free number). Individuals with speech
or hearing impairments may access this number via TTY by calling the
Federal Information Relay Service at
[[Page 57930]]
800-877-8339. Copies of all comments submitted are available for
inspection and downloading at www.regulations.gov.
FOR FURTHER INFORMATION CONTACT:
OCC: Kevin Korzeniewski, Attorney, Legislative and Regulatory
Activities Division, (202) 649-5490, Office of the Comptroller of the
Currency, 400 7th Street SW., Washington, DC 20219.
Board: Benjamin W. McDonough, Senior Counsel, (202) 452-2036; April
C. Snyder, Senior Counsel, (202) 452-3099; Brian P. Knestout, Counsel,
(202) 452-2249; David W. Alexander, Senior Attorney, (202) 452-2877; or
Flora H. Ahn, Senior Attorney, (202) 452-2317, Legal Division; Thomas
R. Boemio, Manager, (202) 452-2982; Donald N. Gabbai, Senior
Supervisory Financial Analyst, (202) 452-3358; Ann P. McKeehan, Senior
Supervisory Financial Analyst, (202) 973-6903; or Sean M. Healey,
Senior Financial Analyst, (202) 912-4611, Division of Banking
Supervision and Regulation; Karen Pence, Assistant Director, Division
of Research & Statistics, (202) 452-2342; or Nikita Pastor, Counsel,
(202) 452-3667, Division of Consumer and Community Affairs, Board of
Governors of the Federal Reserve System, 20th and C Streets NW.,
Washington, DC 20551.
FDIC: Rae-Ann Miller, Associate Director, (202) 898-3898; George
Alexander, Assistant Director, (202) 898-3718; Kathleen M. Russo,
Supervisory Counsel, (703) 562-2071; or Phillip E. Sloan, Counsel,
(703) 562-6137, Federal Deposit Insurance Corporation, 550 17th Street
NW., Washington, DC 20429.
Commission: Steven Gendron, Analyst Fellow; Arthur Sandel, Special
Counsel; David Beaning, Special Counsel; or Katherine Hsu, Chief, (202)
551-3850, in the Office of Structured Finance, Division of Corporation
Finance, U.S. Securities and Exchange Commission, 100 F Street NE.,
Washington, DC 20549-3628.
FHFA: Patrick J. Lawler, Associate Director and Chief Economist,
[email protected], (202) 649-3190; Ronald P. Sugarman, Principal
Legislative Analyst, [email protected], (202) 649-3208; Phillip
Millman, Principal Capital Markets Specialist,
[email protected], (202) 649-3080; or Thomas E. Joseph,
Associate General Counsel, [email protected], (202) 649-3076;
Federal Housing Finance Agency, Constitution Center, 400 7th Street
SW., Washington, DC 20024. The telephone number for the
Telecommunications Device for the Hearing Impaired is (800) 877-8339.
HUD: Michael P. Nixon, Office of Housing, Department of Housing and
Urban Development, 451 7th Street SW., Room 10226, Washington, DC
20410; telephone number 202-402-5216 (this is not a toll-free number).
Persons with hearing or speech impairments may access this number
through TTY by calling the toll-free Federal Information Relay Service
at 800-877-8339.
SUPPLEMENTARY INFORMATION:
Table of Contents
I. Introduction
A. Background
B. Overview of the Original Proposal and Public Comment
C. Overview of the Proposed Rule
II. General Definitions and Scope
A. Overview of Significant Definitions in the Original Proposal
and Comments
1. Asset-Backed Securities, Securitization Transactions, and ABS
Interests
2. Securitizer, Sponsor, and Depositor
3. Originator
4. Servicing Assets, Collateral
B. Proposed General Definitions
III. General Risk Retention Requirement
A. Minimum Risk Retention Requirement
B. Permissible Forms of Risk Retention--Menu of Options
1. Standard Risk Retention
2. Revolving Master Trusts
3. Representative Sample
4. Asset-Backed Commercial Paper Conduits
5. Commercial Mortgage-Backed Securities
6. Government-Sponsored Enterprises
7. Open Market Collateralized Loan Obligations
8. Municipal Bond ``Repackaging'' Securitizations
9. Premium Capture Cash Reserve Account
C. Allocation to the Originator
D. Hedging, Transfer, and Financing Restrictions
IV. General Exemptions
A. Exemption for Federally Insured or Guaranteed Residential,
Multifamily, and Health Care Mortgage Loan Assets
B. Exemption for Securitizations of Assets Issued, Insured, or
Guaranteed by the United States or Any Agency of the United States
and Other Exemptions
C. Exemption for Certain Resecuritization Transactions
D. Other Exemptions From Risk Retention Requirements
1. Utility Legislative Securitizations
2. Seasoned Loans
3. Legacy Loan Securitizations
4. Corporate Debt Repackagings
5. ``Non-Conduit'' CMBS Transactions
6. Tax Lien-Backed Securities Sponsored by a Municipal Entity
7. Rental Car Securitizations
E. Safe Harbor for Foreign Securitization Transactions
F. Sunset on Hedging and Transfer Restrictions
G. Federal Deposit Insurance Corporation Securitizations
V. Reduced Risk Retention Requirements and Underwriting Standards
for ABS Backed by Qualifying Commercial, Commercial Real Estate, or
Automobile Loans
A. Qualifying Commercial Loans
B. Qualifying Commercial Real Estate Loans
1. Ability To Repay
2. Loan-to-Value Requirement
3. Collateral Valuation
4. Risk Management and Monitoring
C. Qualifying Automobile Loans
1. Ability To Repay
2. Loan Terms
3. Reviewing Credit History
4. Loan-to-Value
D. Qualifying Asset Exemption
E. Buyback Requirement
VI. Qualified Residential Mortgages
A. Overview of Original Proposal and Public Comments
B. Approach to Defining QRM
1. Limiting Credit Risk
2. Preserving Credit Access
C. Proposed Definition of QRM
D. Exemption for QRMs
E. Repurchase of Loans Subsequently Determined To Be Non-
Qualified After Closing
F. Alternative Approach to Exemptions for QRMs
VII. Solicitation of Comments on Use of Plain Language
VIII. Administrative Law Matters
A. Regulatory Flexibility Act
B. Paperwork Reduction Act
C. Commission Economic Analysis
D. OCC Unfunded Mandates Reform Act of 1995 Determination
E. Commission: Small Business Regulatory Enforcement Fairness
Act
F. FHFA: Considerations of Differences Between the Federal Home
Loan Banks and the Enterprises
I. Introduction
The agencies are requesting comment on a proposed rule that re-
proposes with modifications a previously proposed rule to implement the
requirements of section 941 of the Dodd-Frank Wall Street Reform and
Consumer Protection Act (the Act, or Dodd-Frank Act).\1\ Section 15G of
the Exchange Act, as added by section 941(b) of the Dodd-Frank Act,
generally requires the Board, the FDIC, the OCC (collectively, referred
to as the Federal banking agencies), the Commission, and, in the case
of the securitization of any ``residential mortgage asset,'' together
with HUD and FHFA, to jointly prescribe regulations that (i) require a
securitizer to retain not less than 5 percent of the credit risk of any
asset that the securitizer, through the issuance of an asset-backed
security (ABS), transfers, sells, or conveys to a third party, and (ii)
prohibit a
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securitizer from directly or indirectly hedging or otherwise
transferring the credit risk that the securitizer is required to retain
under section 15G and the agencies' implementing rules.\2\
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\1\ Public Law 111-203, 124 Stat. 1376 (2010). Section 941 of
the Dodd-Frank Act amends the Securities Exchange Act of 1934 (the
Exchange Act) and adds a new section 15G of the Exchange Act. 15
U.S.C. 78o-11.
\2\ See 15 U.S.C. 78o-11(b), (c)(1)(A) and (c)(1)(B)(ii).
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Section 15G of the Exchange Act exempts certain types of
securitization transactions from these risk retention requirements and
authorizes the agencies to exempt or establish a lower risk retention
requirement for other types of securitization transactions. For
example, section 15G specifically provides that a securitizer shall not
be required to retain any part of the credit risk for an asset that is
transferred, sold, or conveyed through the issuance of ABS by the
securitizer, if all of the assets that collateralize the ABS are
qualified residential mortgages (QRMs), as that term is jointly defined
by the agencies.\3\ In addition, section 15G provides that a
securitizer may retain less than 5 percent of the credit risk of
commercial mortgages, commercial loans, and automobile loans that are
transferred, sold, or conveyed through the issuance of ABS by the
securitizer if the loans meet underwriting standards established by the
Federal banking agencies.\4\
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\3\ See 15 U.S.C. 78o-11(c)(1)(C)(iii), (e)(4)(A) and (B).
\4\ See id. at section 78o-11(c)(1)(B)(ii) and (2).
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In April 2011, the agencies published a joint notice of proposed
rulemaking that proposed to implement section 15G of the Exchange Act
(original proposal).\5\ The proposed rule revises the original
proposal, as described in more detail below.
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\5\ Credit Risk Retention; Proposed Rule, 76 FR 24090 (April 29,
2011) (Original Proposal).
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Section 15G allocates the authority for writing rules to implement
its provisions among the agencies in various ways. As a general matter,
the agencies collectively are responsible for adopting joint rules to
implement the risk retention requirements of section 15G for
securitizations that are backed by residential mortgage assets and for
defining what constitutes a QRM for purposes of the exemption for QRM-
backed ABS.\6\ The Federal banking agencies and the Commission,
however, are responsible for adopting joint rules that implement
section 15G for securitizations backed by all other types of assets,\7\
and are authorized to adopt rules in several specific areas under
section 15G.\8\ In addition, the Federal banking agencies are jointly
responsible for establishing, by rule, the underwriting standards for
non-QRM residential mortgages, commercial mortgages, commercial loans,
and automobile loans that would qualify ABS backed by these types of
loans for a risk retention requirement of less than 5 percent.\9\
Accordingly, when used in this Notice of Proposed Rulemaking, the term
``agencies'' shall be deemed to refer to the appropriate agencies that
have rulewriting authority with respect to the asset class,
securitization transaction, or other matter discussed.
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\6\ See id. at section 78o-11(b)(2), (e)(4)(A) and (B).
\7\ See id. at section 78o-11(b)(1).
\8\ See, e.g. id. at sections 78o-11(b)(1)(E) (relating to the
risk retention requirements for ABS collateralized by commercial
mortgages); (b)(1)(G)(ii) (relating to additional exemptions for
assets issued or guaranteed by the United States or an agency of the
United States); (d) (relating to the allocation of risk retention
obligations between a securitizer and an originator); and (e)(1)
(relating to additional exemptions, exceptions or adjustments for
classes of institutions or assets).
\9\ See id. at section 78o-11(b)(2)(B).
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For ease of reference, the re-proposed rules of the agencies are
referenced using a common designation of Sec. ----.1 to Sec. ----.21
(excluding the title and part designations for each agency). With the
exception of HUD, each agency will codify the rules, when adopted in
final form, within each of their respective titles of the Code of
Federal Regulations.\10\ Section ----.1 of each agency's rule
identifies the entities or transactions subject to such agency's rule.
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\10\ Specifically, the agencies propose to codify the rules as
follows: 12 CFR part 43 (OCC); 12 CFR part 244 (Regulation RR)
(Board); 12 CFR part 373 (FDIC); 12 CFR part 246 (Commission); 12
CFR part 1234 (FHFA). As required by section 15G, HUD has jointly
prescribed the proposed rules for a securitization that is backed by
any residential mortgage asset and for purposes of defining a
qualified residential mortgage. Because the proposed rules would
exempt the programs and entities under HUD's jurisdiction from the
requirements of the proposed rules, HUD does not propose to codify
the rules into its title of the CFR at the time the rules are
adopted in final form.
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The preamble to the original proposal described the agencies'
intention to jointly approve any written interpretations, written
responses to requests for no-action letters and general counsel
opinions, or other written interpretive guidance (written
interpretations) concerning the scope or terms of section 15G of the
Exchange Act and the final rules issued thereunder that are intended to
be relied on by the public generally. The agencies also intended for
the appropriate agencies to jointly approve any exemptions, exceptions,
or adjustments to the final rules. For these purposes, the phrase
``appropriate agencies'' refers to the agencies with rulewriting
authority for the asset class, securitization transaction, or other
matter addressed by the interpretation, guidance, exemption, exception,
or adjustment.
Consistent with section 15G of the Exchange Act, the risk retention
requirements would become effective, for securitization transactions
collateralized by residential mortgages, one year after the date on
which final rules are published in the Federal Register, and two years
after that date for any other securitization transaction.
A. Background
As the agencies observed in the preamble to the original proposal,
the securitization markets are an important link in the chain of
entities providing credit to U.S. households and businesses, and state
and local governments.\11\ When properly structured, securitization
provides economic benefits that can lower the cost of credit to
households and businesses.\12\ However, when incentives are not
properly aligned and there is a lack of discipline in the credit
origination process, securitization can result in harmful consequences
to investors, consumers, financial institutions, and the financial
system.
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\11\ Securitization may reduce the cost of funding, which is
accomplished through several different mechanisms. For example,
firms that specialize in originating new loans and that have
difficulty funding existing loans may use securitization to access
more-liquid capital markets for funding. In addition, securitization
can create opportunities for more efficient management of the asset-
liability duration mismatch generally associated with the funding of
long-term loans, for example, with short-term bank deposits.
Securitization also allows the structuring of securities with
differing maturity and credit risk profiles from a single pool of
assets that appeal to a broad range of investors. Moreover,
securitization that involves the transfer of credit risk allows
financial institutions that primarily originate loans to particular
classes of borrowers, or in particular geographic areas, to limit
concentrated exposure to these idiosyncratic risks on their balance
sheets.
\12\ Report to the Congress on Risk Retention, Board of
Governors of the Federal Reserve System, at 8 (October 2010),
available at http://federalreserve.gov/boarddocs/rptcongress/securitization/riskretention.pdf (Board Report).
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During the financial crisis, securitization transactions displayed
significant vulnerabilities to informational and incentive problems
among various parties involved in the process.\13\ Investors did not
have access to the same information about the assets collateralizing
ABS as other parties in the securitization chain (such as the sponsor
of the securitization transaction or an originator of the securitized
loans).\14\ In addition, assets were resecuritized into complex
instruments, such as collateralized debt obligations (CDOs) and CDOs-
squared, which made it difficult for investors to discern the
[[Page 57932]]
true value of, and risks associated with, an investment in the
securitization.\15\ Moreover, some lenders using an ``originate-to-
distribute'' business model loosened their underwriting standards
knowing that the loans could be sold through a securitization and
retained little or no continuing exposure to the loans.\16\
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\13\ See Board Report at 8-9.
\14\ See S. Rep. No. 111-176, at 128 (2010).
\15\ See id.
\16\ See id.
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Congress intended the risk retention requirements added by section
15G to help address problems in the securitization markets by requiring
that securitizers, as a general matter, retain an economic interest in
the credit risk of the assets they securitize. By requiring that the
securitizer retain a portion of the credit risk of the assets being
securitized, the requirements of section 15G provide securitizers an
incentive to monitor and ensure the quality of the assets underlying a
securitization transaction, and, thus, help align the interests of the
securitizer with the interests of investors. Additionally, in
circumstances where the assets collateralizing the ABS meet
underwriting and other standards that help to ensure the assets pose
low credit risk, the statute provides or permits an exemption.\17\
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\17\ See 15 U.S.C. 78o-11(c)(1)(B)(ii), (e)(1)-(2).
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Accordingly, the credit risk retention requirements of section 15G
are an important part of the legislative and regulatory efforts to
address weaknesses and failures in the securitization process and the
securitization markets. Section 15G complements other parts of the
Dodd-Frank Act intended to improve the securitization markets. Such
other parts include provisions that strengthen the regulation and
supervision of national recognized statistical rating organizations
(NRSROs) and improve the transparency of credit ratings; \18\ provide
for issuers of registered ABS offerings to perform a review of the
assets underlying the ABS and disclose the nature of the review; \19\
and require issuers of ABS to disclose the history of the requests they
received and repurchases they made related to their outstanding
ABS.\20\
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\18\ See, e.g. sections 932, 935, 936, 938, and 943 of the Dodd-
Frank Act (15 U.S.C. 78o-7, 78o-8).
\19\ See section 945 of the Dodd-Frank Act (15 U.S.C. 77g).
\20\ See section 943 of the Dodd-Frank Act (15 U.S.C. 78o-7).
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B. Overview of the Original Proposal and Public Comment
In developing the original proposal, the agencies took into account
the diversity of assets that are securitized, the structures
historically used in securitizations, and the manner in which
securitizers \21\ have retained exposure to the credit risk of the
assets they securitize.\22\ The original proposal provided several
options from which sponsors could choose to meet section 15G's risk
retention requirements, including, for example, retention of a 5
percent ``vertical'' interest in each class of ABS interests issued in
the securitization, retention of a 5 percent ``horizontal'' first-loss
interest in the securitization, and other options designed to reflect
the way in which market participants have historically structured
credit card receivable and asset-backed commercial paper conduit
securitizations. The original proposal also included a special
``premium capture'' mechanism designed to prevent a sponsor from
structuring a securitization transaction in a manner that would allow
the sponsor to offset or minimize its retained economic exposure to the
securitized assets by monetizing the excess spread created by the
securitization transaction.
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\21\ As discussed in the original proposal and further below,
the agencies propose that a ``sponsor,'' as defined in a manner
consistent with the definition of that term in the Commission's
Regulation AB, would be a ``securitizer'' for the purposes of
section 15G.
\22\ Both the language and legislative history of section 15G
indicate that Congress expected the agencies to be mindful of the
heterogeneity of securitization markets. See, e.g., 15 U.S.C. 78o-
11(c)(1)(E), (c)(2), (e); S. Rep. No. 111-76, at 130 (2010) (``The
Committee believes that implementation of risk retention obligations
should recognize the differences in securitization practices for
various asset classes.'').
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The original proposal also included disclosure requirements that
were specifically tailored to each of the permissible forms of risk
retention. The disclosure requirements were an integral part of the
original proposal because they would have provided investors with
pertinent information concerning the sponsor's retained interests in a
securitization transaction, such as the amount and form of interest
retained by sponsors.
As required by section 15G, the original proposal provided a
complete exemption from the risk retention requirements for ABS that
are collateralized solely by QRMs and established the terms and
conditions under which a residential mortgage would qualify as a QRM.
In developing the proposed definition of a QRM, the agencies considered
the terms and purposes of section 15G, public input, and the potential
impact of a broad or narrow definition of QRM on the housing and
housing finance markets. In addition, the agencies developed the QRM
proposal to be consistent with the requirement of section 15G that the
definition of a QRM be ``no broader than'' the definition of a
``qualified mortgage'' (QM), as the term is defined under section
129C(b)(2) of the Truth in Lending Act (TILA) (15 U.S.C. 1639C(b)(2)),
as amended by the Dodd-Frank Act, \23\ and regulations adopted
thereunder.\24\
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\23\ See 15 U.S.C. 78o-11(e)(4)(C). As adopted, the text of
section 15G(e)(4)(C) cross-references section 129C(c)(2) of TILA for
the definition of a QM. However, section 129C(b)(2), and not section
129C(c)(2), of TILA contains the definition of a ``qualified
mortgage.'' The legislative history clearly indicates that the
reference in the statute to section 129C(c)(2) of TILA (rather than
section 129C(b)(2) of TILA) was an inadvertent technical error. See
156 Cong. Rec. S5929 (daily ed. July 15, 2010) (statement of Sen.
Christopher Dodd) (``The [conference] report contains the following
technical errors: the reference to `section 129C(c)(2)' in
subsection (e)(4)(C) of the new section 15G of the Securities and
Exchange Act, created by section 941 of the [Dodd-Frank Act] should
read `section 129C(b)(2).' In addition, the references to
`subsection' in paragraphs (e)(4)(A) and (e)(5) of the newly created
section 15G should read `section.' We intend to correct these in
future legislation.'').
\24\ See 78 FR 6408 (January 30, 2013), as amended by 78 FR
35430 (June 12, 2013). These two final rules were preceded by a
proposed rule defining QM, issued by the Board and published in the
Federal Register. See 76 FR 27390 (May 11, 2011). The Board had
initial responsibility for administration and oversight of TILA
prior to transfer to the Consumer Financial Protection Bureau.
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The original proposal would generally have prohibited QRMs from
having product features that were observed to contribute significantly
to the high levels of delinquencies and foreclosures since 2007. These
included features permitting negative amortization, interest-only
payments, or significant interest rate increases. The QRM definition in
the original proposal also included other underwriting standards
associated with lower risk of default, including a down payment
requirement of 20 percent in the case of a purchase transaction,
maximum loan-to-value ratios of 75 percent on rate and term refinance
loans and 70 percent for cash-out refinance loans, as well as credit
history criteria (or requirements). The QRM standard in the original
proposal also included maximum front-end and back-end debt-to-income
ratios. As explained in the original proposal, the agencies intended
for the QRM proposal to reflect very high quality underwriting
standards, and the agencies expected that a large market for non-QRM
loans would continue to exist, providing ample liquidity to mortgage
lenders.
Consistent with the statute, the original proposal also provided
that sponsors would not have to hold risk retention for securitized
commercial, commercial real estate, and automobile loans that met
proposed underwriting
[[Page 57933]]
standards that incorporated features and requirements historically
associated with very low credit risk in those asset classes.
With respect to securitization transactions sponsored by the
Federal National Mortgage Association (Fannie Mae) and the Federal Home
Loan Mortgage Corporation (Freddie Mac) (jointly, the Enterprises), the
agencies proposed to recognize the 100 percent guarantee of principal
and interest payments by the Enterprises on issued securities as
meeting the risk retention requirement. However, this recognition would
only remain in effect for as long as the Enterprises operated under the
conservatorship or receivership of FHFA with capital support from the
United States.
In response to the original proposal, the agencies received
comments from over 10,500 persons, institutions, or groups, including
nearly 300 unique comment letters. The agencies received a significant
number of comments regarding the appropriate amount and measurement of
risk retention. Many commenters generally supported the proposed menu-
based approach of providing sponsors flexibility to choose from a
number of permissible forms of risk retention, although several argued
for more flexibility in selecting risk retention options, including
using multiple options simultaneously. Comments on the disclosure
requirements in the original proposal were limited.
Many commenters expressed significant concerns with the proposed
standards for horizontal risk retention and the premium capture cash
reserve account (PCCRA), which were intended to ensure meaningful risk
retention. Many commenters asserted that these proposals would lead to
significantly higher costs for sponsors, possibly discouraging them
from engaging in new securitization transactions. However, some
commenters supported the PCCRA concept, arguing that the more
restrictive nature of the account would be offset by the requirement's
contribution to more conservative underwriting practices.
Other commenters expressed concerns with respect to standards in
the original proposal for specific asset classes, such as the proposed
option for third-party purchasers to hold risk retention in commercial
mortgage-backed securitizations instead of sponsors (as contemplated by
section 15G). Many commenters also expressed concern about the
underwriting standards for non-residential asset classes, generally
criticizing them as too conservative to be utilized effectively by
sponsors. Several commenters criticized application of the original
proposal to managers of certain collateralized loan obligation (CLO)
transactions and argued that the original proposal would lead to more
concentration in the industry and reduce access to credit for many
businesses.
An overwhelming majority of commenters criticized the agencies'
proposed QRM standard. Many of these commenters asserted that the
proposed definition of QRM, particularly the 20 percent down payment
requirement, would significantly increase the costs of credit for most
home buyers and restrict access to credit. Some of these commenters
asserted that the proposed QRM standard would become a new
``government-approved'' standard, and that lenders would be reluctant
to originate mortgages that did not meet the standard. Commenters also
argued that this proposed standard would make it more difficult to
reduce the participation of the Enterprises in the mortgage market.
Commenters argued that the proposal was inconsistent with legislative
intent and strongly urged the agencies to eliminate the down payment
requirement, make it substantially smaller, or allow private mortgage
insurance to substitute for the requirement within the QRM standard.
Commenters also argued that the agencies should align the QRM
definition with the definition of QM, as implemented by the Consumer
Financial Protection Bureau (CFPB).\25\
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\25\ See 78 FR 6407 (January 30, 2013), as amended by 78 FR
35429 (June 12, 2013) and 78 FR 44686 (July 24, 2013).
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Various commenters also criticized the agencies' proposed treatment
of the Enterprises. A commenter asserted that the agencies' recognition
of the Enterprises' guarantee as retained risk (while in
conservatorship or receivership with capital support from the United
States) would impede the policy goal of reducing the role of the
Enterprises and the government in the mortgage securitization market
and encouraging investment in private residential mortgage
securitizations. A number of other commenters, however, supported the
proposed approach for the Enterprises.
The preamble to the original proposal described the agencies'
intention to jointly approve certain types of written interpretations
concerning the scope of section 15G and the final rules issued
thereunder. Several commenters on the original proposal expressed
concern about the agencies' processes for issuing written
interpretations jointly and the possible uncertainty about the rules
that may arise due to this process.
The agencies have endeavored to provide specificity and clarity in
the proposed rule to avoid conflicting interpretations or uncertainty.
In the future, if the heads of the agencies determine that further
guidance would be beneficial for market participants, they may jointly
publish interpretive guidance documents, as the federal banking
agencies have done in the past. In addition, the agencies note that
market participants can, as always, seek guidance concerning the rules
from their primary federal banking regulator or, if such market
participant is not a depository institution or a government-sponsored
enterprise, the Commission. In light of the joint nature of the
agencies' rule writing authority, the agencies continue to view the
consistent application of the final rule as a benefit and intend to
consult with each other when adopting staff interpretations or guidance
on the final rule that would be shared with the public generally. The
agencies are considering whether to require that such staff
interpretations and guidance be jointly issued by the agencies with
rule writing authority and invite comment.\26\
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\26\ These items would not include interpretation and guidance
in staff comment letters and other staff guidance directed to
specific institutions that is not intended to be relied upon by the
public generally. Nor would it include interpretations and guidance
contained in administrative or judicial enforcement proceedings by
the agencies, or in an agency report of examination or inspection or
similar confidential supervisory correspondence.
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The specific provisions of the original proposal and public
comments received thereon are discussed in further detail below.
C. Overview of the Proposed Rule
The agencies have carefully considered the many comments received
on the original proposal as well as engaged in further analysis of the
securitization and lending markets in light of the comments. As a
result, the agencies believe it would be appropriate to modify several
important aspects of the original proposal and are issuing a new
proposal incorporating these modifications. The agencies have concluded
that a new proposal would give the public the opportunity to review and
provide comment on the agencies' revised design of the risk retention
regulatory framework and assist the agencies in determining whether the
revised framework is appropriately structured.
The proposed rule takes account of the comments received on the
original proposal. In developing the proposed
[[Page 57934]]
rule, the agencies consistently have sought to ensure that the amount
of credit risk required of a sponsor would be meaningful, consistent
with the purposes of section 15G. The agencies have also sought to
minimize the potential for the proposed rule to negatively affect the
availability and costs of credit to consumers and businesses.
As described in detail below, the proposed rule would significantly
increase the degree of flexibility that sponsors would have in meeting
the risk retention requirements of section 15G. For example, the
proposed rule would permit a sponsor to satisfy its obligation by
retaining any combination of an ``eligible vertical interest'' and an
``eligible horizontal residual interest'' to meet the 5 percent minimum
requirement. The agencies are also proposing that horizontal risk
retention be measured by fair value, reflecting market practice, and
are proposing a more flexible treatment for payments to a horizontal
risk retention interest than that provided in the original proposal. In
combination with these changes, the agencies propose to remove the
PCCRA requirement.\27\ The agencies have incorporated proposed
standards for the expiration of the hedging and transfer restrictions
and proposed new exemptions from risk retention for certain
resecuritizations, seasoned loans, and certain types of securitization
transactions with low credit risk. In addition, the agencies propose a
new risk retention option for CLOs that is similar to the allocation to
originator concept proposed for sponsors generally.
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\27\ The proposal would also eliminate the ``representative
sample'' option, which commenters had argued would be impractical.
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Furthermore, the agencies are proposing revised standards with
respect to risk retention by a third-party purchaser in commercial
mortgage-backed securities (CMBS) transactions and an exemption that
would permit transfer (by a third-party purchaser or sponsor) of a
horizontal interest in a CMBS transaction after five years, subject to
standards described below.
The agencies have carefully considered the comments received on the
QRM standard in the original proposal as well as various ongoing
developments in the mortgage markets, including mortgage regulations.
For the reasons discussed more fully below, the agencies are proposing
to revise the QRM definition in the original proposal to equate the
definition of a QRM with the definition of QM adopted by the CFPB.\28\
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\28\ See 78 FR 6407 (January 30, 2013), as amended by 78 FR
35429 (June 12, 2013) and 78 FR 44686 (July 24, 2013).
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The agencies invite comment on all aspects of the proposed rule,
including comment on whether any aspects of the original proposal
should be adopted in the final rule. Please provide data and
explanations supporting any positions offered or changes suggested.
II. General Definitions and Scope
A. Overview of Significant Definitions in the Original Proposal and
Comments
1. Asset-Backed Securities, Securitization Transactions, and ABS
Interests
The original proposal provided that the proposed risk retention
requirements would have applied to sponsors in securitizations that
involve the issuance of ``asset-backed securities'' and defined the
terms ``asset-backed security'' and ``asset'' consistent with the
definitions of those terms in the Exchange Act. The original proposal
noted that section 15G does not appear to distinguish between
transactions that are registered with the Commission under the
Securities Act of 1933 (the Securities Act) and those that are exempt
from registration under the Securities Act. It further noted that the
proposed definition of ABS, which would have been broader than that of
the Commission's Regulation AB,\29\ included securities that are
typically sold in transactions that are exempt from registration under
the Securities Act, such as CDOs and securities issued or guaranteed by
an Enterprise. As a result, the proposed risk retention requirements
would have applied to securitizers of ABS offerings regardless of
whether the offering was registered with the Commission under the
Securities Act.
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\29\ See 17 CFR 229.1100 through 17 CFR 229.1123.
---------------------------------------------------------------------------
Under the original proposal, risk retention requirements would have
applied to the securitizer in each ``securitization transaction,''
defined as a transaction involving the offer and sale of ABS by an
issuing entity. The original proposal also explained that the term
``ABS interest'' would refer to all types of interests or obligations
issued by an issuing entity, whether or not in certificated form,
including a security, obligation, beneficial interest, or residual
interest, but would not include interests, such as common or preferred
stock, in an issuing entity that are issued primarily to evidence
ownership of the issuing entity, and the payments, if any, which are
not primarily dependent on the cash flows of the collateral held by the
issuing entity.
With regard to these three definitions, some commenters were
critical of what they perceived to be the overly broad scope of the
terms and advocated for express exemptions or exclusions from their
application. Some commenters expressed concern that the definition of
``asset-backed securities'' could be read to be broader than intended
and requested clarification as to the precise contours of the
definition. For example, certain commenters were concerned that the
proposed ABS definition could unintentionally include securities that
do not serve the same purpose or present the same set of risks as
``asset-backed securities,'' such as securities which are, either
directly or through a guarantee, full-recourse corporate obligations of
a creditworthy entity that is not a special-purpose vehicle (SPV), but
are also secured by a pledge of financial assets. Other commenters
suggested that the agencies provide a bright-line safe harbor that
defines conditions under which risk retention is not required even if a
security is collateralized by self-liquidating assets and advocated
that certain securities be expressly excluded from the proposed rule's
definition of ABS.
Similarly, a number of commenters requested clarification with
regard to the scope of the definition of ``ABS interest,'' stating that
its broad definition could potentially capture a number of items not
traditionally considered ``interests'' in a securitization, such as
non-economic residual interests, servicing and special servicing fees,
and amounts payable by the issuing entity under a derivatives contract.
With regard to the definition of ``securitization transaction,'' a
commenter recommended that transactions undertaken solely to manage
financial guarantee insurance related to the underlying obligations not
be considered ``securitizations.''
2. Securitizer, Sponsor, and Depositor
Section 15G stipulates that its risk retention requirements be
applied to a ``securitizer'' of an ABS and, in turn, that a securitizer
is both an issuer of an ABS or a person who organizes and initiates a
securitization transaction by selling or transferring assets, either
directly or indirectly, including through an affiliate or issuer. The
original proposal noted that the second prong of this definition is
substantially identical to the definition of a ``sponsor'' of a
securitization transaction in the
[[Page 57935]]
Commission's Regulation AB.\30\ Accordingly, the original proposal
would have defined the term ``sponsor'' in a manner consistent with the
definition of that term in the Commission's Regulation AB.\31\
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\30\ See Item 1101 of the Commission's Regulation AB (17 CFR
229.1101) (defining a sponsor as ``a person who organizes and
initiates an asset-backed securities transaction by selling or
transferring assets, either directly or indirectly, including
through an affiliate, to the issuing entity.'').
\31\ As discussed in the original proposal, when used in the
federal securities laws, the term ``issuer'' may have different
meanings depending on the context in which it is used. For the
purposes of section 15G, the original proposal provided that the
agencies would have interpreted an ``issuer'' of an asset-back
security to refer to the ``depositor'' of an ABS, consistent with
how that term has been defined and used under the federal securities
laws in connection with an ABS.
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Other than issues concerning CLOs, which are discussed in Part
III.B.7 of this Supplementary Information, comments with regard to
these terms were generally limited to requests that the final rules
provide that certain specified persons--such as underwriting sales
agents--be expressly excluded from the definition of securitizer or
sponsor for the purposes of the risk retention requirements.
3. Originator
The original proposal would have defined the term ``originator'' in
the same manner as section 15G, namely, as a person who, through the
extension of credit or otherwise, creates a financial asset that
collateralizes an ABS, and sells the asset directly or indirectly to a
securitizer (i.e., a sponsor or depositor). The original proposal went
on to note that because this definition refers to the person that
``creates'' a loan or other receivable, only the original creditor
under a loan or receivable--and not a subsequent purchaser or
transferee--would have been an originator of the loan or receivable for
purposes of section 15G.
4. Securitized Assets, Collateral
The original proposal referred to the assets underlying a
securitization transaction as the ``securitized assets,'' meaning
assets that are transferred to the SPV that issues the ABS interests
and that stand as collateral for those ABS interests. ``Collateral''
would be defined as the property that provides the cash flow for
payment of the ABS interests issued by the issuing entity. Taken
together, these definitions were meant to suggest coverage of the
loans, leases, or similar assets that the depositor places into the
issuing SPV at the inception of the transaction, though it would have
also included other assets such as pre-funded cash reserve accounts.
Commenters pointed out that, in addition to this property, the issuing
entity may hold other assets. For example, the issuing entity may
acquire interest rate derivatives to convert floating rate interest
income to fixed rate, or the issuing entity may accrete cash or other
liquid assets in reserve funds that accumulate cash generated by the
securitized assets. As another example, commenters noted that an asset-
backed commercial paper conduit may hold a liquidity guarantee from a
bank on some or all of its securitized assets.
B. Proposed General Definitions
The agencies have carefully considered all of the comments raised
with respect to the general definitions of the original proposal. The
agencies do not believe that significant changes to these definitions
are necessary and, accordingly, are proposing to maintain the general
definitions in substantially the same form as they were presented in
the original proposal, with one exception.\32\
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\32\ Regarding comments about what securities constitutes an ABS
interest under the proposed definition, the agencies preliminarily
believe that non-economic residual interests would constitute ABS
interests. However, as the proposal makes clear, fees for services
such as servicing fees would not fall under the definition of an ABS
interest.
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To describe the additional types of property that could be held by
an issuing entity, the agencies are proposing a definition of
``servicing assets,'' which would be any rights or other assets
designed to assure the servicing, timely payment, or timely
distribution of proceeds to security holders, or assets related or
incidental to purchasing or otherwise acquiring and holding the issuing
entity's securitized assets. These may include cash and cash
equivalents, contract rights, derivative agreements of the issuing
entity used to hedge interest rate and foreign currency risks, or the
collateral underlying the securitized assets. As noted in the rule
text, it also includes proceeds of assets collateralizing the
securitization transactions, whether in the form of voluntary payments
from obligors on the assets or otherwise (such as liquidation
proceeds). The agencies are proposing this definition in order to
ensure that the provisions of the proposal appropriately accommodate
the need, in administering a securitization transaction on an ongoing
basis, to hold various assets other than the loans or similar assets
that are transferred into the asset pool by the securitization
depositor. The proposed definition is similar to elements of the
definition of ``eligible assets'' in Rule 3a-7 under the Investment
Company Act of 1940, which specifies conditions under which the issuer
of non-redeemable fixed-income securities backed by self-liquidating
financial assets will not be deemed to be an investment company.
To facilitate the agencies revised proposal for the QRM definition,
the agencies are proposing to define the term ``residential mortgage''
by reference to the definition of ``covered transaction'' to be found
in the CFPB's Regulation Z.\33\ Accordingly, for purposes of the
proposed rule, a residential mortgage would mean a consumer credit
transaction that is secured by a dwelling, as such term is also defined
in Regulation Z \34\ (including any real property attached to a
dwelling) and any transaction that is exempt from the definition of
``covered transaction'' under the CFPB's Regulation Z.\35\ Therefore,
the term ``residential mortgage'' would include home equity lines of
credit, reverse mortgages, mortgages secured by interests in timeshare
plans, and temporary loans. By defining residential mortgage in this
way, the agencies seek to ensure that relevant definitions in the
proposed rule and in the CFPB's rules on and related to QM are
harmonized to reduce compliance burden and complexity, and the
potential for conflicting definitions and interpretations where the
proposed rule and the QM standard intersect. Additionally, the agencies
are proposing to include those loans excluded from the definition of
``covered transaction'' in the definition of ``residential mortgage''
for purposes of risk retention so that those categories of loans would
be subject to risk retention requirements that are applied to
residential mortgage securitizations under the proposed rule.
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\33\ See 78 FR 6584 (January 30, 2013), to be codified at 12 CFR
1026.43.
\34\ 12 CFR 1026.2(a)(19).
\35\ Id.
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III. General Risk Retention Requirement
A. Minimum Risk Retention Requirement
Section 15G of the Exchange Act generally requires that the
agencies jointly prescribe regulations that require a securitizer to
retain not less than 5 percent of the credit risk for any asset that
the securitizer, through the issuance of an ABS, transfers, sells, or
conveys to a third party, unless an exemption from the risk retention
requirements for the securities or transaction is otherwise available
(e.g., if the ABS is collateralized exclusively
[[Page 57936]]
by QRMs). Consistent with the statute, the original proposal generally
required that a sponsor retain an economic interest equal to at least 5
percent of the aggregate credit risk of the assets collateralizing an
issuance of ABS (the base risk retention requirement). Under the
original proposal, the base risk retention requirement would have
applied to all securitization transactions that are within the scope of
section 15G, regardless of whether the sponsor were an insured
depository institution, a bank holding company or subsidiary thereof, a
registered broker-dealer, or other type of entity.\36\
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\36\ Synthetic securitizations and securitizations that meet the
requirements of the foreign safe harbor are examples of
securitization transactions that are not within the scope of section
15G.
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The agencies requested comment on whether the minimum 5 percent
risk retention requirement was appropriate or whether a higher risk
retention requirement should be established. Several commenters
expressed support for the minimum 5 percent risk retention requirement,
with some commenters supporting a higher risk retention requirement.
However, other commenters suggested tailoring the risk retention
requirement to the specific risks of distinct asset classes.
Consistent with the original proposal, the proposed rule would
apply a minimum 5 percent base risk retention requirement to all
securitization transactions that are within the scope of section 15G,
regardless of whether the sponsor is an insured depository institution,
a bank holding company or subsidiary thereof, a registered broker-
dealer, or other type of entity, and regardless of whether the sponsor
is a supervised entity.\37\ The agencies continue to believe that this
exposure should provide a sponsor with an incentive to monitor and
control the underwriting of assets being securitized and help align the
interests of the sponsor with those of investors in the ABS. In
addition, the sponsor also would be prohibited from hedging or
otherwise transferring its retained interest prior to the applicable
sunset date, as discussed in Part III.D of this SUPPLEMENTARY
INFORMATION.
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\37\ See proposed rule at Sec. Sec. ----.3 through ----.10.
Similar to the original proposal, the proposed rule, in some
instances, would permit a sponsor to allow another person to retain
the required amount of credit risk (e.g., originators, third-party
purchasers in commercial mortgage-backed securities transactions,
and originator-sellers in asset-backed commercial paper conduit
securitizations). However, in such circumstances, the proposal
includes limitations and conditions designed to ensure that the
purposes of section 15G continue to be fulfilled. Further, even when
a sponsor would be permitted to allow another person to retain risk,
the sponsor would still remain responsible under the rule for
compliance with the risk retention requirements.
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The agencies note that the base risk retention requirement under
the proposed rule would be a regulatory minimum. The sponsor,
originator, or other party to a securitization may retain additional
exposure to the credit risk of assets that the sponsor, originator, or
other party helps securitize beyond that required by the proposed rule,
either on its own initiative or in response to the demands or
requirements of private market participants.
B. Permissible Forms of Risk Retention--Menu of Options
Section 15G expressly provides the agencies the authority to
determine the permissible forms through which the required amount of
risk retention must be held.\38\ Accordingly, the original proposal
provided sponsors with multiple options to satisfy the risk retention
requirements of section 15G. The flexibility provided in the original
proposal's menu of options for complying with the risk retention
requirement was designed to take into account the heterogeneity of
securitization markets and practices and to reduce the potential for
the proposed rules to negatively affect the availability and costs of
credit to consumers and businesses. The menu of options approach was
designed to be consistent with the various ways in which a sponsor or
other entity, in historical market practices, may have retained
exposure to the credit risk of securitized assets.\39\ Historically,
whether or how a sponsor retained exposure to the credit risk of the
assets it securitized was determined by a variety of factors including
the rating requirements of the NRSROs, investor preferences or demands,
accounting and regulatory capital considerations, and whether there was
a market for the type of interest that might ordinarily be retained (at
least initially by the sponsor).
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\38\ See 15 U.S.C. 78o-11(c)(1)(C)(i); see also S. Rep. No. 111-
176, at 130 (2010) (``The Committee [on Banking, Housing, and Urban
Affairs] believes that implementation of risk retention obligations
should recognize the differences in securitization practices for
various asset classes.'').
\39\ See Board Report; see also Macroeconomic Effects of Risk
Retention Requirements, Chairman of the Financial Stability
Oversight Counsel (January 2011), available at http://www.treasury.gov/initiatives/wsr/Documents/Section 946 Risk
Retention Study (FINAL).pdf.
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The agencies requested comment on the appropriateness of the menu
of options in the original proposal and the permissible forms of risk
retention that were proposed. Commenters generally supported the menu-
based approach of providing sponsors with the flexibility to choose
from a number of permissible forms of risk retention. Many commenters
requested that sponsors be permitted to use multiple risk retention
options in any percentage combination, as long as the aggregate
percentage of risk retention would be at least 5 percent.
The agencies continue to believe that providing options for risk
retention is appropriate in order to accommodate the variety of
securitization structures that would be subject to the proposed rule.
Accordingly, subpart B of the proposed rule would maintain a menu of
options approach to risk retention. Additionally, the agencies have
considered commenters' concerns about flexibility in combining forms of
risk retention and are proposing modifications to the various forms of
risk retention, and how they may be used, to increase flexibility and
facilitate different circumstances that may accompany various
securitization transactions. Additionally, the permitted forms of risk
retention in the proposal would be subject to terms and conditions that
are intended to help ensure that the sponsor (or other eligible entity)
retains an economic exposure equivalent to at least 5 percent of the
credit risk of the securitized assets. Each of the forms of risk
retention being proposed by the agencies is described below.
1. Standard Risk Retention
a. Overview of Original Proposal and Public Comments
In the original proposal, to fulfill risk retention for any
transactions (standard risk retention), the agencies proposed to allow
sponsors to use one of three methods: (i) Vertical risk retention; (ii)
horizontal risk retention; and (iii) L-shaped risk retention.
Under the vertical risk retention option in the original proposal,
a sponsor could satisfy its risk retention requirement by retaining at
least 5 percent of each class of ABS interests issued as part of the
securitization transaction. As discussed in the original proposal, this
would provide the sponsor with an interest in the entire securitization
transaction. The agencies received numerous comments supporting the
vertical risk retention option as an appropriate way to align the
interests of the sponsor with those of the investors in the ABS in a
manner that would be easy to calculate. However, some commenters
expressed concern that the vertical risk retention option would expose
the sponsor to
[[Page 57937]]
substantially less risk of loss than if the sponsor had retained risk
under the horizontal risk retention option, thereby making risk
retention less effective.
Under the horizontal risk retention option in the original
proposal, a sponsor could satisfy its risk retention obligations by
retaining a first-loss ``eligible horizontal residual interest'' in the
issuing entity in an amount equal to at least 5 percent of the par
value of all ABS interests in the issuing entity that were issued as
part of the securitization transaction. In lieu of holding an eligible
horizontal residual interest, the original proposal allowed a sponsor
to cause to be established and funded, in cash, a reserve account at
closing (horizontal cash reserve account) in an amount equal to at
least 5 percent of the par value of all the ABS interests issued as
part of the transaction (i.e., the same dollar amount (or corresponding
amount in the foreign currency in which the ABS are issued, as
applicable) as would be required if the sponsor held an eligible
horizontal residual interest).
Under the original proposal, an interest qualified as an eligible
horizontal residual interest only if it was an ABS interest that was
allocated all losses on the securitized assets until the par value of
the class was reduced to zero and had the most subordinated claim to
payments of both principal and interest by the issuing entity. While
the original proposal would have permitted the eligible horizontal
residual interest to receive its pro rata share of scheduled principal
payments on the underlying assets in accordance with the relevant
transaction documents, the eligible horizontal residual interest
generally could not receive any other payments of principal made on a
securitized asset (including prepayments) until all other ABS interests
in the issuing entity were paid in full.
The agencies solicited comment on the structure of the eligible
horizontal residual interest, including the proposed approach to
measuring the size of the eligible horizontal residual interest and the
proposal to restrict unscheduled payments of principal to the sponsor
holding horizontal risk retention. Several commenters expressed support
for the horizontal risk retention option and believed that it would
effectively align the interests of the sponsor with those of the
investors in the ABS. However, many commenters raised concerns about
the agencies' proposed requirements for the eligible horizontal
residual interest. Many commenters requested clarification as to the
definition of ``par value'' and how sponsors should calculate the
eligible horizontal residual interest when measuring it against 5
percent of the par value of the ABS interests. Moreover, several
commenters recommended that the agencies use different approaches to
the measurement of the eligible horizontal residual interest. A few of
these commenters recommended the agencies take into account the ``fair
value'' of the ABS interests as a more appropriate economic measure of
risk retention.
Several commenters pointed out that the restrictions in the
original proposal on principal payments to the eligible horizontal
residual interest would be impractical to implement. For example, some
commenters expressed concern that the restriction would prevent the
normal operation of a variety of ABS structures, where servicers do not
distinguish which part of a monthly payment is interest or principal
and which parts of principal payments are scheduled or unscheduled.
The original proposal also contained an ``L-shaped'' risk retention
option, whereby a sponsor, subject to certain conditions, could use an
equal combination of vertical risk retention and horizontal risk
retention to meet its 5 percent risk retention requirement.\40\
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\40\ Specifically, the original proposal would have allowed a
sponsor to meet its risk retention obligations under the rules by
retaining: (1) Not less than 2.5 percent of each class of ABS
interests in the issuing entity issued as part of the securitization
transaction (the vertical component); and (2) an eligible horizontal
residual interest in the issuing entity in an amount equal to at
least 2.564 percent of the par value of all ABS interests in the
issuing entity issued as part of the securitization transaction,
other than those interests required to be retained as part of the
vertical component (the horizontal component).
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The agencies requested comment on whether a higher proportion of
the risk retention held by a sponsor under this option should be
composed of a vertical component or a horizontal component. Many
commenters expressed general support for the L-shaped option, but
recommended that the agencies allow sponsors to utilize multiple risk
retention options in different combinations or in any percentage
combination as long as the aggregate percentage of risk retained is at
least 5 percent. Commenters suggested that the flexibility would permit
sponsors to fulfill the risk retention requirements by selecting a
method that would minimize the costs of risk retention to sponsors and
any resulting increase in costs to borrowers.
b. Proposed Combined Risk Retention Option
The agencies carefully considered all of the comments on the
horizontal, vertical, and L-shaped risk retention with respect to the
original proposal.
In the proposed rule, to provide more flexibility to accommodate
various sponsors and securitization transactions and in response to
comments, the agencies are proposing to combine the horizontal,
vertical, and L-shaped risk retention options into a single risk
retention option with a flexible structure.\41\ Additionally, to
provide greater clarity for the measurement of risk retention and to
help prevent sponsors from structuring around their risk retention
requirement by negating or reducing the economic exposure they are
required to maintain, the proposal would require sponsors to measure
their risk retention requirement using fair value, determined in
accordance with U.S. generally accepted accounting principles
(GAAP).\42\
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\41\ See proposed rule at Sec. ----.4.
\42\ Cf. Financial Accounting Standards Board Accounting
Standards Codification Topic 820.
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The proposed rule would provide for a combined standard risk
retention option that would permit a sponsor to satisfy its risk
retention obligation by retaining an ``eligible vertical interest,'' an
``eligible horizontal residual interest,'' or any combination thereof,
in a total amount equal to no less than 5 percent of the fair value of
all ABS interests in the issuing entity that are issued as part of the
securitization transaction. The eligible horizontal residual interest
may consist of either a single class or multiple classes in the issuing
entity, provided that each interest qualifies, individually or in the
aggregate, as an eligible horizontal residual interest.\43\ In the case
of multiple classes, this requirement would mean that the classes must
be in consecutive order based on subordination level. For example, if
there were three levels of subordinated classes and the two most
subordinated classes had a combined fair value equal to 5 percent of
all ABS interests, the sponsor would be required to retain these two
most subordinated classes if it were going to discharge its risk
retention obligations by holding only eligible horizontal residual
interests. As discussed below, the agencies are proposing to refine the
definitions of the eligible vertical interest and the eligible
horizontal residual interest as well.
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\43\ See proposed rule at Sec. ----.2 (definition of ``eligible
horizontal residual interest'').
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This standard risk retention option would provide sponsors with
greater flexibility in choosing how to structure their retention of
credit risk in a manner compatible with the practices of the
securitization markets. For example, in
[[Page 57938]]
securitization transactions where the sponsor would typically retain
less than 5 percent of an eligible horizontal residual interest, the
standard risk retention option would permit the sponsor to hold the
balance of the risk retention as a vertical interest. In addition, the
flexible standard risk retention option should not in and of itself
result in a sponsor having to consolidate the assets and liabilities of
a securitization vehicle onto its own balance sheet because the
standard risk retention option does not mandate a particular proportion
of horizontal to vertical interest or require retention of a minimum
eligible horizontal residual interest. Under the proposed rule, a
sponsor would be free to hold more of an eligible vertical interest in
lieu of an eligible horizontal residual interest. The inclusion of more
of a vertical interest could reduce the significance of the risk
profile of the sponsor's economic exposure to the securitization
vehicle. The significance of the sponsor's exposure is one of the
characteristics the sponsor evaluates when determining whether to
consolidate the securitization vehicle for accounting purposes.
As proposed, a sponsor may satisfy its risk retention requirements
with respect to a securitization transaction by retaining at least 5
percent of the fair value of each class of ABS interests issued as part
of the securitization transaction. A sponsor using this approach must
retain at least 5 percent of the fair value of each class of ABS
interests issued in the securitization transaction regardless of the
nature of the class of ABS interests (e.g., senior or subordinated) and
regardless of whether the class of interests has a par value, was
issued in certificated form, or was sold to unaffiliated investors. For
example, if four classes of ABS interests were issued by an issuing
entity as part of a securitization--a senior AAA-rated class, a
subordinated class, an interest-only class, and a residual interest--a
sponsor using this approach with respect to the transaction would have
to retain at least 5 percent of the fair value of each such class or
interest.
A sponsor may also satisfy its risk retention requirements under
the vertical option by retaining a ``single vertical security.'' A
single vertical security would be an ABS interest entitling the holder
to a specified percentage (e.g., 5 percent) of the principal and
interest paid on each class of ABS interests in the issuing entity
(other than such single vertical security) that result in the security
representing the same percentage of fair value of each class of ABS
interests. By permitting the sponsor to hold the vertical form of risk
retention as a single security, the agencies intend to provide sponsors
an option that is simpler than carrying multiple securities
representing a percentage share of every series, tranche, and class
issued by the issuing entity, each of which might need to be valued by
the sponsor on its financial statements every financial reporting
period. The single vertical security option provides the sponsor with
the same principal and interest payments (and losses) as the vertical
stack, in the form of one security to be held on the sponsor's books.
The agencies considered the comments on the measurement of the
eligible horizontal residual interest in the original proposal and are
proposing a fair value framework for calculating the standard risk
retention because it uses methods more consistent with market
practices. The agencies' use of par value in the original proposal
sought to establish a simple and transparent measure, but the PCCRA
requirement, which the agencies proposed to ensure that the eligible
horizontal residual interest had true economic value, tended to
introduce other complexities. In addition, the use of fair value as
defined in GAAP provides a consistent framework for calculating
standard risk retention across very different securitization
transactions and different classes of interests within the same type of
securitization structure.
However, fair value is a methodology susceptible to yielding a
range of results depending on the key variables selected by the sponsor
in determining fair value. Accordingly, as part of the agencies'
proposal to rely on fair value as a measure that will adequately
reflect the amount of a sponsor's economic ``skin in the game,'' the
agencies propose to require disclosure of the sponsor's fair value
methodology and all significant inputs used to measure its eligible
horizontal residual interest, as discussed below in this section.
Sponsors that elect to utilize the horizontal risk retention option
must disclose the reference data set or other historical information
which would meaningfully inform third parties of the reasonableness of
the key cash flow assumptions underlying the measure of fair value. For
the purposes of this requirement, key assumptions may include default,
prepayment, and recovery. The agencies believe these key metrics will
help investors assess whether the fair value measure used by the
sponsor to determine the amount of its risk retention are comparable to
market expectations.
The agencies are also proposing limits on payments to holders of
the eligible horizontal residual interest, but the limits differ from
those in the original proposal, based on the fair value measurement.
The agencies continue to believe that limits are necessary to establish
economically meaningful horizontal risk retention that better aligns
the sponsor's incentives with those of investors. However, the agencies
also intend for sponsors to be able to satisfy their risk retention
requirements with the retention of an eligible horizontal residual
interest in a variety of ABS structures, including those structures
that, in contrast to mortgage-backed securities transactions, do not
distinguish between principal and interest payments and between
principal losses and other losses.
The proposed restriction on projected cash flows to be paid to the
eligible horizontal residual interest would limit how quickly the
sponsor can recover the fair value amount of the eligible horizontal
residual interest in the form of cash payments from the securitization
(or, if a horizontal cash reserve account is established, released to
the sponsor or other holder of such account). The proposed rule would
prohibit the sponsor from structuring a deal where it receives such
amounts at a faster rate than the rate at which principal is paid to
investors in all ABS interests in the securitization, measured for each
future payment date. Since the cash flows projected to be paid to
sponsors (or released to the sponsor or other holder of the horizontal
cash reserve account) and all ABS interests would already be calculated
at the closing of the transactions as part of the fair value
calculation, it should not be unduly complex or burdensome for sponsors
to project the cash flows to be paid to the eligible horizontal
residual interest (or released to the sponsor or other holder of the
horizontal cash reserve account) and the principal to be paid to all
ABS interests on each payment date. To compute the fair value of
projected cash flows to be paid to the eligible horizontal residual
interest (or released to the sponsor or other holder of the horizontal
cash reserve account) on each payment date, the sponsor would discount
the projected cash flows to the eligible horizontal residual interest
on each payment date (or released to the sponsor or other holder of the
horizontal cash reserve account) using the same discount rate that was
used in the fair value calculation (or the amount that must be placed
in an eligible horizontal cash reserve account, equal to the fair value
of an eligible horizontal residual
[[Page 57939]]
interest). To compute the cumulative fair value of cash flows projected
to be paid to the eligible horizontal residual interest through each
payment date, the sponsor would add the fair value of cash flows to the
eligible horizontal residual interest (or released to the sponsor or
other holder of the horizontal cash reserve account) from issuance
through each payment date (or the termination of the horizontal cash
reserve account). The ratio of the cumulative fair value of cash flows
projected to be paid to the eligible horizontal residual interest (or
released to the sponsor or other holder of the horizontal cash reserve
account) at each payment date divided by the fair value of the eligible
horizontal residual interest (or the amount that must be placed in an
eligible horizontal cash reserve account, equal to the fair value of an
eligible horizontal residual interest) at issuance (the EHRI recovery
percentage) measures how quickly the sponsor can be projected to
recover the fair value of the eligible horizontal residual interest. To
measure how quickly investors as a whole are projected to be repaid
principal through each payment date, the sponsor would divide the
cumulative amount of principal projected to be paid to all ABS
interests through each payment date by the total principal of ABS
interests at issuance (ABS recovery percentage).
In order to comply with the proposed rule, the sponsor, prior to
the issuance of the eligible horizontal residual interest (or funding a
horizontal cash reserve account), or at the time of any subsequent
issuance of ABS interests, as applicable, would have to certify to
investors that it has performed the calculations required by section
4(b)(2)(i) of the proposed rule and that the EHRI recovery percentages
are not expected to be larger than the ABS recovery percentages for any
future payment date.\44\ In addition, the sponsor would have to
maintain record of such calculations and certifications in written form
in its records and must provide disclosure upon request to the
Commission and its appropriate Federal banking agency, if any, until
three years after all ABS interests are no longer outstanding. If this
test fails for any payment date, meaning that the eligible horizontal
residual interest is projected to recover a greater percentage of its
fair value than the percentage of principal projected to be repaid to
all ABS interests with respect to such future payment date, the
sponsor, absent provisions in the cash flow waterfall that prohibit
such excess projected payments from being made on such payment date,
would not be in compliance with the requirements of section 4(b)(2) of
the proposed rule. For example, the schedule of target
overcollateralization in an automobile loan securitization might need
to be adjusted so that the sponsor's retained interest satisfies the
eligible horizontal residual interest repayment restriction.
---------------------------------------------------------------------------
\44\ See proposed rule at Sec. ----.4(b).
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The cash flow projection would be a one-time calculation performed
at issuance on projected cash flows. This is in part to limit
operational burdens and to allow for sponsors to receive the upside
from a transaction performing above expectations in a timely fashion.
It should also minimize increases in the cost of credit to borrowers as
a result of the risk retention requirement. At the same time, the
restriction that a sponsor cannot structure a transaction in which the
sponsor is projected to recover the fair value of the eligible
horizontal residual interest any faster than all investors are repaid
principal should help to maintain the alignment of interests of the
sponsor with those of investors in the ABS, while providing flexibility
for various types of securitization structures. Moreover, the
restriction would permit a transaction to be structured so that the
sponsor could receive a large, one-time payment, which is a feature
common in deals where certain cash flows that would otherwise be paid
to the eligible horizontal residual interest are directed to pay other
classes, such as a money market tranche in an automobile loan
securitization, provided that such payment did not cause a failure to
satisfy the projected payment test.
On the other hand, the restriction would prevent the sponsor from
structuring a transaction in which the sponsor is projected to be paid
an amount large enough to increase the leverage of the transaction by
more than the amount which existed at the issuance of the asset-backed
securities. In other words, the purpose of the restriction is to
prevent sponsors from structuring a transaction in which the eligible
horizontal residual interest is projected to receive such a
disproportionate amount of money that the sponsor's interests are no
longer aligned with investors' interests. For example, if the sponsor
has recovered all of the fair value of an eligible horizontal residual
interest, the sponsor effectively has no retained risk if losses on the
securitized assets occur later in the life of the transaction.
In addition, in light of the fact that the EHRI recovery percentage
calculation is determined one time, before closing of the transaction,
based on the sponsor's projections, the agencies are proposing to
include an additional disclosure requirement about the sponsor's past
performance in respect to the EHRI recovery percentage calculation. For
each transaction that includes an EHRI, the sponsor will be required to
make a disclosure that looks back to all other EHRI transactions the
sponsor has brought out under the requirements of the risk retention
rules for the previous five years, and disclose the number of times the
actual payments made to the sponsor under the EHRI exceeded the amounts
projected to be paid to the sponsor in determining the Closing Date
Projected Cash Flow Rate (as defined in section 4(a) of the proposed
rule).
Similar to the original proposal, the proposed rule would allow a
sponsor, in lieu of holding all or part of its risk retention in the
form of an eligible horizontal residual interest, to cause to be
established and funded, in cash, a reserve account at closing
(horizontal cash reserve account) in an amount equal to the same dollar
amount (or corresponding amount in the foreign currency in which the
ABS are issued, as applicable) as would be required if the sponsor held
an eligible horizontal residual interest.\45\
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\45\ See proposed rule at Sec. ----.4(c).
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This horizontal cash reserve account would have to be held by the
trustee (or person performing functions similar to a trustee) for the
benefit of the issuing entity. Some commenters on the original proposal
recommended relaxing the investment restrictions on the horizontal cash
reserve account to accommodate foreign transactions. The proposed rule
includes several important restrictions and limitations on such a
horizontal cash reserve account to ensure that a sponsor that
establishes a horizontal cash reserve account would be exposed to the
same amount and type of credit risk on the underlying assets as would
be the case if the sponsor held an eligible horizontal residual
interest. For securitization transactions where the underlying loans or
the ABS interests issued are denominated in a foreign currency, the
amounts in the account may be invested in sovereign bonds issued in
that foreign currency or in fully insured deposit accounts denominated
in the foreign currency in a foreign bank (or a subsidiary thereof)
whose home country supervisor (as defined in section 211.21 of the
Board's Regulation K) \46\ has adopted capital standards consistent
with the Capital Accord of the Basel Committee on Banking Supervision,
as amended, provided the foreign bank is
[[Page 57940]]
subject to such standards.\47\ In addition, amounts that could be
withdrawn from the account to be distributed to a holder of the account
would be restricted to the same degree as payments to the holder of an
eligible horizontal residual interest (such amounts to be determined as
though the account was an eligible horizontal residual interest), and
the sponsor would be required to comply with all calculation
requirements that it would have to perform with respect to an eligible
horizontal residual interest in order to determine permissible
distributions from the cash account.
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\46\ 12 CFR 211.21.
\47\ Otherwise, as in the original proposal, amounts in a
horizontal cash reserve account may only be invested in: (1) United
States Treasury securities with remaining maturities of one year or
less; and (2) deposits in one or more insured depository
institutions (as defined in section 3 of the Federal Deposit
Insurance Act (12 U.S.C. 1813)) that are fully insured by federal
deposit insurance. See proposed rule at Sec. ----.4(c)(2).
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Disclosure requirements would also be required with respect to a
horizontal cash reserve account, including the fair value and
calculation disclosures required with respect to an eligible horizontal
residual interest, as discussed below.
The original proposal included tailored disclosure requirements for
the vertical, horizontal, and L-shaped risk retention options. A few
commenters recommended deleting the proposed requirement that the
sponsor disclose the material assumptions and methodology used in
determining the aggregate dollar amount of ABS interests issued by the
issuing entity in the securitization. In the proposed rule, the
agencies are proposing disclosure requirements similar to those in the
original proposal, with some modifications, and are proposing to add
new requirements for the fair value measurement and to reflect the
structure of the proposed standard risk retention option.
The proposed rule would require sponsors to provide or cause to be
provided to potential investors a reasonable time prior to the sale of
ABS interests in the issuing entity and, upon request, to the
Commission and its appropriate Federal banking agency (if any)
disclosure of:
The fair value (expressed as a percentage of the fair
value of all ABS interests issued in the securitization transaction and
dollar amount (or corresponding amount in the foreign currency in which
the ABS are issued, as applicable)) of the eligible horizontal residual
interest that will be retained (or was retained) by the sponsor at
closing, and the fair value (expressed as a percentage of the fair
value of all ABS interests issued in the securitization transaction and
dollar amount (or corresponding amount in the foreign currency in which
the ABS are issued, as applicable)) of the eligible horizontal residual
interest required to be retained by the sponsor in connection with the
securitization transaction;
A description of the material terms of the eligible
horizontal residual interest to be retained by the sponsor;
A description of the methodology used to calculate the
fair value of all classes of ABS interests;
The key inputs and assumptions used in measuring the total
fair value of all classes of ABS interests and the fair value of the
eligible horizontal residual interest retained by the sponsor
(including the range of information considered in arriving at such key
inputs and assumptions and an indication of the weight ascribed
thereto) and the sponsor's technique(s) to derive the key inputs;
For sponsors that elect to utilize the horizontal risk
retention option, the reference data set or other historical
information that would enable investors and other stakeholders to
assess the reasonableness of the key cash flow assumptions underlying
the fair value of the eligible horizontal residual interest. Examples
of key cash flow assumptions may include default, prepayment, and
recovery;
Whether any retained vertical interest is retained as a
single vertical security or as separate proportional interests;
Each class of ABS interests in the issuing entity
underlying the single vertical security at the closing of the
securitization transaction and the percentage of each class of ABS
interests in the issuing entity that the sponsor would have been
required to retain if the sponsor held the eligible vertical interest
as a separate proportional interest in each class of ABS interest in
the issuing entity; and
The fair value (expressed as a percentage of the fair
value of all ABS interests issued in the securitization transaction and
dollar amount (or corresponding amount in the foreign currency in which
the ABS are issued, as applicable)) of any single vertical security or
separate proportional interests that will be retained (or was retained)
by the sponsor at closing, and the fair value (expressed as a
percentage of the fair value of all ABS interests issued in the
securitization transaction and dollar amount (or corresponding amount
in the foreign currency in which the ABS are issued, as applicable)) of
the single vertical security or separate proportional interests
required to be retained by the sponsor in connection with the
securitization transaction.
Consistent with the original proposal, a sponsor electing to
establish and fund a horizontal cash reserve account would be required
to provide disclosures similar to those required with respect to an
eligible horizontal residual interest, except that these disclosures
have been modified to reflect the different nature of the account.
Request for Comment
1(a). Should the agencies require a minimum proportion of risk
retention held by a sponsor under the standard risk retention option to
be composed of a vertical component or a horizontal component? 1(b).
Why or why not?
2(a). The agencies observe that horizontal risk retention, as
first-loss residual position, generally would impose the most economic
risk on a sponsor. Should a sponsor be required to hold a higher
percentage of risk retention if the sponsor retains only an eligible
vertical interest under this option or very little horizontal risk
retention? 2(b). Why or why not?
3. Are the disclosures proposed sufficient to provide investors
with all material information concerning the sponsor's retained
interest in a securitization transaction and the methodology used to
calculate fair value, as well as enable investors and the agencies to
monitor whether the sponsor has complied with the rule?
4(a). Is the requirement for sponsors that elect to utilize the
horizontal risk retention option to disclose the reference data set or
other historical information that would enable investors and other
stakeholders to assess the reasonableness of the key cash flow
assumptions underlying the fair value of the eligible horizontal
residual interest useful? 4(b). Would the requirement to disclose this
information impose a significant cost or undue burden to sponsors?
4(c). Why or why not? 4(d). If not, how should proposed disclosures be
modified to better achieve those objectives?
5(a). Does the proposal require disclosure of any information that
should not be made publicly available? 5(b). If so, should such
information be made available to the Commission and Federal banking
agencies upon request?
6. Are there any additional factors that the agencies should
consider with respect to the standard risk retention?
7. To what extent would the flexible standard risk retention option
address concerns about a sponsor having to consolidate a securitization
vehicle for accounting purposes due to the risk retention requirement
itself, given that
[[Page 57941]]
the standard risk retention option does not require a particular
proportion of horizontal to vertical interest?
8(a). Is the proposed approach to measuring risk retention
appropriate? 8(b). Why or why not?
9(a). Would a different measurement of risk retention be more
appropriate? 9(b). Please provide details and data supporting any
alternative measurement methodologies.
10(a). Is the restriction on certain projected payments to the
sponsor with respect to the eligible horizontal residual interest
appropriate and sufficient? 10(b). Why or why not?
11(a). The proposed restriction on certain projected payments to
the sponsor with respect to the eligible horizontal residual interest
compares the rate at which the sponsor is projected to recover the fair
value of the eligible horizontal residual interest with the rate which
all other investors are projected to be repaid their principal. Is this
comparison of two different cash flows an appropriate means of
providing incentives for sound underwriting of ABS? 11(b). Could it
increase the cost to the sponsor of retaining an eligible horizontal
residual interest? 11(c). Could sponsors or issuers manipulate this
comparison to reduce the cost to the sponsor of retaining an eligible
horizontal residual interest? How? 11(d). If so, are there adjustments
that could be made to this requirement that would reduce or eliminate
such possible manipulation? 11(e). Would some other cash flow
comparison be more appropriate? 11(f). If so, which cash flows should
be compared? 11(g). Does the proposed requirement for the sponsor to
disclose, for previous ABS transactions, the number of times the
sponsor was paid more than the issuer predicted for such transactions
reach the right balance of incremental burden to the sponsor while
providing meaningful information to investors? 11(h). If not, how
should it be modified to better achieve those objectives?
12(a). Does the proposed form of the single vertical security
accomplish the agencies' objective of providing a way for sponsors to
hold vertical risk retention without the need to perform valuation of
multiple securities for accounting purposes each financial reporting
period? 12(b). Is there a different approach that would be more
efficient?
13(a). Is three years after all ABS interests are no longer
outstanding an appropriate time period for the sponsors' record
maintenance requirement with respect to the calculations and other
requirements in section 4? 13(b). Why or why not? 13(c). If not, what
would be a more appropriate time period?
14(a). Would the calculation requirements in section 4 of the
proposed rule likely be included in agreed upon procedures with respect
to an interest retained pursuant to the proposed rule? 14(b). Why or
why not? 14(c). If so, what costs may be associated with such a
practice?
c. Alternative Eligible Horizontal Residual Interest Proposal
The agencies have also considered, and request comment on, an
alternative provision relating to the amount of principal payments
received by the eligible horizontal residual interest. Under this
alternative, on any payment date, in accordance with the transaction's
governing documents, the cumulative amount paid to an eligible
horizontal residual interest may not exceed a proportionate share of
the cumulative amount paid to all holders of ABS interests in the
transaction. The proportionate share would equal the percentage, as
measured on the date of issuance, of the fair value of all of the ABS
interests issued in the transaction that is represented by the fair
value of the eligible horizontal residual interest.
For purposes of this calculation, fees and expenses paid to service
providers would not be included in the cumulative amounts paid to
holders of ABS interests. All other amounts paid to holders of ABS
would be included in the calculations, including principal repayment,
interest payments, excess spread and residual payments. The transaction
documents would not allow distribution to the eligible horizontal
residual interest any amounts payable to the eligible horizontal
residual interest that would exceed the eligible horizontal residual
interest's permitted proportionate share. Such excess amounts could be
paid to more senior classes, placed into a reserve account, or
allocated in any manner that does not otherwise result in payments to
the holder of the eligible horizontal residual interest that would
exceed the allowed amount.
By way of illustration, assume the fair value of the eligible
horizontal residual interest for a particular transaction was equal to
10 percent of the fair value of all ABS interests issued in that
transaction. In order to meet the requirements of the proposal, the
cumulative amount paid to the sponsor in its capacity as holder of the
eligible horizontal residual interest on any given payment date could
not exceed 10 percent of the cumulative amount paid to all holders of
ABS interests, excluding payment of expenses and fees to service
providers. This would allow large payments to the eligible horizontal
residual interest so long as such payments do not otherwise result in
payments to the holder of the eligible horizontal residual interest
that would exceed the allowed amount.
The agencies request comment on this alternative mechanism for
allowing the eligible horizontal residual interest to receive
unscheduled principal payments, including whether the agencies should
adopt the alternative proposal instead of the proposed mechanism for
these payments described above.
Request for Comment
15(a). Other than a cap in the priority of payments on amounts to
be paid to the eligible horizontal residual interest and related
calculations on distribution dates and related provisions to allocate
any amounts above the cap, would there be any additional steps
necessary to comply with the alternative proposal? 15(b). If so, please
describe those additional steps and any associated costs.
16. Would the cost and difficulty of compliance with the
alternative proposal, including monitoring compliance, be higher or
lower, than with the proposal?
17(a). Does the alternative proposal accommodate more or less of
the current market practice than the proposal? 17(b). If there is a
difference, please provide data with respect to the scale of that
difference.
18. With respect to the alternative proposal, should amounts other
than payment of expenses and fees to service providers be excluded from
the calculations?
19(a). Does the alternative proposal adequately accommodate
structures with unscheduled payments of principal, such as scheduled
step downs? 19(b). Does the alternative adequately address structures
which do not distinguish between interest and principal received from
underlying assets for purposes of distributions?
20(a). Are there asset classes or transaction structures for which
the alternative proposal would not be economically viable? 20(b). Are
there asset classes or transaction structures for which the alternative
proposal would be more economically feasible than the proposal?
21. Should both the proposal and the alternative proposal be made
available to sponsors?
22(a). The proposal includes a restriction on how payments on an
eligible horizontal residual interest must be structured but does not
restrict actual
[[Page 57942]]
payments to the eligible horizontal residual interest, which could be
different than the projected payments if losses are higher or lower
than expected. The alternative proposal for payments on eligible
horizontal residual interests does not place restrictions on structure
but does restrict actual payments to the eligible horizontal residual
interest. Does the proposal or the alternative proposal better align
the sponsor's interests with investors' interests? 22(b). Why or why
not?
2. Revolving Master Trusts
a. Overview
Securitization sponsors frequently use a revolving master trust
when they seek to issue more than one series of ABS collectively backed
by a common pool of assets that change over time.\48\ Pursuant to the
original proposal, the seller's interest form of risk retention would
only be available to revolving master trusts.
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\48\ In a revolving master trust securitization, assets (e.g.,
credit card receivables or dealer floorplan financings) are
periodically added to the pool to collateralize current and future
issuances of the securities backed by the pool. Often, but not
always, the assets are receivables generated by revolving lines of
credit originated by the sponsor. A major exception would be the
master trusts used in the United Kingdom to finance residential
mortgages.
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The seller's interest is an undivided interest held by the master
trust securitization sponsor in the pool of receivables or loans held
in the trust. It entitles the sponsor to a percentage of all payments
of principal, interest, and fees, as well as recoveries from defaulted
assets that the trust periodically receives on receivables and loans
held in the trust, as well as the same percentage of all payment
defaults on those assets. Investors in the various series of ABS issued
by the trust have claims on the remaining principal and interest, as a
source of repayment for the ABS interests they hold.\49\ Typically, the
seller's interest is pari passu to the investors' interest with respect
to collections and losses on the securitized assets, though in some
revolving master trusts, it is subordinated to the investors' interest
in this regard. If the seller's interest is pari passu, it generally
becomes subordinated to investors' interests in the event of an early
amortization of the ABS interests held by investors, as discussed more
below. Commenters representing the interests of securitization sponsors
generally favored the seller's interest approach but requested certain
modifications.
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\49\ Generally, the trust sponsor retains the right to any
excess cash flow from payments of interest and fees received by the
trust that exceeds the amount owed to ABS investors. Excess cash
flow from payments of principal is paid to the sponsor in exchange
for newly generated receivables in the trust's existing revolving
accounts. However, the specific treatment of excess interest, fees,
and principal payments with respect to any ABS series within the
trust is a separate issue, discussed in connection with the
agencies' proposal to give sponsors credit for some forms of
eligible horizontal risk retention at the series level, as explained
in further detail below.
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The agencies are proposing to maintain the seller's interest as the
specific risk retention option for master trusts, with changes from the
original proposal that reflect many of the comments received, as
discussed in further detail below. The modifications to this option are
intended to refine this method of risk retention to better reflect the
way revolving master trust securitizations operate in the current
market.
As discussed in greater detail below, among other things, the
agencies are proposing to modify the original proposal with respect to
master trusts by:
Allowing sponsors that hold a first-loss exposure in every
series of ABS issued by a master trust to count the percent of such
interest that is held consistently across all ABS series toward the
minimum 5 percent seller's interest requirement;
Removing the restriction in the original proposal that
prohibited the use of the seller's interest risk retention option for
master trust securitizations backed by non-revolving assets;
Clarifying how the seller's interest can be used in
connection with multi-level legacy trusts and master trusts in which
some of the seller's interest corresponds to loans or receivables held
in a legacy master trust;
Revising the calculation of the 5 percent seller's
interest amount so it is based on the trust's amount of outstanding ABS
rather than the amount of trust assets;
Clarifying the rules regarding the use of certain
structural features, including delinked credit enhancement structures,
where series-specific credit enhancements that do not support the
seller's interest-linked structures, and the limited use of assets that
are not part of the seller's interest to administer the features of the
ABS issued to investors; and
Clarify how the rule would apply to a revolving master
trust in early amortization.
b. Definitions of Revolving Master Trust and Seller's Interest
The seller's interest form of retention would only be available to
revolving master trusts. These are trusts established to issue ABS
interests on multiple issuance dates out of the same trust. In some
instances the trust will issue to investors a series with multiple
classes of tranched ABS periodically. In others, referred to as
``delinked credit enhancement structures,'' the master trust maintains
one or more series, but issues tranches of ABS of classes in the series
periodically, doing so in amounts that maintain levels of subordination
between classes as required in the transaction documents. The revolving
master trust risk retention option is designed to accommodate both of
these structures.
The agencies' original proposal would require that all securitized
assets in the master trust must be loans or other extensions of credit
that arise under revolving accounts. The agencies received comments
indicating that a small number of securitizers in the United States,
such as insurance premium funding trusts, use revolving trusts to
securitize short-term loans, replacing loans as they mature with new
loans, in order to sustain cash flow and collateral support to longer-
term securities. In response to commenters, the agencies are proposing
to expand the securitized asset requirement to include non-revolving
loans.\50\ Nevertheless, as with the original proposal, all ABS
interests issued by the master trust must be collateralized by the
master trust's common pool of receivables or loans. Furthermore, the
common pool's principal balance must revolve so that cash representing
principal remaining after payment of principal due, if any, to
outstanding ABS on any payment date, as well as cash flow from
principal payments allocated to seller's interest is reinvested in new
extensions of credit at a price that is predetermined at the
transaction and new receivables or loans are added to the pool from
time to time to collateralize existing series of ABS issued by the
trust. The seller's interest option would not be available to a trust
that issues series of ABS at different times backed by segregated
independent pools of securitized assets within the trust as a series
trust, or a trust that issues shorter-term ABS interests backed by a
static pool of long-term loans, or a trust with a re-investment period
that precedes an ultimate amortization period.
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\50\ Revolving master trusts are also used in the United Kingdom
to securitize mortgages, and U.S. investors may invest in RMBS
issued by these trusts. This proposed change would make it easier
for these issuers to structure their securitizations in compliance
with section 15G for such purpose.
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In general, the seller's interest represents the seller/sponsor's
interest in the portion of the receivables or loans that does not
collateralize outstanding
[[Page 57943]]
investors' interests in ABS issued under series. Investor interests
include any sponsor/seller's retained ABS issued under a series. As
discussed above, a seller's interest is a typical form of risk
retention in master trusts, whereby the sponsor of a master trust holds
an undivided interest in the securitized assets. The original proposal
defined ``seller's interest'' consistent with these features, as an ABS
interest (i) in all of the assets that are held by the issuing entity
and that do not collateralize any other ABS interests issued by the
entity; (ii) that is pari passu with all other ABS interests issued by
the issuing entity with respect to the allocation of all payments and
losses prior to an early amortization event (as defined in the
transaction documents); and (iii) that adjusts for fluctuations in the
outstanding principal balances of the securitized assets.
The proposal would define ``seller's interest'' similarly to the
original proposal. However, in response to comments, the agencies have
made changes to the definition from the original proposal to reflect
market practice. The first change would modify the definition to
reflect the fact that the seller's interest is pari passu with
investors' interests at the series level, not at the level of all
investors' interests collectively. The agencies are proposing this
change because each series in a revolving master trust typically uses
senior-subordinate structures under which investors are entitled to
different payments out of that series' percentage share of the
collections on the trust's asset pool, so some investors in
subordinated classes are subordinate to the seller's interest. The
second change would modify the definition to reflect the fact that, in
addition to the receivables and loans that collateralize the trust's
ABS interests, a master trust typically includes servicing assets.\51\
To the extent these assets are allocated as collateral only for a
specific series, these assets are not part of the seller's
interest.\52\ Furthermore, the proposal clarifies that the seller's
interest amount is the unpaid principal balance of the seller's
interest in the common pool of receivables or loans. The seller's
interest amount must at least equal the required minimum seller's
interest.
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\51\ The definition of ``servicing assets'' is discussed in Part
II.B of this Supplementary Information.
\52\ Although this language allows certain assets held by the
trust to be allocated as collateral only for a specific series and
excluded from the seller's interest, it does not allow a trust to
claim eligibility for the seller's interest form of risk retention
unless the seller's interest is, consistent with the revolving
master trust definition, generally collateralized by a common pool
of assets, the composition of which changes over time, and that
securitizes all ABS interests in the trust. Absent broad exposure to
the securitized assets, the seller's interest ceases to be a
vertical form of risk retention. The proposed language is designed
to accommodate limited forms of exclusion from the seller's interest
in connection with administering the trust, dealing with the
revolving versus amortizing periods for investor ABS series,
implementation of interest rate features, and similar aspects of
these securitization transactions.
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In addition, the agencies are considering whether they should make
additional provisions for subordinated seller's interests. In some
revolving master trusts, there is an interest similar to a seller's
interest, except that instead of the interest being pari passu with the
investors' interest with respect to principal collections and interest
and fee collections, the sponsor's (or depositor's) share of the
collections in the interest are subordinated, to enhance the ABS
interests issued to investors at the series level. The agencies are
considering whether to permit these subordinated interests to count
towards the 5 percent seller's interest treatment, since they perform a
loss-absorbing function that is analogous to a horizontal interest
(whereas a typical seller's interest is analogous to a vertical
interest, and typically is only subordinated in the event of early
amortization). Because they are subordinated, however, the agencies are
considering requiring them be counted toward the 5 percent requirement
on a fair value basis, instead of the face value basis applied for
regular, unsubordinated seller's interests.\53\ The sponsor would be
required to apply the same fair value standards as the rule imposes
under the general risk retention requirement.
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\53\ The fair value determination would be for purposes of the
amount of subordinated seller's interest included in the numerator
of the 5 percent ratio. The denominator would be the unpaid
principal balance of all outstanding investors' ABS interests, as is
proposed for regular, unsubordinated seller's interests.
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In addition to these definitional changes, the agencies are
proposing modifications to the overall structure of the master trust
risk retention option as it was proposed in the original proposal, in
light of comments concerning the manner in which the seller's interest
is held. In some cases, the seller's interest may be held by the
sponsor, as was specified in the original proposal, but in other
instances, it may be held by another entity, such as the depositor, or
two or more originators may sponsor a single master trust to securitize
receivables generated by both firms, with each firm holding a portion
of the seller's interest. Accordingly, the agencies are proposing to
allow the seller's interest to be held by any wholly-owned affiliate of
the sponsor.\54\
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\54\ The requirement for the holder to be a wholly-owned
affiliate of the sponsor is consistent with the restrictions on
permissible transferees of risk retention generally required to be
held by the sponsor under the rule. See Part III.D.2 of this
Supplementary Information.
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In response to comments, the agencies are also proposing to allow
the seller's interest to be retained in multiple interests, rather than
a single interest. This approach is intended to address legacy trust
structures and would impose requirements on the division of the
seller's interest in such structures. In these structures, a sponsor
that controls an older revolving master trust that no longer issues ABS
to investors keeps the trust in place, with the credit lines that were
designated to the trust over the years still in operation and
generating new receivables for the legacy trust. The legacy trust
issues certificates collateralized by these receivables to a newer
issuing trust, which typically also has credit lines designated to the
trust, providing the issuing trust with its own pool of receivables.
The issuing trust issues investors' ABS interests backed by receivables
held directly by the issuing trust and also indirectly in the legacy
trust (as evidenced by the collateral certificates held by the issuing
trust).
The proposal would permit the seller's interest for the legacy
trust's receivables to be held separately, but still be considered
eligible risk retention, by the sponsor at the issuing trust level
because it functions as though it were part of the seller's interest
associated with all the securitized assets held by the issuing trust
(i.e., its own receivables and the collateral certificates). However,
the portion of the seller's interest held through the legacy trust must
be proportional to the percentage of assets the collateral certificates
comprise of the issuing trust's assets. If the sponsor held more, and
the credit quality of the receivables feeding the issuing trust turned
out to be inferior to the credit lines feeding the legacy trust, the
sponsor would be able to avoid the full effect of those payment
defaults at the issuing trust level.
The proposal would require the sponsor to retain a minimum seller's
interest in the receivables or loans held by the trust representing at
least 5 percent of the total unpaid principal balance of the investors'
ABS interests issued by the trust and outstanding.\55\
[[Page 57944]]
The sponsor would be required to meet this 5 percent test at the
closing of each issuance of securities by the master trust, and at
every seller's interest measurement date specified under the
securitization transaction documents, but no less than monthly. The
sponsor would remain subject to its obligation to meet the seller's
interest requirement on these measurement dates until the trust no
longer has ABS interests outstanding to any third party.
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\55\ The agencies originally proposed 5 percent of the total
receivables and loans in the trust, but are persuaded by commenters
that this is disproportionate to the base risk retention requirement
in some cases. Revolving master trusts may hold receivables far in
excess of the amount of investors' ABS interests outstanding, for
example, when the sponsor has other funding sources at more
favorable costs than those available from investors in the master
trust's ABS.
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The agencies are proposing to include the principal balance instead
of the fair value of outstanding ABS interests as the basis for the
calculation of the minimum seller's interest requirement. The agencies
currently consider this approach to be sufficiently conservative,
because sponsors of revolving master trusts do not include senior
interest-only bonds or premium bonds in their ABS structures. If this
were not the case, it would be more appropriate to require the minimum
seller's interest requirement to be included based on the fair value
basis of outstanding ABS interests. However, the fair value
determination would create additional complexity and costs, especially
given the frequency of the measurements required. In consideration of
this, the agencies would expect to include in any final rule a
prohibition against the seller's interest approach for any revolving
trust that includes senior interest-only bonds or premium bonds in the
ABS interest it issues to investors.
Request for Comment
23(a). Is such prohibition appropriate? 23(b). If not, what is a
better approach, and why? Commenters proposing an alternative approach
should provide specific information about which revolving trusts in the
marketplace currently include such interests in their capital
structures, and the manner in which they could comply with a fair value
approach.
24. In revising the definition of ``seller's interest'' the
agencies have modified the rule text to exclude ``assets that
collateralize other specified ABS interests issued by the issuing
entity'' as well as rule text excluding ``servicing assets,'' which is
a defined term under the proposal. Are such exclusions redundant, or
would they exclude rights to assets or cash flow that are commonly
included as seller's interest?
c. Combining Seller's Interest With Horizontal Risk Retention at the
Series Level
The original proposal for revolving asset master trusts focused
primarily on the seller's interest form of risk retention. Commenters
requested that the agencies modify the original proposal to recognize
as risk retention the various forms of subordinated exposures sponsors
hold in master trust securitization transactions. The proposal would
permit sponsors to combine the seller's interest with either of two
horizontal types of risk retention held at the series level, one of
which meets the same criteria as the standard risk retention
requirement, and the other of which is eligible under the special
conditions discussed below.
To be eligible to combine the seller's interest with horizontal
risk retained at the series level, the sponsor would be required to
maintain a specified amount of horizontal risk retention in every
series issued by the trust. If the sponsor retained these horizontal
interests in every series across the trust, the sponsor would be
permitted to reduce its seller's interest by a corresponding
percentage. For example, if the sponsor held 2 percent, on a fair value
basis, of all the securities issued in each series in either of the two
forms of permitted horizontal interests, the sponsor's seller's
interest requirement would be reduced to 3 percent of the unpaid
principal balance of all investor interests outstanding, instead of 5
percent. However, if the sponsor ever subsequently issued a series (or
additional classes or tranches out of an existing series of a delinked
structure) that did not meet this 2 percent minimum horizontal interest
requirement, the sponsor would be required to increase its minimum
seller's interest up to 5 percent for the entire trust (i.e., 5 percent
of the total unpaid principal balance of all the investors' ABS
interest outstanding in every series, not just the series for which the
sponsor decided not to hold the minimum 2 percent horizontal interest).
The agencies propose to permit the sponsor to hold horizontal
interests at the series level in the form of a certificated or
uncertificated ABS interest. The interest in the series would need to
be issued in a form meeting the definition of an eligible horizontal
residual interest or a specialized horizontal form, available only to
revolving master trusts. The residual interest held by sponsors of
revolving trusts at the series level typically does not meet the
requirement of the proposed definition of eligible horizontal residual
interest which would limit the rate of payments to the sponsor to the
rate of payments made to the holders of senior ABS interests.
Many revolving asset master trusts are collateralized with
receivables that pay relatively high rates of interest, such as credit
and charge card receivables or floor plan financings. The ABS interests
sold to investors are structured so there is an initial revolving
period, under which the series' share of borrower repayments of
principal on the receivables are used by the trust to purchase new,
replacement receivables. Subsequently, during the ``controlled
amortization'' phase, principal payments are accumulated for the
purpose of amortizing and paying off the securities on an expected
maturity date. Under the terms of the transaction, principal payments
are handled in a separate waterfall from interest payments. The series'
share of interest payments received by the trust each period (typically
a month) is used to pay trust expenses and the interest due to holders
of ABS interests.\56\ Because the series' share of cash flow from
interest payments is generally in excess of amounts needed to pay
principal and interest, it is used to cover the series' share of losses
on receivables that were charged-off during the period and a surplus
typically still remains. This residual interest is returned to the
sponsor (though it may, under the terms of the transaction, first be
made available to other series in the trust to cover shortfalls in
interest due and receivable losses during the period that were not
covered by other series' shares of the trust's proceeds).
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\56\ In some trusts the expenses are senior in priority, but
this varies.
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This subordinated claim to residual interest by the sponsor is a
form of horizontal risk retention; the residual interest is payable to
the sponsor only to the extent it exceeds the amount needed to cover
principal losses on more senior securities in the series. The agencies
therefore believe it would be appropriate to recognize this form of
risk retention as an acceptable method of meeting a sponsor's risk
retention requirement for revolving master trusts. Accordingly, the
agencies are proposing to recognize the fair value of the sponsor's
claim to this residual interest as a permissible form of horizontal
risk retention for revolving master trust structures, for which the
sponsor could take credit against the seller's interest requirement in
the manner described above. Under the proposal, the sponsor would
receive credit for the residual interest whether it is certificated or
[[Page 57945]]
uncertificated, subject to the following requirements:
Each series distinguishes between the series' share of
collection of interest, fees, and principal from the securitized assets
(separate waterfalls);
The sponsor's claim to any of the series' share of
interest and fee proceeds each period pursuant to the horizontal
residual interest is subordinated to all interest due to all ABS
interests in the series for that period, and further reduced by the
series' share of defaults on principal of the trust's securitized
assets for that period (that is, charged-off receivables);
The horizontal residual interest, to the extent it has
claims to any part of the series' share of principal proceeds, has the
most subordinated claim; and
The horizontal residual interest is only eligible for
recognition as risk retention so long as the trust is a revolving
trust.
Some commenters on the original proposal also requested that the
sponsor be permitted to combine the seller's interest with other
vertical forms of risk retention at the series level. The agencies are
not aware of any current practice of vertical holding at the series
level. The agencies would consider including, as part of the seller's
interest form of risk retention, vertical forms of risk retention
(subject to an approach similar to the one described in this proposal
for horizontal interests) if it was, in fact, market practice to hold
vertical interests in every series of ABS issued by revolving master
trusts. The agencies have considered this possibility but, especially
in light of the lack of market practice, are not proposing to allow
sponsors to meet their risk retention requirement in this manner.
In addition, the sponsor would need to make the calculations and
disclosures on every measurement date required under the rule for the
seller's interest and horizontal interest, as applicable, under the
proposed rule. Furthermore, the sponsor would be required to retain the
disclosures in its records and make them available to the Commission or
supervising Federal banking agency (as applicable) until three years
after all ABS interests issued in a series are no longer outstanding.
Request for Comment
25(a). Is there a market practice of retaining vertical forms of
risk retention at the series level? 25(b). What advantages and
disadvantages would there be in allowing sponsors to meet their risk
retention requirement through a combination of seller's interest and
vertical holdings at the series level?
26(a). Are the disclosure and recordkeeping requirements in the
proposal appropriate? 26(b). Why or why not? 26(c). Is there a
different time frame that would be more appropriate and if so, what
would it be?
d. Early Amortization
The original proposal did not address the impact of early
amortization on the seller's interest risk retention option. As noted
above, revolving master trusts issue ABS interests with a revolving
period, during which each series' share of principal collections on the
trust's receivables are used to purchase replacement receivables from
the sponsor. The terms of the revolving trust securitization describe
various circumstances under which all series will stop revolving and
principal collections will be used to amortize investors' ABS interests
as quickly as possible. These terms are designed to protect investors
from declines in the credit quality of the trust's asset pool. Early
amortization is exceedingly rare, but when it occurs, the seller's
interest may fall below its minimum maintenance level, especially if
the terms of the securitization subordinate the seller's interest to
investor interests either through express subordination or through a
more beneficial reallocation to other investors of collections that
would otherwise have been allocated to the seller's interest.
Accordingly, the agencies are revising the proposed rule to address the
circumstances under which a sponsor would fall out of compliance with
risk retention requirements after such a reduction in the seller's
interest in the early amortization context.
Under the proposed rule, a sponsor that suffers a decline in its
seller's interest during an early amortization period caused by an
unsecured adverse event would not violate the rule's risk retention
requirements as a result of such decline, provided that each of the
following four requirements were met:
The sponsor was in full compliance with the risk retention
requirements on all measurement dates before the early amortization
trigger occurred;
The terms of the seller's interest continue to make it
pari passu or subordinate to each series of investor ABS with respect
to allocation of losses;
The master trust issues no additional ABS interests after
early amortization is initiated to any person not wholly-owned by the
sponsor; \57\ and
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\57\ In other words, the sponsor is not prohibited from repaying
all outstanding investors' ABS interests and maintaining the trust
as a legacy trust, which could be used at a later date to issue
collateral certificates to a new issuing trust.
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To the extent that the sponsor is relying on any
horizontal interests of the type described in the preceding subsection
to reduce the percentage of its required seller's interest, those
interests continue to absorb losses as described above.
The ability of a sponsor to avoid a violation of the risk retention
in this way is only available to sponsors of master trusts comprised of
revolving assets. If securitizers of ordinary non-revolving assets were
permitted to avail themselves of the seller's interest and this early
amortization treatment, they could create master trust transactions
that revolved only briefly, with ``easy'' early amortization triggers,
and thereby circumvent the cash distribution restrictions otherwise
applicable to risk retention interests under section 4 of the proposed
rule.
As an ancillary provision to this proposed early amortization
treatment, the agencies are proposing to recognize so-called excess
funding accounts as a supplement to the seller's interest. An excess
funding account is a segregated account in the revolving master trust,
to which certain collections on the securitized assets that would
otherwise be payable to the holder of the seller's interest are
diverted if the amount of the seller's interest falls below the minimum
specified in the deal documentation.\58\ If an early amortization event
for the trust is triggered, the cash in the excess funding account is
distributed to investors' ABS interests in the same manner as
collections on the securitized assets. Accordingly, funding of an
excess funding account would typically be temporary, eventually
resolved either by the sponsor adding new securitized assets to restore
the trust to its minimum seller's interest amount (and the funds
trapped in the excess funding account subsequently would be paid to the
sponsor), or by the subsequent early amortization of the trust for
failure to attain the minimum seller's interest over multiple
measurement dates.
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\58\ Ordinarily, if the seller's interest would not meet the
minimum amount required under a formula contained in the deal
documentation, the sponsor is required to designate additional
eligible credit plans to the transaction and transfer the
receivables from those credit plans into the trust to restore the
securitized assets in the trust to the specified ratio. If the
sponsor cannot do this for some reason, the excess funding account
activates to trap certain funds that would otherwise be paid to the
sponsor out of the trust.
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As a general matter, the agencies would not propose to confer
eligible risk retention status on an account that is funded by cash
flow from securitized
[[Page 57946]]
assets. However, for the other forms of risk retention proposed by the
agencies, the amount of retention is measured and set at the inception
of the transaction. Due to the revolving nature of the master trusts,
periodic measurement of risk retention at the trust level is necessary
for an effective seller's interest option.
The agencies are therefore proposing the above-described early
amortization treatment for trusts that enter early amortization,
analogous to the measurement at inception under the other approaches.
If a revolving trust breaches its minimum seller's interest, the excess
funding account (under the conditions described in the proposed rule)
functions as an interim equivalent to the seller's interest for a brief
period and gives the sponsor an opportunity to restore securitized
asset levels to normal levels.\59\ Under the proposed rule, the amount
of the seller's interest may be reduced on a dollar-for-dollar basis by
the amount of cash retained in an excess funding account triggered by
the trust's failure to meet the minimum seller's interest, if the
account is pari passu with (or subordinate to) each series of the
investors' ABS interests and funds in the account are payable to
investors in the same manner as collections on the securitized assets.
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\59\ In addition, the only excess funding account that is
eligible for consideration under the proposed rule is one that is
triggered from the trust's failure to meet its collateral tests in a
given period; this is materially different than a violation of, for
example, a base rate trigger, which signals unexpected problems with
the credit quality of the securitized assets in the pool.
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Request for Comment
27(a). Are there changes the agencies should consider making to the
proposed early amortization and excess funding account provisions in
order to align them better with market practice while still serving the
agencies' stated purpose of these sections? 27(b). If so, what changes
should the agencies consider?
e. Compliance by the Effective Date
Commenters requested that they only be required to maintain a 5
percent seller's interest for the amount of the investors' ABS
interests issued after the effective date of the regulations. As a
general principle, the agencies also do not seek to apply risk
retention to ABS issued before the effective date of the regulations.
On the other hand, the agencies believe that the treatment requested by
commenters is not appropriate, because the essence of the seller's
interest form of risk retention is that it is a pro rata, pari passu
exposure to the entire asset pool. Accordingly, at present, the
agencies propose to require sponsors relying on the seller's interest
approach to comply with the rule with respect to the entirety of the
unpaid principal balance of the trust's outstanding investors' ABS
interests after the effective date of the rule, without regard to
whether the investors' ABS interests were issued before or after the
rule's effective date.
If the terms of the agreements under which an existing master trust
securitization operates do not require the sponsor to hold a minimum
seller's interest to the exact terms of the proposed rule, then the
sponsor could find revising the terms of outstanding series to conform
to the rule's exact requirements to be difficult or impracticable.
Therefore, the agencies propose to recognize a sponsor's compliance
with the risk retention requirements based on the sponsor's actual
conduct. If a sponsor has the ability under the terms of the master
trust's documentation to retain a level of seller's interest (adjusted
by qualifying horizontal interests at the series level, if any), and
does not retain a level of seller's interest as required, the agencies
would consider this to be failure of compliance with the proposed
rule's requirements.
Request for Comment
28(a). The agencies request comment as to how long existing
revolving master trusts would need to come into compliance with the
proposed risk retention rule under the conditions described above. Do
existing master trust agreements effectively prohibit compliance?
28(b). Why or why not? 28(c). From an investor standpoint, what are the
implications of the treatment requested by sponsor commenters, under
which sponsors would only hold a seller's interest with respect to
post-effective date issuances of ABS interests out of the trust?
29(a). Should the agencies approve exceptions on a case by case
basis during the post-adoption implementation period, subject to case-
specific conditions appropriate to each trust? 29(b). How many trusts
would need relief and under what circumstances should such relief be
granted?
30. The agencies seek to formulate the seller's interest form of
risk retention in a fashion that provides meaningful risk retention on
par with the base forms of risk retention under the rule, and at the
same time accommodates prudent features of existing market structures.
The agencies request comment whether the proposal accomplishes both
these goals and, if not, what additional changes the agencies should
consider to that end.
3. Representative Sample
a. Overview of Original Proposal and Public Comment
The original proposal would have provided that a sponsor could
satisfy its risk retention requirement for a securitization transaction
by retaining ownership of a randomly selected representative sample of
assets, equal to at least 5 percent of the unpaid principal balance of
all pool assets initially identified for securitizing that is
equivalent in all material respects to the securitized assets. To
ensure that the sponsor retained exposure to substantially the same
type of credit risk as investors in the securitized transaction, the
sponsor electing to use the representatives sample option would have
been required to construct a ``designated pool'' of assets consisting
of at least 1,000 separate assets from which the securitized assets and
the assets comprising the representative sample would be drawn and
containing no assets other than securitized assets or assets comprising
the representative sample. The proposed rule would have required a
sponsor to select a sample of assets from the designated pool using a
random selection process that would not take into account any
characteristics other than unpaid principal balance and to then assess
that representative sample to ensure that, for each material
characteristic of the assets in the pool, the mean of any quantitative
characteristic and the proportion of any categorical characteristic is
within a 95 percent two-tailed confidence interval of the mean or
proportion of the same characteristics of the assets in the designated
pool. If the representative sample did not satisfy this requirement,
the proposal stipulated that a sponsor repeat the random selection
process until it selected a qualifying sample or opt to use another
risk retention form.
The original proposal set forth a variety of safeguards meant to
ensure that a sponsor using the representative sample option created
the representative pool in conformance with the requirements described
above. These included a requirement to obtain a report regarding
agreed-upon procedures from an independent public accounting firm
describing whether the sponsor has the required procedures in place for
selecting the assets to be retained, maintains documentation that
clearly identifies the assets in the representative sample, and ensures
that the retained assets are not included in the designated pool of any
other
[[Page 57947]]
securitizations. The proposed rule also would have required, until all
of the securities issued in the related securitization had been paid in
full or the related issuing entity had been dissolved, that servicing
of the assets in the representative sample and in the securitization
pool be performed by the same entity under the same contractual
standards and that the individuals responsible for this servicing must
not be able to identify an asset as being part of the representative
sample or the securitization pool. In addition, the sponsor would have
been required to make certain specified disclosures.
While some commenters were supportive of the proposal's inclusion
of the representative sample option, many commenters were critical of
the option. A number of commenters stated that it would be impractical
to implement this option for a variety of reasons, including that it
would be unworkable with respect to various asset classes, would be
subject to manipulation, and was too burdensome with respect to its
disclosure requirements. Other commenters recommended that the option
be limited for use with automobile loans and other loans that are not
identified at origination for sale through securitization. A number of
commenters expressed concerns regarding the required size of the
designated pool, including that the pool size was too large to be
practical, that it would favor larger lenders, and that it would not
work well with larger loans, such as jumbo residential mortgage-backed
securities and commercial mortgages.
Commenters were generally critical of the proposed requirement for
a procedures report, contending that the report would impose costs upon
a sponsor without a commensurate benefit. Additionally, commenters
representing accounting firms and professionals questioned the value of
the procedures report and stated that if not provided to investors in
the securitized transaction, the report could run afoul of certain
rules governing the professional standards of accountants. Commenters
also recommended that the blind servicing requirement of the option be
modified to allow for certain activities, such as loss mitigation,
assignment of loans to special servicers, disclosure of loan level
data, and remittance of funds to appropriate parties.
b. Proposed Treatment
The agencies have considered the comments on the representative
sample option in the original proposal and are concerned that, based on
observations by commenters, the representative sample option would be
difficult to implement and may result in the costs of its utilization
outweighing its benefits. Therefore, the agencies are not proposing to
include a representative sample option in the re-proposed rule. The
agencies believe that the other proposed risk retention options would
be better able to achieve the purposes of section 15G, including the
standard risk retention option, while reducing the potential to
negatively affect the availability and costs of credit to consumers and
businesses.
Request for Comment
31(a). Should the agencies include a representative sample option
as a form of risk retention? 31(b). If so, how should such an option be
constructed, consistent with establishing a statistically
representative sample? 31(c). What benefits would including such an
option provide to the securitization market, investors, borrowers, or
others?
4. Asset-Backed Commercial Paper Conduits
a. Overview of the Original Proposal and Public Comments
The original proposal included a risk retention option specifically
designed for asset-backed commercial paper (ABCP) structures. As
explained in the original proposal, ABCP is a type of liability that is
typically issued by a special purpose vehicle (commonly referred to as
a ``conduit'') sponsored by a financial institution or other sponsor.
The commercial paper issued by the conduit is collateralized by a pool
of assets, which may change over the life of the entity. Depending on
the type of ABCP program being conducted, the securitized assets
collateralizing the ABS interests that support the ABCP may consist of
a wide range of assets including automobile loans, commercial loans,
trade receivables, credit card receivables, student loans, and other
loans. Like other types of commercial paper, the term of ABCP typically
is short, and the liabilities are ``rolled,'' or refinanced, at regular
intervals. Thus, ABCP conduits generally fund longer-term assets with
shorter-term liabilities.\60\ The original proposal was designed to
take into account the special structures through which some conduits
typically issue ABCP, as well as the manner in which participants in
the securitization chain of these conduits typically retain exposure to
the credit risk of the underlying assets.
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\60\ See Original Proposal at Sec. ----.9.
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Under the original proposal, this risk retention option would have
been available only for short-term ABCP collateralized by asset-backed
securities that were issued or initially sold exclusively to ABCP
conduits and supported by a liquidity facility that provides 100
percent liquidity coverage from a banking institution. The option would
not have been available to ABCP conduits that lack 100 percent
liquidity coverage or ABCP conduits that operate purchased securities
or arbitrage programs \61\ in the secondary market.
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\61\ Structured investment vehicles (SIVs) and securities
arbitrage ABCP programs both purchase securities (rather than
receivables and loans) from originators. SIVs typically lack
liquidity facilities covering all of these liabilities issued by the
SIV, while securities arbitrage ABCP programs typically have such
liquidity coverage, though terms are more limited than those of the
ABCP conduits eligible for special treatment pursuant to the
proposed rule.
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In a typical ABCP conduit, the sponsor of the ABCP conduit approves
the originators whose loans or receivables will collateralize the ABS
interests that support the ABCP issued by the conduit. Banks can use
ABCP conduits that they sponsor to meet the borrowing needs of a bank
customer and offer that customer a more attractive cost of funds than a
commercial loan or a traditional debt or equity financing. In such a
transaction, the customer (an ``originator-seller'') may sell loans or
receivables to an intermediate, bankruptcy remote SPV established by
the originator-seller. The credit risk of the receivables transferred
to the intermediate SPV then typically is separated into two classes--a
senior ABS interest that is purchased by the ABCP conduit and a
residual ABS interest that absorbs first losses on the receivables and
that is retained by the originator-seller. The residual ABS interest
retained by the originator-seller typically is sized with the intention
that it be sufficiently large to absorb all losses on the underlying
receivables.
The ABCP conduit, in turn, issues short-term ABCP that is
collateralized by the senior ABS interests purchased from one or more
intermediate SPVs (which are supported by the subordination provided by
the residual ABS interests retained by the originator-sellers). The
sponsor of this type of ABCP conduit, which is usually a bank or other
regulated financial institution or an affiliate or subsidiary of a bank
or other regulated financial institution, also typically provides (or
arranges for another regulated financial institution or group of
financial institution to provide) 100 percent liquidity coverage on the
ABCP issued by the conduit. This liquidity coverage typically requires
the
[[Page 57948]]
support provider to provide funding to, or purchase assets or ABCP
from, the ABCP conduit in the event that the conduit lacks the funds
necessary to repay maturing ABCP issued by the conduit.
The original proposal included several conditions designed to
ensure that this option would be available only to the type of ABCP
conduits that do not purchase securities in the secondary market, as
described above. For example, this option would have been available
only with respect to ABCP issued by an ``eligible ABCP conduit,'' as
defined by the original proposal. The original proposal defined an
eligible ABCP conduit as an issuing entity that issues ABCP and that
meets each of the following criteria.\62\ First, the issuing entity
would have been required to have been bankruptcy remote or otherwise
isolated for insolvency purposes from the sponsor and any intermediate
SPV. Second, the ABS issued by an intermediate SPV to the issuing
entity would have been required to be collateralized solely by assets
originated by a single originator-seller.\63\ Third, all the interests
issued by an intermediate SPV would have been required to be
transferred to one or more ABCP conduits or retained by the originator-
seller. Fourth, a regulated liquidity provider would have been required
to enter into a legally binding commitment to provide 100 percent
liquidity coverage (in the form of a lending facility, an asset
purchase agreement, a repurchase agreement, or similar arrangement) to
all of the ABCP issued by the issuing entity by lending to, or
purchasing assets or ABCP from, the issuing entity in the event that
funds were required to repay maturing ABCP issued by the issuing
entity.\64\
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\62\ See Original Proposal at Sec. ----.2 (definition of
``eligible ABCP conduit'').
\63\ Under the original proposal, an originator-seller would
mean an entity that creates financial assets through one or more
extensions of credit or otherwise and sells those financial assets
(and no other assets) to an intermediate SPV, which in turn sells
interests collateralized by those assets to one or more ABCP
conduits. The original proposal defined an intermediate SPV as a
special purpose vehicle that is bankruptcy remote or otherwise
isolated for insolvency purposes that purchases assets from an
originator-seller and that issues interests collateralized by such
assets to one or more ABCP conduits. See Original Proposal at Sec.
----.2 (definitions of ``originator-seller'' and ``intermediate
SPV'').
\64\ The original proposal defined a regulated liquidity
provider as a depository institution (as defined in section 3 of the
Federal Deposit Insurance Act (12 U.S.C. 1813)); a bank holding
company (as defined in 12 U.S.C. 1841) or a subsidiary thereof; a
savings and loan holding company (as defined in 12 U.S.C. 1467a)
provided all or substantially all of the holding company's
activities are permissible for a financial holding company under 12
U.S.C. 1843(k) or a subsidiary thereof; or a foreign bank (or a
subsidiary thereof) whose home country supervisor (as defined in
Sec. 211.21 of the Federal Reserve Board's Regulation K (12 CFR
211.21)) has adopted capital standards consistent with the Capital
Accord of the Basel Committee on Banking Supervision, as amended,
provided the foreign bank is subject to such standards. See http://www.bis.org/bcbs/index.htm for more information about the Basel
Capital Accord.
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Under the original proposal, the sponsor of an eligible ABCP
conduit would have been permitted to satisfy its base risk retention
obligations if each originator-seller that transferred assets to
collateralize the ABS interests that supported the ABCP issued by the
conduit retained the same amount and type of credit risk as would be
required under the horizontal risk retention option under the original
proposal as if the originator-seller was the sponsor of the
intermediate SPV. Specifically, the original proposal provided that a
sponsor of an ABCP securitization transaction could satisfy its base
risk retention requirement with respect to the issuance of ABCP by an
eligible ABCP conduit if each originator-seller retained an eligible
horizontal residual interest in each intermediate SPV established by or
on behalf of that originator-seller for purposes of issuing interests
to the eligible ABCP conduit. The eligible horizontal residual interest
retained by the originator-seller would have been required to equal at
least 5 percent of the par value of all interests issued by the
intermediate SPV.
Accordingly, each originator-seller would have been required to
retain credit exposure to the receivables sold by that originator-
seller to support issuance of the ABCP. The originator-seller also
would have been prohibited from selling, transferring, or hedging the
eligible horizontal residual interest that it is required to retain.
This option was designed to accommodate the special structure and
features of these types of ABCP programs.
The original proposal also would have imposed certain obligations
directly on the sponsor in recognition of the key role the sponsor
plays in organizing and operating an eligible ABCP conduit. First, the
original proposal provided that the sponsor of an eligible ABCP conduit
that issues ABCP in reliance on the option would have been responsible
for compliance with the requirements of this risk retention option.
Second, the sponsor would have been required to maintain policies and
procedures to monitor the originator-sellers' compliance with the
requirements of the proposal.
The sponsor also would have been required to provide, or cause to
be provided, to potential purchasers a reasonable period of time prior
to the sale of any ABCP from the conduit, and to the Commission and its
appropriate Federal banking agency, if any, upon request, the name and
form of organization of each originator-seller that retained an
interest in the securitization transaction pursuant to section 9 of the
original proposal (including a description of the form, amount, and
nature of such interest), and of the regulated liquidity provider that
provided liquidity coverage to the eligible ABCP conduit (including a
description of the form, amount, and nature of such liquidity
coverage).
Section 15G permits the agencies to allow an originator (rather
than a sponsor) to retain the required amount and form of credit risk
and to reduce the amount of risk retention required of the sponsor by
the amount retained by the originator.\65\ In developing the risk
retention option for eligible ABCP conduits in the original proposal,
the agencies considered the factors set forth in section 15G(d)(2) of
the Exchange Act.\66\ The original proposal included conditions
designed to ensure that the interests in the intermediate SPVs sold to
an eligible ABCP conduit would have low credit risk, and to ensure that
originator-sellers had incentives to monitor the quality of the assets
that are sold to an intermediate SPV and collateralize the ABCP issued
by the conduit. In addition, the original proposal was designed to
effectuate the risk retention requirements of section 15G of the
Exchange Act in a manner that facilitated reasonable access to credit
by consumers and businesses through the issuance of ABCP backed by
consumer and business receivables. Finally, as noted above, an
originator-seller would have been subject to the same restrictions on
transferring or hedging the retained eligible horizontal residual
interest to a third party as applied to sponsors under the original
proposal.
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\65\ See 15 U.S.C. 78o-11(c)(1)(G)(iv) and (d) (permitting the
Commission and the Federal banking agencies to allow the allocation
of risk retention from a sponsor to an originator).
\66\ See id. at Section 78o-11(d)(2). These factors are whether
the assets sold to the securitizer have terms, conditions, and
characteristics that reflect low credit risk; whether the form or
volume of transactions in securitization markets creates incentives
for imprudent origination of the type of loan or asset to be sold to
the securitizer; and the potential impact of the risk retention
obligations on the access of consumers and businesses to credit on
reasonable terms, which may not include the transfer of credit risk
to a third party.
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b. Comments on the Original Proposal
Commenters generally supported including an option specifically for
ABCP structures. Commenters
[[Page 57949]]
expressed concern, however, about several aspects of the option. Many
commenters recommended allowing the credit enhancements usually found
in ABCP conduit programs (i.e., 100 percent liquidity facilities or
program-wide credit enhancement) to qualify as a form of risk
retention, in addition to the proposed option, because sponsors that
provide this level of protection to their conduit programs are already
exposed to as much (or more) risk of loss as a sponsor that holds an
eligible horizontal residual interest. Several commenters also
requested that the agencies permit originator-sellers to also use the
other permitted menu options, such as master trusts.
Commenters generally did not support the restrictions in the
definition of ``eligible ABCP conduit'' in the original proposal
because these restrictions would prevent ABCP multi-seller conduits
from financing ABS that was collateralized by securitized assets
originated by more than one originator. In particular, the restriction
that assets held by an intermediate SPV must have been ``originated by
a single originator-seller'' would, as these commenters asserted,
preclude funding assets that an originator-seller acquires from a third
party or from multiple affiliated originators under a corporate group,
which commenters asserted was a common market practice. Many commenters
noted that the requirement that all of the interests issued by the
intermediate SPV be transferred to one or more ABCP conduits or
retained by the originator-seller did not take into account that, in
many cases, an intermediate SPV may also sell interests to investors
other than ABCP conduits.
Some commenters also observed that the original proposal did not
appear to accommodate ABCP conduit transactions where originator-
sellers sell their entire interest in the securitized receivables to an
intermediate SPV in exchange for cash consideration and an equity
interest in the SPV. The SPV, in turn, would hold the retained
interest. Therefore, these commenters recommended that the rule permit
an originator-seller to retain its interest through its or its
affiliate's ownership of the equity in the intermediate SPV, rather
than directly. In addition, a commenter requested that the agencies
revise the ABCP option to accommodate structures where the intermediate
SPV is the originator. A few commenters requested that the agencies
expand the definition of eligible liquidity provider to include
government entities, and to allow multiple liquidity providers for one
sponsor. Some commenters also criticized the monitoring and disclosure
requirements for the ABCP option in the original proposal. A few
commenters recommended that the ABCP option be revised so that ABCP
with maturities of up to 397 days could use the ABCP option.
c. Proposed ABCP Option
The agencies are proposing an option for ABCP securitization
transactions that retains the basic structure of the original proposal
with modifications to a number of requirements intended to address
issues raised by commenters.\67\ As with the original proposal, the
proposal permits the sponsor to satisfy its base risk retention
requirement if each originator-seller that transfers assets to
collateralize the ABCP issued by the conduit retains the same amount
and type of credit risk as would be required as if the originator-
seller was the sponsor of the intermediate SPV. The agencies continue
to believe that such an approach, as modified by the proposal, is
appropriate in light of the considerations set forth in section
15G(d)(2) of the Exchange Act.\68\ These modifications are intended to
allow the ABCP option to accommodate certain of the wider variety of
market practices observed in the comments on the original proposal
while establishing a meaningful risk retention requirement. In summary,
these modifications are designed to permit somewhat more flexibility on
behalf of originator-sellers that finance through ABCP conduits
extensions of credit they create in connection with their business
operations. The additional flexibility granted under the revised
proposal permits affiliated groups of originator-sellers to finance
credits through a combined intermediate SPV. It also permits additional
flexibility where an originator seller uses an intermediate SPV not
only to finance credits through an ABCP conduit, but also other ABS
channels, such as direct private placements in the investor market. The
proposal also permits additional flexibility to accommodate the
structures of intermediate SPVs, such as revolving master trusts and
pass-through intermediate special purpose vehicles (ISPVs).
Nevertheless, the revised proposal retains the original proposal's core
requirements, including the 100 percent liquidity coverage requirement.
The revised proposal also does not accommodate ``aggregators'' who use
ABCP to finance assets acquired in the market; the assets underlying
each intermediate SPV must be created by the respective originator-
seller.
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\67\ As with the original proposal, the proposal permits the
sponsor to satisfy its base risk retention requirement if each
originator-seller that transfers assets to collateralize the ABCP
issued by the conduit retains the same amount and type of credit
risk as would be required as if the originator-seller was the
sponsor of the intermediate SPV, provided that all other conditions
to this option are satisfied. The agencies continue to believe that
such an approach, as modified by the proposal, is appropriate in
light of the considerations set forth in section 15G(d)(2) of the
Exchange Act. See note 66, supra. In developing the risk retention
option for eligible ABCP conduits in the original proposal, the
agencies considered the factors set forth in section 15G(d)(2) of
the Exchange Act. The proposal include conditions designed to ensure
that the interests in the intermediate SPVs sold to an eligible ABCP
conduit would have low credit risk, and to ensure that originator-
sellers had incentives to monitor the quality of the assets that are
sold to an intermediate SPV and collateralize the ABCP issued by the
conduit. In addition, the proposal is designed to effectuate the
risk retention requirements of section 15G of the Exchange Act in a
manner that facilitates reasonable access to credit by consumers and
businesses through the issuance of ABCP backed by consumer and
business receivables. Finally, as noted above, an originator-seller
would be subject to the same restrictions on transferring or hedging
the retained interest to a third party as applied to sponsors of
securitization transactions.
\68\ See note 66, supra.
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First, the proposal would introduce the concept of a ``majority-
owned originator-seller affiliate'' (OS affiliate), which would be
defined under the proposal as an entity that, directly or indirectly,
majority controls, is majority controlled by, or is under common
majority control with, an originator-seller participating in an
eligible ABCP conduit. For purposes of this definition, majority
control would mean ownership of more than 50 percent of the equity of
an entity or ownership of any other controlling financial interest in
the entity (as determined under GAAP). Under the proposal, both an
originator-seller and a majority-owned OS affiliate could sell or
transfer assets that these entities have originated to an intermediate
SPV.\69\ However, intermediate SPVs could not acquire assets directly
from non-affiliates. This modification addresses the agencies' concern
about asset aggregators that acquire loans and receivables from
multiple sources in the market, place them in an intermediate SPV, and
issue interests to ABCP conduits. Where, as in
[[Page 57950]]
the case of an eligible ABCP conduit, a banking institution provides
100 percent liquidity coverage to the conduit, the Federal banking
agencies are concerned that the aggregation model could interfere with
the liquidity provider's policies and practices for monitoring and
managing the risk exposure of the guarantee. In light of the purposes
of section 15G, the Federal banking agencies do not believe that
extending the ABCP option to ABCP conduits that are used to finance the
purchase and securitization of receivables purchased in the secondary
market would consistently help ensure high quality underwriting of ABS.
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\69\ With the majority ownership standard, the agencies are
proposing to require a high level of economic identity of interest
between firms that are permitted to use a common intermediate SPV as
a vehicle to finance their assets. The agencies are concerned that a
lower standard of affiliation in this regard could make it more
difficult for the conduit sponsor and liquidity provider to
understand the credit quality of assets backing the conduit.
Moreover, a lower standard of affiliation creates opportunities for
an originator-seller to act as an aggregator by securitizing
purchased assets through special-purpose vehicles the originator-
seller creates and controls for such purposes, and putting the ABS
issued by those special-purpose vehicles into the intermediate SPV.
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Second, the proposal would allow for multiple intermediate SPVs
between an originator-seller and a majority-owned OS affiliate. As
indicated in the comments on the original proposal, there are instances
where, for legal or other purposes, there is a need for multiple
intermediate SPVs. Under the proposal, an intermediate SPV would be
defined to be a direct or indirect wholly-owned affiliate \70\ of the
originator-seller that is bankruptcy remote or otherwise isolated for
insolvency purposes from the eligible ABCP conduit, the originator-
seller, and any majority-controlled OS affiliate that, directly or
indirectly, sells or transfers assets to such intermediate SPV. The
intermediate SPV would be permitted to acquire assets originated by the
originator-seller or its majority-controlled OS affiliate from the
originator-seller or majority-controlled OS affiliate, or it could also
acquire assets or asset-backed securities from another controlled
intermediate SPV collateralized solely by securitized assets originated
by the originator-seller or its majority-controlled OS affiliate and
servicing assets. Finally, intermediate SPVs in structures with
multiple intermediate SPVs that do not issue asset-backed securities
collateralized solely by ABS interests must be pass-through entities
that either transfer assets to other SPVs in anticipation of
securitization (e.g., a depositor) or transfer ABS interests to the
ABCP conduit or another intermediate SPV. Finally, under the proposal,
all ABS interests held by an eligible ABCP conduit must be issued in a
securitization transaction sponsored by an originator-seller and
supported by securitized assets originated or created by an originator-
seller or one or more majority-owned OS affiliates of the originator-
seller.
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\70\ See proposed rule at Sec. ----.2 (definition of
``affiliate'').
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Third, the proposed rule, in contrast to the original proposal,
would allow an intermediate SPV to sell asset-backed securities that it
issues to third parties other than ABCP conduits. For example, the
agencies believe that some originator-sellers operate a revolving
master trust to finance extensions of credit the originator-seller
creates in connection with its business operations. The master trust
sometimes issues a series of ABS backed by an interest in those credits
directly to investors through a private placement transaction or
registered offering, and other times issues an interest to an eligible
ABCP conduit. The proposed rule would accommodate this practice.
Fourth, the proposal would clarify and expand (as compared to the
original proposal) the types of collateral that an eligible ABCP
conduit could acquire from an originator-seller. Under the proposed
definition of ``eligible ABCP conduit'', a conduit could acquire any of
the following types of assets: (1) ABS interests supported by
securitized assets originated by an originator-seller or one or more
majority-controlled OS affiliates of the originator seller, and by
servicing assets; \71\ (2) special units of beneficial interest or
similar interests in a trust or special purpose vehicle that retains
legal title to leased property underlying leases that were transferred
to an intermediate SPV in connection with a securitization
collateralized solely by such leases originated by an originator-seller
or majority-controlled OS affiliate and by servicing assets; and (3)
interests in a revolving master trust collateralized solely by assets
originated by an originator-seller or majority-controlled OS affiliate;
and by servicing assets.\72\
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\71\ The purpose of this clarification is to allow originator-
sellers certain additional flexibility in structuring their
participation in eligible ABCP conduits, while retaining the core
principle that the assets being financed have been originated by the
originator-seller or a majority-controlled OS affiliate, not
purchased and aggregated.
\72\ The definition of ``servicing assets'' is discussed in Part
II.B of this Supplementary Information. The agencies are allowing an
ABCP conduit to hold servicing assets, and thus acknowledge the
kinds of rights and assets that a typical ABCP conduit needs to have
in order to conduct the activities required in a securitization.
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Consistent with this principle, the agencies seek to clarify that
the ABS interests acquired by the conduit could not be collateralized
by securitized assets otherwise purchased or acquired by the
intermediate SPV's originator-seller, majority-controlled OS affiliate,
or by the intermediate SPV from unaffiliated originators or sellers.
The ABS interests also would have to be acquired by the ABCP conduit in
an initial issuance by or on behalf of an intermediate SPV, (1)
directly from the intermediate SPV, (2) from an underwriter of the
securities issued by the intermediate SPV, or (3) from another person
who acquired the securities directly from the intermediate SPV. In
addition, the ABCP conduit would have to be collateralized solely by
asset-backed securities acquired by the ABCP conduit in an initial
issuance by or on behalf of an intermediate SPV directly from the
intermediate SPVs, from an underwriter of the securities issued by the
intermediate SPV, or from another person who acquired the securities
directly from the intermediate SPV and servicing assets. Because
eligible ABCP conduits can only purchase ABS interests in an initial
issuance, eligible ABCP conduits may not aggregate ABS interests by
purchasing them in the secondary market.
Fifth, in response to comments on the original proposal that an
originator-seller should be able to use a wider variety of risk
retention options, the proposal would expand the retention options
available to the originator-seller. Under the proposed rule, an
eligible ABCP conduit would satisfy its risk retention requirements if,
with respect to each asset-backed security the ABCP conduit acquires
from an intermediate SPV, the originator-seller or majority-controlled
OS affiliate held risk retention in the same form, amount, and manner
as would be required using the standard risk retention or revolving
asset master trust options. Thus, in the example above of an
originator-seller that finances credits through a revolving master
trust, the originator-seller could retain risk in the form of a
seller's interest meeting the requirements of the revolving master
trust provisions of the proposed rule.
Sixth, consistent with the original proposal, the proposal requires
that a regulated liquidity provider must have entered into a legally
binding commitment to provide 100 percent liquidity coverage (in the
form of a lending facility, an asset purchase agreement, a repurchase
agreement, or similar arrangement) of all the ABCP issued by the
issuing entity by lending to, or purchasing assets from, the issuing
entity in the event that funds are required to repay maturing ABCP
issued by the issuing entity. The proposal clarifies that 100 percent
liquidity coverage means that, in the event that the ABCP conduit is
unable for any reason to repay maturing ABCP issued by the issuing
entity, the total amount for which the liquidity provider may be
obligated is equal to 100 percent of the amount of ABCP outstanding
plus
[[Page 57951]]
accrued and unpaid interest. Amounts due pursuant to the required
liquidity coverage may not be subject to credit performance of the ABS
held by the ABCP conduit or reduced by the amount of credit support
provided to the ABCP conduit. Liquidity coverage that only funds
performing receivables or performing ABS interests will not meet the
requirements of the ABCP option.
d. Duty To Monitor and Disclosure Requirements
Consistent with the original proposal, the agencies are proposing
that the sponsor of an eligible ABCP conduit would continue to be
responsible for compliance. Some commenters on the original proposal
requested that the agencies replace the monitoring obligation with a
contractual obligation of an originator-seller to maintain compliance.
However, the agencies believe that the sponsor of an ABCP conduit is in
the best position to monitor compliance by originator-sellers.
Accordingly, the proposal would continue to require the sponsor of an
ABCP conduit to monitor compliance by an originator-seller.
e. Disclosure Requirements
The agencies also are proposing disclosure requirements that are
similar to those in the original proposal, with two changes. First, the
agencies are proposing to remove the requirement that the sponsor of
the ABCP conduit disclose the names of the originator-sellers. The
proposal would continue to require the sponsor of an ABCP conduit to
provide to each purchaser of ABCP the name and form of organization of
the regulated liquidity provider that provides liquidity coverage to
the eligible ABCP conduit, including a description of the form, amount,
and nature of such liquidity coverage, and notice of any failure to
fund. In addition, with respect to each ABS interest held by the ABCP
conduit, the sponsor of the ABCP conduit would be required to provide
the asset class or brief description of the underlying receivables for
each ABS interest, the standard industrial category code (SIC Code) for
the originator-seller or majority-controlled OS affiliate that will
retain (or has retained) pursuant to this section an interest in the
securitization transaction, and a description of the form, amount
(expressed as a percentage and as a dollar amount (or corresponding
amount in the foreign currency in which the ABS are issued, as
applicable) of the fair value of all ABS interests issued in the
securitization transaction. Finally, an ABCP conduit sponsor relying on
the ABCP option would be required to provide, or cause to be provided,
upon request, to the Commission and its appropriate Federal banking
agency, if any, in writing, all of the information required to be
provided to investors and the name and form of organization of each
originator-seller or majority-controlled OS affiliate that will retain
(or has retained) an interest in the underlying securitization
transactions.
Second, a sponsor of an ABCP conduit would be required to promptly
notify investors, the Commission, and its appropriate Federal banking
agency, if any, in writing of (1) the name and form of organization of
any originator-seller that fails to maintain its risk retention as
required by the proposed rule and the amount of asset-backed securities
issued by an intermediate SPV of such originator-seller and held by the
ABCP conduit; (2) the name and form of organization of any originator-
seller that hedges, directly or indirectly through an intermediate SPV,
its risk retention in violation of its risk retention requirements and
the amount of asset-backed securities issued by an intermediate SPV of
such originator-seller and held by the ABCP conduit; and (3) and any
remedial actions taken by the ABCP conduit sponsor or other party with
respect to such asset-backed securities. In addition, the sponsor of an
ABCP conduit would be required to take other appropriate steps upon
learning of a violation by an originator-seller of its risk retention
obligations including, as appropriate, curing any breach of the
requirements, or removing from the eligible ABCP conduit any asset-
backed security that does not comply with the applicable requirements.
To cure the non-compliance of the non-conforming asset, the sponsor
could, among other things, purchase the non-conforming asset from the
ABCP conduit, purchase 5 percent of the outstanding ABCP and comply
with the vertical risk retention requirements, or declare an event of
default under the underlying transaction documents (assuming the
sponsor negotiated such a term) and accelerate the repayment of the
underlying assets.
f. Other Items
In most cases, the sponsor of the ABCP issued by the conduit will
be the bank or an affiliate of the bank that organizes the conduit. The
agencies note that the use of the ABCP option by the sponsor of an
eligible ABCP conduit would not relieve the originator-seller from its
independent obligation to comply with its own risk retention
obligations under the revised proposal, if any. In most, if not all,
cases, the originator-seller will be the sponsor of the asset-backed
securities issued by an intermediate SPV and will therefore be required
to hold an economic interest in the credit risk of the assets
collateralizing the asset-backed securities issued by the intermediate
SPV. The agencies also note that a sponsor of an ABCP conduit would not
be limited to using the ABCP option to satisfy its risk retention
requirements. An ABCP conduit sponsor could rely on any of the risk
retention options described in section 4 of the proposed rule.
The agencies are proposing definitions of ``ABCP'' and ``eligible
liquidity provider'' that are the same as the definitions in the
original proposal. The agencies believe it would be inappropriate to
expand the ABCP option to commercial paper that has a term of over nine
months, because a duration of nine months accommodates almost all
outstanding issuances and the bulk of those issuances have a
significantly shorter term of 90 days or less. In addition, the
agencies have not expanded the definition of eligible liquidity
provider to include sovereign entities. The agencies do not believe
that prudential requirements could be easily designed to accommodate a
sovereign entity that functions as a liquidity provider to an ABCP
conduit.
Request for Comments
32(a). To the extent that the proposed ABCP risk retention option
does not reflect market practice, how would modifying the proposal help
ensure high quality underwriting of ABCP? 32(b). What structural or
definitional changes to the proposal would be appropriate, including
but not limited to any changes to the proposed definitions of 100
percent liquidity coverage, eligible ABCP conduit, intermediate SPV,
majority-owned OS affiliate, originator-seller, and regulated liquidity
provider? 32(c). Do ABCP conduits typically have 100 percent liquidity
coverage as defined in the proposal? 32(d). What percentage of ABCP
conduits and what percentage of ABCP currently outstanding was issued
by such conduits?
33(a). Do ABCP conduits typically only purchase assets directly
from intermediate SPVs (i.e., that meet the requirements of the
proposal? 33(b). What percentage of ABCP currently outstanding was
issued by such conduits?
34(a). Do ABCP conduits typically purchase receivables directly
from customers, rather than purchasing ABS interests from SPVs
sponsored by customers? 34(b). What percentage of ABCP currently
outstanding was issued
[[Page 57952]]
by such conduits? 34(c). Is the requirement that an ABCP conduit
relying on this option may not purchase receivables directly from the
originator appropriate? 34(d). Why or why not?
35(a). Is the requirement that an ABCP conduit relying on this
option may not purchase ABS interests in the secondary market
appropriate? 35(b). Why or why not? 35(c). Does the proposed ABCP
option appropriately capture assets that are acquired through business
combinations?
36(a). Do ABCP conduits typically purchase corporate debt
securities on a regular or occasional basis? 36(b). What percentage of
ABCP currently outstanding was issued by such conduits?
37(a). Do ABCP conduits typically purchase ABS in the secondary
market on a regular or occasional basis? 37(b). What percentage of ABCP
currently outstanding was issued by such conduits?
38. With respect to ABCP conduits that purchase assets that do not
meet the requirements of the proposal, what percentage of those ABCP
conduits' assets do not meet the requirements?
39(a). Should the agencies allow multiple eligible liquidity
providers for purposes of the ABCP risk retention options? 39(b). If
so, should this be limited to special circumstances? 39(c). Should the
agencies allow a liquidity provider to provide liquidity coverage with
respect to a specific ABS interest?
40(a). Does the definition of majority-owned OS affiliate
appropriately capture companies that are affiliated with an originator-
seller? 40(b). Why or why not?
41. Should the rule require disclosure of the originator seller in
the case of noncompliance by the originator seller?
42(a). Should the rule also require disclosure to investors in ABCP
in all cases of violation of this section? 42(b). Why or why not?
42(c). If so, should the rule prescribe how such disclosure be made
available to investors?
43. Are there other changes that should be made to disclosure
provisions?
44. Should the rule provide further clarity as to who will be
deemed a sponsor of ABCP issued by an ABCP conduit?
45(a). Should there be a supplemental phase-in period (beyond the
delayed effective dates in 15 U.S.C. 78o-11(i)) for existing ABCP
conduits that do not meet the proposed definition of eligible ABCP
conduit? 45(b). Why or why not? 45(c). If so, what would be the
appropriate limit (e.g., up to 10 percent of the assets in the ABCP
conduit could be nonconforming), and what would be the appropriate time
period(s) for conformance (e.g., up to two years)?
5. Commercial Mortgage-Backed Securities
a. Overview of the Original Proposal and Public Comments
Section 15G(c)(1)(E) of the Exchange Act (15 U.S.C. 78o-
11(c)(1)(E)) provides that, with respect to CMBS, the regulations
prescribed by the agencies may provide for retention of the first-loss
position by a third-party purchaser that specifically negotiates for
the purchase of such first-loss position, holds adequate financial
resources to back losses, provides due diligence on all individual
assets in the pool before the issuance of the asset-backed securities,
and meets the same standards for risk retention as the Federal banking
agencies and the Commission require of the securitizer. In light of
this provision and the historical market practice of third-party
purchasers acquiring first-loss positions in CMBS transactions, the
agencies originally proposed to permit a sponsor of ABS that is
collateralized by commercial real estate loans to meet its risk
retention requirements if a third-party purchaser acquired an eligible
horizontal residual interest in the issuing entity.\73\ The acquired
interest would have had to take the same form, amount, and manner as
the sponsor would have been required to retain under the horizontal
risk retention option. The CMBS risk retention option would have been
available only for securitization transactions where commercial real
estate loans constituted at least 95 percent of the unpaid principal
balance of the assets being securitized and where six proposed
requirements were met:
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\73\ Such third-party purchasers are commonly referred to in the
CMBS market as ``B-piece buyers'' and the eligible horizontal
residual interest is commonly referred to as the ``B-piece.''
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(1) The third-party purchaser retained an eligible horizontal
residual interest in the securitization in the same form, amount, and
manner as would be required of the sponsor under the horizontal risk
retention option;
(2) The third-party purchaser paid for the first-loss subordinated
interest in cash at the closing of the securitization without financing
being provided, directly or indirectly, from any other person that is a
party to the securitization transaction (including, but not limited to,
the sponsor, depositor, or an unaffiliated servicer), other than a
person that is a party solely by reason of being an investor;
(3) The third-party purchaser performed a review of the credit risk
of each asset in the pool prior to the sale of the asset-backed
securities;
(4) The third-party purchaser could not be affiliated with any
other party to the securitization transaction (other than investors) or
have control rights in the securitization (including, but not limited
to acting as servicer or special servicer) that were not collectively
shared by all other investors in the securitization;
(5) The sponsor provided, or caused to be provided, to potential
purchasers certain information concerning the third-party purchaser and
other information concerning the transaction; and
(6) Any third-party purchaser acquiring an eligible horizontal
residual interest under the CMBS option complied with the hedging,
transfer and other restrictions applicable to such interest under the
proposed rules as if the third-party purchaser was a sponsor who had
acquired the interest under the horizontal risk retention option.
As stated in the original proposal, these requirements were
designed to help ensure that the form, amount and manner of the third-
party purchaser's risk retention would be consistent with the purposes
of section 15G of the Exchange Act.
Generally, commenters supported the ability of sponsors to transfer
credit risk to third-party purchasers. One commenter stated that the
CMBS option acknowledged the mandate of section 941 of the Dodd-Frank
Act and the recommendations of the Federal Reserve Board by providing
much need flexibility to the risk retention rules and recognized the
impact and importance of the third-party purchaser in the CMBS market.
Some commenters, however, believed the proposed criteria for the option
would discourage the use of the option or render the option unworkable.
In particular, one commenter raised concerns with the restrictions on
financing and hedging of the B-piece, the restrictions on the transfer
of such interest for the life of the transaction, restrictions on
servicing and control rights including the introduction of an operating
advisor, and requirements related to the disclosure of the B-piece
purchase price would likely discourage the use of the CMBS option.
In response to the agencies' question in the original proposal as
to whether a third-party risk retention option should be available to
other asset classes, commenters' views were mixed. Some commenters
expressed support for allowing third parties to retain the risk in
other asset classes, with other commenters supporting a third-party
[[Page 57953]]
option for RMBS and another commenter suggesting the option be made
available to any transaction in which individual assets may be
significant enough in size to merit the individual review required of a
third-party purchaser.
The agencies believe that a third-party purchaser that specifically
negotiates for the purchase of a first-loss position is a common
feature of commercial mortgage securitizations that is generally not
found in other asset classes. For this reason, section 15G(c)(1)(E)(ii)
of the Exchange Act specifically permits the agencies to create third-
party risk retention for commercial mortgage securitizations. However,
the agencies believe there is insufficient benefit to market liquidity
to justify an expansion of third-party risk retention to other asset
classes, and propose to maintain the more direct alignment of
incentives achieved by requiring the sponsor to retain risk for the
other asset classes not covered by section 15G(c)(1)(E)(ii).
The agencies also received many comments with respect to the
specific conditions of the CMBS option in the original proposal. In
this proposed rule, the CMBS option is similar to that of the original
proposal, but incorporates a number of key changes the agencies believe
are appropriate in response to concerns raised by commenters. These are
discussed below.
b. Proposed CMBS Option
i. Number of Third-Party Purchasers and Retention of Eligible Interest
Under the original proposal, only one third-party purchaser could
retain the required risk retention interest. Additionally, the third-
party purchaser would have been required to retain an eligible
horizontal residual interest in the securitization in the same form,
amount and manner as would be required of the sponsor under the
horizontal retention option. The proposed CMBS option was not designed
to permit a third-party purchaser to share the required risk retention
with the sponsor.
Many commenters on the original proposal requested flexibility in
satisfying the CMBS option through the sharing of risk retention
between sponsors and third-party purchasers, as well as among multiple
third-party purchasers. In particular, some commenters noted that
allowing such flexibility would be consistent with how the proposed
rule would allow a sponsor to choose to retain a vertical and
horizontal retention piece to share the risk retention obligation with
an originator.
The agencies considered the comments on the original proposal
carefully and believe that some additional flexibility for the CMBS
risk retention option would be appropriate. Accordingly, under the
proposed rule, the agencies would allow two (but no more than two)
third-party purchasers to satisfy the risk retention requirement
through the purchase of an eligible horizontal residual interest (as
defined under the proposed rule). Each third-party purchaser's interest
would be required to be pari passu with the other third-party
purchaser's interest, so that neither third-party purchaser's losses
are subordinate to the other's losses. The agencies do not believe it
would be appropriate to allow more than two third-party purchasers to
satisfy the risk retention requirement for a single transaction,
because it could dilute too much the incentives generated by the risk
retention requirement to monitor the credit quality of the commercial
mortgages in the pool.
The agencies are also revising the CMBS option to clarify that,
when read together with the revisions that have been made to the
standard risk retention requirements, the eligible horizontal residual
interest held by the third-party purchasers can be used to satisfy the
standard risk retention requirements, either by itself as the sole
credit risk retained or in combination with a vertical interest held by
the sponsor. The agencies believe this flexibility increases the
likelihood that third-party purchasers will assume risk retention
obligations. The agencies further believe that the interests of the
third-party purchaser and other investors are aligned through other
provisions of the proposed CMBS option, namely the Operating Advisor
provisions and disclosure provisions discussed below.
ii. Third-Party Purchaser Qualifying Criteria
In the original proposal, the agencies did not propose qualifying
criteria for third-party purchasers related to the third-party
purchaser's experience or financial capabilities.
One commenter proposed that only ``qualified'' third-party
purchasers be permitted to retain the risk under the CMBS option, with
such qualifications based on certain pre-determined criteria of
experience, financial analysis capability, capability to direct the
special servicer and certain financial capabilities to sustain losses.
Another commenter requested that the final rule require third-party
purchasers to be independent from special servicers.
Consistent with the original proposal, the agencies are not
proposing to add specific qualifying criteria for third-party
purchasers. The agencies believe that investors in the business of
purchasing B-piece interests in CMBS transactions, who are typically
interested in acquiring special servicing rights in such transactions,
likely have the requisite experience and capabilities to make an
informed decision regarding their purchases. Furthermore, the agencies
continue to propose disclosure requirements with respect to the
identity and experience of third-party purchasers in the transaction,
which will alert investors in a CMBS transaction as to the experience
of third-party purchasers and other material information necessary to
make an informed investment decision. Additionally, based generally on
comments the agencies have received, the agencies have not added a
requirement that third-party purchasers be independent from special
servicers since the acquisition of special servicing rights is a
primary reason why third-party purchasers are willing to purchase the
B-piece in the CMBS transactions. Such an independence requirement
would adversely affect the willingness of third-party purchasers to
assume the risk retention obligations in CMBS transactions.
iii. Composition of Collateral
Consistent with the original proposal, the agencies are restricting
the third-party purchaser option to securitization transactions
collateralized by commercial real estate loans. However, the original
proposal allowed up to 5 percent of the collateral to be other types of
assets, in order to accommodate assets other than loans that are
typically needed to administer a securitization. Since then, the
agencies have added the servicing assets definition to the proposed
rule, to accommodate these kinds of assets.\74\ Accordingly, the
agencies are eliminating the 95 percent test and revising the
collateral restriction to cover securitization transactions
collateralized by commercial real estate loans and servicing assets.
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\74\ The definition of ``servicing assets'' is discussed in Part
II.B of this Supplementary Information.
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iv. Source of Funds
The original proposal would have required that the third-party
purchaser pay for its eligible horizontal residual interest in cash,
and would have prohibited the third-party purchaser from obtaining
financing, directly or
[[Page 57954]]
indirectly, for the purchase of such interest from any party to the
securitization transaction other than an investor.
A few commenters supported the proposed limitation on financing,
while another commenter recommended that no distinction be made between
the sponsor's ability to finance its risk retention interest compared
to third-party purchasers. Several commenters requested clarification
on what ``indirect'' financing means under the proposal and requested
that the final rule not prohibit the third-party purchaser from
obtaining financing from a party for an unrelated transaction.
The agencies are re-proposing this condition consistent with the
original proposal. The limitation on obtaining financing would apply
only to financings for the purchase of the B-piece in a specific CMBS
transaction and only where the financing provider is another party to
that same CMBS transaction. The agencies are clarifying that the
financing provider restriction would include affiliates of the other
parties to the CMBS transaction. This limitation would not restrict
third-party purchasers from obtaining financing from a transaction
party for a purpose other than purchasing the B-piece in the
transaction; provided that none of such financing is later used to
purchase the B-piece, which would be an indirect financing of the B-
piece. Nor would third-party purchasers be restricted from obtaining
financing from a person that is not a party to the specific
transaction, unless that person had some indirect relationship with a
party to the transaction, such as a parent-subsidiary relationship or a
subsidiary-subsidiary relationship under a parent company (subject to
the required holding period and applicable hedging restrictions). The
use of the term indirect financing is meant to ensure that these types
of indirect relationships are prohibited under the financing
limitations of the rule.
v. Review of Assets by Third-Party Purchaser
Under the original proposal, a third-party purchaser would have
been required to conduct a review of the credit risk of each
securitized asset prior to the sale of the ABS that includes, at a
minimum, a review of the underwriting standards, collateral, and
expected cash flows of each loan in the pool. Most commenters
addressing this issue generally supported the proposed condition that a
third-party purchaser must separately examine each asset in the pool.
Specifically, one commenter noted that this level of review is
currently the industry standard and is a clear indication of the
strength of the credit review process for CMBS transactions.
The agencies are proposing this condition again with only minor
changes to indicate, in the event there is more than one third-party
purchaser in a transaction, that each third-party purchaser would be
required to conduct an independent review of the credit risk of each
CMBS asset.
vi. Operating Advisor
(1) Affiliation and Control Rights
The original proposal included a condition of the CMBS option
intended to address the potential conflicts of interest that can arise
when a third-party purchaser serves as the ``controlling class'' of a
CMBS transaction. This condition would have prohibited a third-party
purchaser from (1) being affiliated with any other party to the
securitization transaction (other than investors); or (2) having
control rights in the securitization (including, but not limited to
acting as servicer or special servicer) that are not collectively
shared by all other investors in the securitization. The proposed
prohibition of control rights related to servicing would have been
subject to an exception from this condition, however, only if the
underlying securitization transaction documents provided for the
appointment of an independent operating advisor (``Operating Advisor'')
with certain powers and responsibilities that met certain criteria. The
proposed criteria were: (1) The Operating Advisor is not affiliated
with any other party to the securitization, (2) the Operating Advisor
does not directly or indirectly have any financial interest in the
securitization other than in fees from its role as Operating Advisor,
and (3) the Operating Advisor is required to act in the best interest
of, and for the benefit of, investors as a collective whole. The
original proposal would have required that an independent Operating
Advisor be appointed if the third-party purchaser was acting as, or was
affiliated with, a servicer for any of the securitized assets and had
control rights related to such servicing.
(2) Operating Advisor Criteria and Responsibilities
The agencies received many comments with respect to the criteria in
the original proposal for the Operating Advisor, as well as with
respect to the Operating Advisor's required responsibilities.
Commenters had mixed views concerning when the rule should require
an Operating Advisor and whether the Operating Advisor should play an
active role while the third-party purchaser is the ``controlling
class.'' There was a comment supporting the proposed requirement that
an Operating Advisor be included when the third-party purchaser is
affiliated with and controls the special servicing function of the
transaction. Some commenters supported the inclusion of an Operating
Advisor in all CMBS transactions. Other commenters supported a dormant
role for the Operating Advisor while the third-party purchaser was the
``controlling class,'' and the Operating Advisor's power would be
triggered when such purchaser was no longer the controlling class
(typically when the third-party purchaser's interest is reduced to less
than 25 percent of its original principal balance after taking into
account appraisal reductions). Some of these commenters asserted that
the introduction of an Operating Advisor may support the interests of
the senior investors at the expense of the third-party purchaser,
thereby adversely affecting the willingness of third-party purchasers
to assume the risk retention obligations. Further, commenters stated
that the Operating Advisor would add layers of administrative burden on
an already highly structured CMBS framework and make servicing and
workouts for the underlying loans more difficult and expensive, thereby
reducing returns. Finally, some commenters stated that oversight is
unnecessary while the third-party purchaser continues to have an
economic stake in the transaction because third-party purchasers are
highly incentivized to discharge their servicing duties in a manner
that maximizes recoveries. One of these commenters noted that this is
its current approach and is working to the satisfaction of both
investment grade investors and third-party purchasers. Some commenters
recommended a framework whereby the Operating Advisor would be involved
immediately but its role would depend on whether the third-party
purchaser was the controlling class.
Additionally, some commenters specifically requested that the
Operating Advisor's authority apply only to the special servicer
(instead of all servicers as originally proposed) for three reasons.
First, the special servicer has authority or consent rights with
respect to all material servicing actions and defaulted loans, whereas
the master servicer has very little discretion because its servicing
duties are typically set forth in detail in the pooling and
[[Page 57955]]
servicing agreement and its authority to modify loans is limited.
Moreover, any control right held by a third-party purchaser with
respect to servicing is typically exercised through the special
servicer and the third-party purchaser does not generally provide any
direct input into master servicer decisions.
Second, the B-piece termination right is another structural feature
of CMBS transactions that applies to special servicers but not to
master servicers. The third-party purchaser's right to terminate and
replace the special servicer without cause is one method of control by
the third-party purchaser over special servicing. The master servicer,
however, is not subject to this termination without cause. The master
servicer typically can be terminated by the trustee only upon the
occurrence of one of the negotiated events of default with respect to
the master servicer. In the event of such a default, holders of ABS
evidencing a specified percentage of voting rights (25 percent in many
deals) of all certificates can direct the trustee to take such
termination action.
Third, an Operating Advisor's right to remove the master servicer
may be problematic for the master servicer's servicing rights assets.
Master servicers usually purchase their servicing rights from the
sponsors in the securitization and these rights retain an ongoing
value. Therefore, any termination rights beyond those based on
negotiated events of default jeopardize the value of the master
servicer's servicing asset.
Based on comments received, the agencies acknowledge that third-
party purchasers often are, or are affiliated with, the special
servicers in CMBS transactions. Because of this strong connection
between third-party purchasers and the special servicing rights in CMBS
transactions, the agencies are proposing to limit application of the
Operating Advisor provisions to special servicers, rather than any
affiliated servicers as originally proposed in the original proposal.
Consequently, the agencies are also proposing a revised CMBS option to
require as a separate condition the appointment of an Operating Advisor
in all CMBS transactions that rely on the CMBS risk retention option.
As stated in the original proposal, the agencies believe that the
introduction of an independent Operating Advisor provides a check on
third-party purchasers by limiting the ability of third-party
purchasers to manipulate cash flows through special servicing. In
approving loans for inclusion in the securitization, third-party
purchasers ideally will be mindful of the limits on their ability to
offset the consequences of poor underwriting through servicing tactics
if loans become troubled, thereby providing a stronger incentive for
third-party purchasers to be diligent in assessing the credit quality
of pool assets at the time of securitization. Because the agencies are
proposing that an Operating Advisor be required for all CMBS
transactions relying on the CMBS option, the prohibition on third-party
purchasers having control rights related to servicing is no longer
necessary and has been removed.
(3) Operating Advisor Independence
The original proposal would have prohibited the Operating Advisor
from being affiliated with any party to the transaction and from
having, directly or indirectly, any financial interest in the
transaction other than its fees from its role as Operating Advisor.
An investor commenter supported complete independence for the
Operating Advisor, reasoning that the Operating Advisor should not in
any way be conflicted when representing all holders of ABS. Other
commenters did not support the independence criteria, instead proposing
to rectify any conflicts of interest through disclosure. One of these
commenters commented that it would be counter-productive to preclude
current Operating Advisors from serving in that capacity in the future,
as such a framework would leave only smaller firms with little or no
experience as the only eligible candidates and could result in
diminution of available investment capital. Independence concerns
should instead be addressed by the Operating Advisor's disclosure at
the time it initiates proceedings to replace a special servicer, of
whether the Operating Advisor has any conflicts of interest.
Consistent with the original proposal, the CMBS option in the
proposed rule would require that the Operating Advisor not be
affiliated with other parties to the securitization transaction. Also
consistent with the original proposal, the Operating Advisor would be
prohibited from having, directly or indirectly, any financial interest
in the securitization transaction other than fees from its role as
Operating Advisor and would be required to act in the best interest of,
and for the benefit of, investors as a collective whole. As stated
above, the agencies believe that an independent Operating Advisor is a
key factor in providing a check on third-party purchasers and special
servicers, thereby protecting investors' interests.
(4) Qualifications of the Operating Advisor
In the original proposal, the agencies did not propose
qualifications for the Operating Advisor other than independence from
other parties to the securitization transaction.
One commenter recommended that the final rule include eligibility
requirements for Operating Advisors, such as requiring an Operating
Advisor to have an existing servicing platform (not necessarily rated);
have at least 25 full time employees; have at least $25 million in
capital; and have some metric for assuring that the Operating Advisor
will have an ongoing real estate market presence and the in-house
expertise necessary to effectively carry out their responsibilities.
Another commenter requested clarification regarding the qualifications
of an Operating Advisor but did not expressly advocate for or against
particular qualifications.
Based in part on comments received, the agencies are proposing
certain general qualifications for the Operating Advisor. Under the
proposed rule, the underlying transaction documents must provide for
standards with respect to the Operating Advisor's experience, expertise
and financial strength to fulfill its duties and responsibilities under
the applicable transaction documents over the life of the
securitization transaction. Additionally, the transaction documents
must describe the terms of the Operating Advisor's compensation with
respect to the securitization transaction.
The agencies do not believe it is necessary to mandate specific
minimum levels of experience, expertise and financial strength for
Operating Advisors in CMBS transactions relying on the CMBS option.
Rather, the agencies believe that CMBS transaction parties should be
permitted to establish Operating Advisor qualification standards and
compensation in each transaction. By requiring disclosure to investors
of such qualification standards, how an Operating Advisor satisfies
such standards, and the Operating Advisor's related compensation, the
proposed rule provides investors with an opportunity to evaluate the
Operating Advisor's qualifications and compensation in the relevant
transaction.
(5) Role of the Operating Advisor
Under the original proposal, the duties of the Operating Advisor
were generally to (1) act in the best interest of investors as a
collective whole, (2) require the servicer for the securitized assets
to consult with the Operating Advisor in connection with, and prior
[[Page 57956]]
to, any major decision in connection with servicing, which would
include any material loan modification and foreclosures and
acquisitions of properties, and (3) review the actions of the
affiliated servicer and report to investors and the issuing entity on a
periodic basis.
With respect to the role of the Operating Advisor in the original
proposal, comments were mixed. Investor commenters generally supported
the consultative role given to Operating Advisors under the original
proposal. Issuers and industry association commenters did not support
such role and believed that the powers granted to the Operating Advisor
under the original proposal were too broad. In particular, these
commenters generally did not support the proposed requirement that the
servicer consult with the Operating Advisor prior to any major
servicing decision.
Another commenter recommended a framework such that after the
change-in-control event (that is, when the B-piece position is reduced
to less than 25 percent of its original principle balance), the
Operating Advisor's role would be that of a monitoring role and
investigate claims of special servicer noncompliance when initiated by
a specified percentage of investors, and provide its findings on a
regular basis to CMBS investors, the sponsor and the servicers.
A trade association commenter, supported by two other commenters,
preferred an approach in which the Operating Advisor's role would be
reactive while the third-party purchaser is the controlling class, and
become proactive when the third-party purchaser is no longer the
controlling class. Under this commenter's approach, the rule would
provide that the third-party purchaser is no longer in control if the
sum of principal payments, appraisal reductions and realized losses
have reduced the third-party purchaser's initial positions to less than
25 percent of its original face amount.
Consistent with the original proposal, the proposed rule would
require consultation with the Operating Advisor in connection with, and
prior to, any major investing decision in connection with the servicing
of the securitized assets. However, based on comments received, the
consultation requirement only applies to special servicers and only
takes effect once the eligible horizontal residual interest held by
third-party purchasers in the transaction has a principal balance of 25
percent or less of its initial principal balance.
(6) Operating Advisor's Evaluation of Servicing Standards
The original proposal would have included a requirement that the
Operating Advisor be responsible for reviewing the actions of any
affiliated servicer and issue a report evaluating whether the servicer
is operating in compliance with any standard required of the servicer,
as provided in the applicable transaction documents.
One trade association commenter recommended that the rule establish
the standard by which the Operating Advisor evaluates the special
servicer. It stated that one such standard would be to include language
in the pooling and servicing agreement or similar transaction document
that would require the special servicer to maximize the net present
value of the loan without consideration of the impact of such action on
any specific class of ABS. However, as this trade association was
unsupportive of requiring the servicer to consult with the Operating
Advisor prior to any material workout, it also stated that an
alternative to actually including the servicing standard would be for
the Operating Advisor to monitor all loan workouts and, if the special
servicer is not meeting the stated standard, the Operating Advisor
could then take the appropriate action.
The agencies are proposing that the CMBS option require the
Operating Advisor to have adequate and timely access to information and
reports necessary to fulfill its duties under the transaction
documents. Further, the proposed rule would require the Operating
Advisor to be responsible for reviewing the actions of the special
servicer, reviewing all reports made by the special servicer to the
issuing entity, reviewing for accuracy and consistency calculations
made by the special servicer within the transaction documents, and
issuing a report to investors and the issuing entity on special
servicer's performance.
(7) Servicer Removal Provisions
Under the original proposal, the Operating Advisor would have had
the authority to recommend that a servicer be replaced if it determined
that the servicer was not in compliance with the servicing standards
outlined in the transaction documents. This recommendation would be
submitted to investors and would be approved unless a majority of each
class of investors voted to retain the servicer.
Many commenters were of the view that the rule granted too much
authority to the Operating Advisor in regards to the removal of a
servicer. As discussed above, many commenters believed that the
Operating Advisor's authority should only apply to special servicers.
Following on this point, many commenters commented that the special
servicer should be removed only upon the affirmative vote of ABS
holders (instead of a negative vote as originally proposed).
One commenter suggested that the special servicer removal process
should be negotiated among the CMBS transaction parties and specified
in the pooling and servicing agreement or similar transaction document.
In this scenario, the special servicer would have the opportunity to
explain its conduct, the Operating Advisor would be required to
publicly explain its rationale for recommending special servicer
removal, and investors in non-controlling classes would vote in the
affirmative for special servicer removal. Another commenter proposed
that an Operating Advisor's recommendation to remove a special servicer
would have to be approved by two-thirds of all ABS holders voting as a
whole, or through an arbitration mechanism. Another commenter proposed
that a minimum of 5 percent of all ABS holders based on par dollar
value of holdings be required for quorum, and decisions would be
adopted with the support of a simple majority of the dollar value of
par of quorum. Another commenter advocated removal only after the
third-party purchaser is no longer the controlling class.
After considering comments that the servicer removal provision
should only apply to special servicers, the agencies are proposing that
the Operating Advisor's authority to recommend removal and replacement
would be limited to special servicers. Additionally, based on comments
received, the agencies are proposing that the actual removal of the
special servicer would require the affirmative vote of a majority of
the outstanding principal balance of all ABS interests voting on the
matter, and require a quorum of 5 percent of the outstanding principal
balance of all ABS interests.
Because of the agencies' belief that the introduction of an
independent Operating Advisor provides a check on third-party
purchasers by limiting the ability of third-party purchasers to
manipulate cash flows through special servicing, the agencies believe
that the removal of the special servicer should be independent of
whether the third-party purchaser is the controlling class in the
securitization transaction or similar considerations. The proposed
affirmative majority vote and quorum requirements are designed to
provide
[[Page 57957]]
additional protections to investors in this regard.
c. Disclosures
Under the original proposal, the sponsor would have been required
to provide, or cause to be provided, to potential purchasers and
federal supervisors certain information concerning the third-party
purchaser and other information concerning the CMBS transaction, such
as the third-party purchaser's name, the purchaser's experience
investing in CMBS, and any other material information about the third-
party purchaser deemed material to investors in light of the particular
securitization transaction.
Additionally, a sponsor would have been required to disclose to
investors the amount of the eligible horizontal residual interest that
the third-party purchaser will retain (or has retained) in the
transaction (expressed as a percentage of the fair value of all ABS
interests issued in the securitization transaction and the dollar
amount of the fair value of such ABS interests); the purchase price
paid for such interest; the material terms of such interest; the amount
of the interest that the sponsor would have been required to retain if
the sponsor had retained an interest in the transaction; the material
assumptions and methodology used in determining the aggregate amount of
ABS interests of the issuing entity; and certain information about the
representations and warranties concerning the securitized assets.
While commenters generally supported the proposed disclosure
requirements, many commenters raised concerns about specific portions
of these requirements.
Under the original proposal, the sponsor would have been required
to disclose to investors the name and form of organization of the
third-party purchaser as well as a description of the third-party
purchaser's experience in investing in CMBS. The original proposal also
solicited comment as to whether disclosure concerning the financial
resources of the third-party purchaser would be necessary in light of
the requirement that the third-party purchaser fund the acquisition of
the eligible horizontal residual interest in cash, without direct or
indirect financing from a party to the transaction. Some commenters
supported these proposed requirements, while others did not.
Under the original proposal, a third-party purchaser would have
been required to disclose the actual purchase price paid for the
retained residual interest. Several commenters did not support
requiring purchase price disclosure. These commenters noted that price
disclosure raises confidentiality concerns and could reveal the
purchaser's price parameters to its competitors. These commenters
provided suggestions for maintaining the confidentiality of such
information or alternatives to actual disclosure of prices paid.
Under the original proposal, sponsors would have been required to
disclose to investors the material assumptions and methodology used in
determining the aggregate amount of ABS interests issued by the issuing
entity, including those pertaining to any estimated cash flows and the
discount rate used. One commenter did not support requiring this
disclosure and believed that such disclosure would be irrelevant in
CMBS transactions in that the principal balance of the certificates
sold to investors would equal the aggregate initial principal balance
of the mortgage loans, and CMBS transactions did not utilize
overcollateralization (as is the case with covered bonds and other
structures).
Under the original proposal, the sponsor would have been required
to disclose the representations and warranties concerning the assets, a
schedule of exceptions to these representations and warranties, and
what factors were used to make the determination that such exceptions
should be included in the pool even though they did not meet the
representations and warranties.
One commenter agreed that loan-by-loan exceptions should be
disclosed but did not comment on whether the disclosure of subjective
factors disclosure should be required. This commenter also advocated
for a standardized format of disclosure of representations and
warranties. Another commenter noted that in recent CMBS transactions,
all representations and warranties and all exceptions thereto are fully
disclosed. Two commenters were unsupportive of requiring disclosure of
why exceptions were allowed into the pool because they stated that such
determinations are often qualitative and the benefit of such disclosure
would be outweighed by the burden imposed on the issuer. The original
proposal also requested comment on whether the rule should require that
a blackline of the representations and warranties for the
securitization transaction against an industry-accepted standard for
model representations and warranties be provided to investors at a
reasonable time prior to sale. One commenter noted that it was
unnecessary to require that investors be provided with a blackline so
long as the representations and warranties are themselves disclosed.
The original proposal requested comment on whether the rule should
specify the particular types of information about a third-party
purchaser that should be disclosed, rather than requiring disclosure of
any other information regarding the third-party purchaser that is
material to investors in light of the circumstances of the particular
securitization transaction. One investor commenter generally supported
requiring disclosure of any other information regarding the purchaser
that is material to investors in light of the circumstances. A few
commenters were unsupportive of this disclosure requirement. One
commenter stated that there should be a safe harbor for the types of
information about the third-party purchaser and that requiring this
material information disclosure is too broad. Another commenter stated
that disclosure of ``material information'' is already required under
existing disclosure rules.
The agencies are proposing disclosure requirements for the CMBS
option substantially consistent with the original proposal. The
agencies have carefully considered the concerns raised by commenters,
but believe that the importance of the proposed disclosures to
investors with respect to third-party purchasers, the retained residual
interest (including the purchase price), the material terms of the
eligible horizontal residual interest retained by each third-party
purchaser (including the key inputs and assumptions used in measuring
the total fair value of all classes of ABS interests, and the fair
value of the eligible horizontal residual interest), and the
representations and warranties concerning the securitized assets,
outweigh any issues associated with the sponsor or third-party
purchaser to making such information available.
The agencies are also proposing again to require disclosure of the
material terms of the applicable transaction documents with respect to
the Operating Advisor, including without limitation, the name and form
of organization of the Operating Advisor, the qualification standards
applicable to the Operating Advisor and how the Operating Advisor
satisfies these standards, and the terms of the Operating Advisor's
compensation.
d. Transfer of B-Piece
As discussed above, consistent with the original proposal, the
proposed rule would allow a sponsor of a CMBS transaction to meet its
risk retention requirement where a third-party
[[Page 57958]]
purchaser acquires the B-piece, and all other criteria and conditions
of the proposed requirements for this option as described are met.
Under the original proposal, the sponsor or, if an eligible third-
party purchaser purchased the B-piece, the third-party purchaser, would
have been required to retain the required eligible horizontal residual
interest for the full duration of the securitization transaction.
Numerous commenters urged that this proposal be changed to allow
transfer of the B-piece prior to the end of the securitization
transaction. Some of the commenters making this recommendation
requested a specified termination point (or ``sunset'') for the CMBS
risk retention requirement. Other commenters recommended that third-
party purchasers be permitted to transfer the retained interest to
other third-party purchasers, either immediately or after a maximum
waiting period of one year. Some commenters proposed that there be both
an overall sunset period for any risk retention requirement and that,
prior to the end of that period, transfers between qualified third-
party purchasers be permitted.
Several commenters asserted that permitting transfers by third-
party purchasers was critical to the continuation of the third-party
purchaser structure for CMBS transactions. Another commenter, a
securitization sponsor, stated that the transfer restrictions included
in the original proposal would undermine the effectiveness of the CMBS
option because some investors could not (due to fiduciary or
contractual obligations) or did not desire to invest where such
restrictions would be imposed. A broker-dealer commenter stated that it
was crucial for the rules to give third-party purchasers some ability
to sell the B-piece to qualified transferees because third-party
purchasers or their investors would not be able to agree to a
prohibition on the sale of the B-piece investment for the entire life
of the transaction.
Commenters that advocated a sunset for CMBS risk retention
generally requested that it occur after two-to-five years. Commenters
that requested permitted transfers to a qualified third-party purchaser
by the original B-piece holder prior to the end of the risk retention
requirement advocated that there be no minimum retention period by the
original B-piece holder, while one commenter suggested a one-year
initial retention period.
Certain commenters contended that the restrictions of the original
proposal were not necessary to promote good underwriting and that
permitting transfer of the B-piece prior to the end of the
securitization transaction would be warranted because after a certain
amount of time, performance of the underlying commercial mortgages is
dependent more on economic conditions rather than an underwriting
requirement. One industry group stated that three years would be
sufficient to provide all securitization participants the opportunity
to determine the quality of underwriting, arguing that after a three-
year period, deficient underwriting or other performance factors would
be reflected in the sale price of the retained interest.
Some of the commenters that recommended permitting transfers to
qualified third-party purchasers suggested additional conditions, such
as that the third-party purchaser also be a qualified institutional
buyer or accredited investor for purposes of the Securities Act of
1933, or that the transferee certify that it had performed the same due
diligence and had the same access to information as the original third-
party purchaser. One commenter suggested that qualified institutional
buyer or accredited investor status alone should cause an entity to
qualify as a qualified transferee of a third-party purchaser.
The agencies have considered the points raised by commenters on the
original proposal with respect to transferability of the B-piece and
believe, for the reasons discussed further below, that limited
transfers prior to the end of the securitization transaction are
warranted. The agencies are therefore proposing, as an exception to the
transfer and hedging restrictions of the proposed rule and section 15G
of the Exchange Act, to permit the transfer of the retained interest by
any initial third-party purchaser to another third-party purchaser at
any time after five years after the date of the closing of the
securitization transaction, provided that the transferee satisfies each
of the conditions applicable to the initial third-party purchaser under
the CMBS option (as described above) in connection with such purchase.
The proposed rule also would permit transfers by any such subsequent
third-party purchaser to any other purchaser satisfying the criteria
applicable to initial third-party purchasers. In addition, in the event
that the sponsor retained the B-piece at closing, the proposed rule
would permit the sponsor to transfer such interest to a purchaser
satisfying the criteria applicable to third-party purchasers after a
five-year period following the closing of the securitization
transaction has expired. The proposed rule would require that any
transferring third-party purchaser provide the sponsor with complete
identifying information as to the transferee third-party purchaser.
In considering the comments and formulating the revised proposed
rule, the agencies attempted to balance two overriding goals: (1) Not
disrupting the existing CMBS third-party purchaser structure, and (2)
ensuring that risk retention promotes good underwriting. The agencies
followed the analysis of the commenters who asserted that, after a five
year period, the quality of the underwriting would be sufficiently
evident that the initial third-party purchaser or, if there was no
initial third-party purchaser, the sponsor would suffer the
consequences of poor underwriting in the form of a reduced sales price
for such interest. The agencies also believe that the initial holder of
the B-piece, whether a third-party purchaser or the sponsor, would need
to assume that retention for a five-year period would result in such
holder bearing the consequences of poor underwriting and, thus, that by
permitting transfer after the five year period the agencies would not
be creating a structure which resulted in the initial holder being less
demanding of the underwriting than if it was required to retain the B-
piece until the full sunset period applicable to CMBS securitizations
had expired. In connection with this, the requirement (among other
conditions) that a subsequent purchaser, like the initial third-party
purchaser, conduct an independent review of the credit risk of each
securitized asset was important to the agencies, as this requirement
would emphasize to the initial B-piece holder that the performance of
the securitized assets would be scrutinized by any potential purchaser,
thus exposing the initial purchaser to the full risks of poor
underwriting.
The standards for the Federal banking agencies to provide
exemptions to the risk requirements and prohibition on hedging are
outlined in section 941(e) of the Dodd-Frank Act. The exemption
described above would allow third-party purchasers and sponsors to
transfer a horizontal risk retention interest after a five year period
to sponsors or third-party purchasers that meet the same standards. The
agencies believe that under 15 U.S.C. 78o-11(e)(2), a five-year
retention duration helps ensure high underwriting standards for the
securitizers and originators of assets that are securitized or
available for securitization by forcing sponsors or initial third-party
purchasers to absorb a significant
[[Page 57959]]
portion of losses related to underwriting deficiencies. Furthermore,
the agencies believe that this exemption would meet the statute's
requirement that the exemption encourage appropriate risk management
practices by the securitizers and originators of assets, improve the
access of consumers and businesses to credit on reasonable terms, or
otherwise is in the public interest and for the protection of
investors. By limiting the risk retention requirement for CMBS to five
years rather than the entire duration of the underlying assets, the
agencies are responding to commenters' concerns that lifetime retention
requirements would eliminate B-piece buyers' ability to participate in
the CMBS market, and without their participation, market liquidity for
commercial mortgages would be severely impacted. The proposed approach
of requiring the third-party purchaser to hold for at least five years
accommodates continuing participation of B-piece buyers in the market,
in a way that still requires meaningful risk retention as an incentive
to good risk management practices by securitizers in selecting assets,
and addressing specific concerns about maintaining consumers' and
businesses' access to commercial mortgage credit.
The agencies have not adopted the recommendations made by several
commenters that transfers to qualified third-party purchasers be
permitted with no minimum holding period or after a one year holding
period. The agencies decided that unless there was a holding period
that was sufficiently long to enable underwriting defects to manifest
themselves, the original third-party purchaser might not be
incentivized to insist on effective underwriting of the securitized
assets. This, in turn, would be in violation of section 941(e)'s
requirement that any exemption continue to help ensure high quality
underwriting standards. The agencies are therefore proposing a period
of five years based on the more conservative comments received as to
duration of the CMBS retention period. The agencies believe that
permitting transfers to qualifying third-party purchasers after five
years should not diminish in any respect the pressure on the sponsor to
use proper underwriting methods.
Request for Comment
46. Should the period for B-piece transfer be any longer or shorter
than five years? Please provide any relevant data analysis to support
your conclusion.
47(a). Should the agencies only allow one third-party purchaser to
satisfy the risk retention requirement? 47(b). Should the agencies
consider allowing for more than two third-party purchasers to satisfy
the risk retention requirement?
48(a). Are the third-party qualifying criteria the agencies are
proposing appropriate? 48(b). Why or why not? 48(c). Would a sponsor be
able to track the source of funding for other purposes to determine if
funds are used for the purchase of the B-piece?
49(a). Are the Operating Advisor criteria and responsibilities the
agencies are proposing appropriate? 49(b). Why or why not?
e. Duty To Comply
The original proposal would have required the sponsor of a CMBS
transaction to maintain and adhere to policies and procedures to
monitor the third-party purchaser's compliance with the CMBS option and
to notify investors if the sponsor learns that the third-party
purchaser no longer complies with such requirements.
Several commenters criticized the proposed monitoring obligations
because they believed that such monitoring would not be feasible for a
sponsor, especially the restriction on hedging. Some commenters
proposed alternatives, such as making the Operating Advisor responsible
for compliance by the third-party purchaser or using contractual
representations and warranties and covenants to ensure compliance.
Another commenter suggested that the pooling and servicing
agreement or similar transaction document set forth a dispute
resolution mechanism for investors, including the ability of investors
to demand an investigation of possible noncompliance by the special
servicer upon request from a specified percentage of ABS and how the
costs of resulting investigations would be borne and that independent
parties would perform such investigations.
The agencies have considered these comments but continue to believe
that it is important for the sponsor to monitor third-party purchasers.
A transfer of risk to a third-party purchaser is not, under the
agencies' view of the risk retention requirement, a transfer of the
sponsor's general obligation to satisfy the requirement. Although the
proposal allows third-party purchasers to retain the required eligible
horizontal residual interest, the agencies believe that the sponsor of
the CMBS transaction should ultimately be responsible for compliance
with the requirements of the CMBS option, rather than shifting the
obligation to the third-party purchaser or Operating Advisor, as some
commenters on the original proposal suggested, by requiring
certifications or representations and warranties. Additionally, the
agencies are not proposing a specific requirement that the pooling and
servicing agreement or similar transaction document include dispute
resolution provisions because the agencies believe that most investor
disputes, particularly disputes related to possible noncompliance by
the special servicer, will be resolved through the proposed Operating
Advisor process. However, this is not intended to limit investors and
other transaction parties from continuing to include negotiated rights
and remedies in CMBS transaction documents, including dispute
resolution provisions in addition to the proposed Operating Advisor
provisions.
Accordingly, the agencies are proposing the same monitoring and
notification requirements as under the original proposal with no
modifications. The sponsor would be required to maintain policies and
procedures to actively monitor the third-party purchaser's compliance
with the requirements of the rule and to notify (or cause to be
notified) ABS holders in the event of any noncompliance with the rule.
6. Government-Sponsored Enterprises
a. Overview of Original Proposal and Public Comment
In the original proposal, the agencies proposed that the guarantee
(for timely payment of principal and interest) by the Enterprises while
they operate under the conservatorship or receivership of FHFA with
capital support from the United States would satisfy the risk retention
requirements of section 15G of the Exchange Act with respect to the
mortgage-backed securities issued by the Enterprises. Similarly, an
equivalent guarantee provided by a limited-life regulated entity that
has succeeded to the charter of an Enterprise, and that is operating
under the authority and oversight of FHFA under section 1367(i) of the
Federal Housing Enterprises Financial Safety and Soundness Act of 1992,
would satisfy the risk retention requirements, provided that the entity
is operating with capital support from the United States. The original
proposal also provided that the hedging and finance provisions would
not apply to an Enterprise while operating under conservatorship or
receivership with capital support from the United States, or to a
limited-life regulated entity that
[[Page 57960]]
has succeeded to the charter of an Enterprise and is operating under
the authority and oversight of FHFA with capital support from the
United States. Under the original proposal, a sponsor (that is, the
Enterprises) utilizing this option would have been required to provide
to investors, in written form under the caption ``Credit Risk
Retention'' and, upon request, to FHFA and the Commission, a
description of the manner in which it met the credit risk retention
requirements.
As the agencies explained in the original proposal, if either an
Enterprise or a successor limited-life regulated entity began to
operate other than as described, the Enterprise or successor entity
would no longer be able to avail itself of the credit risk retention
option provided to the Enterprises and would have become subject to the
related requirements and prohibitions set forth elsewhere in the
proposal.
In the original proposal, the agencies explained what factors they
took into account regarding the treatment of the Enterprises while they
were in conservatorship or receivership with capital support from the
United States.\75\ First, the agencies observed that because the
Enterprise fully guaranteed the timely payment of principal and
interest on the mortgage-backed securities they issued, the Enterprises
were exposed to the entire credit risk of the mortgages that
collateralize those securities. The agencies also highlighted that the
Enterprises had been operating under the conservatorship of FHFA since
September 6, 2008, and that as conservator, FHFA had assumed all powers
formerly held by each Enterprise's officers, directors, and
shareholders and was directing its efforts as conservator toward
minimizing losses, limiting risk exposure, and ensuring that the
Enterprises priced their services to adequately address their costs and
risk. Finally, the agencies described how each Enterprise, concurrent
with being placed in conservatorship, entered into a Senior Preferred
Stock Purchase Agreement (PSPA) with the United States Department of
the Treasury (Treasury) and that the PSPAs provided capital support to
the relevant Enterprise if the Enterprise's liabilities had exceeded
its assets under GAAP.\76\
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\75\ See Original Proposal, 76 FR at 24111-24112.
\76\ Under each PSPA as amended, Treasury purchased senior
preferred stock of each Enterprise. In exchange for this cash
contribution, the liquidation preference of the senior preferred
stock that Treasury purchased from the Enterprise under the
respective PSPA increases in an equivalent amount. The senior
preferred stock of each Enterprise purchased by Treasury is senior
to all other preferred stock, common stock or other capital stock
issued by the Enterprise.
Treasury's commitment to each Enterprise is the greater of: (1)
$200 billion; or (2) $200 billion plus the cumulative amount of the
Enterprise's net worth deficit as of the end of any calendar quarter
in 2010, 2011 and 2012, less any positive net worth as of December
31, 2012. Under amendments to each PSPA signed in August 2012, the
fixed-rate quarterly dividend that each Enterprise had been required
to pay to Treasury was replaced, beginning on January 1, 2013, with
a variable dividend based on each Enterprise's net worth, helping to
ensure the continued adequacy of the financial commitment made under
the PSPA and eliminating the need for an Enterprise to borrow
additional amounts to pay quarterly dividends to Treasury. The PSPAs
also require the Enterprises to reduce their retained mortgage
portfolios over time.
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The agencies received a number of comments on the original proposal
with respect to the Enterprises, including comments from banks and
other financial businesses, trade organizations, public interest and
public policy groups, members of Congress and individuals. A majority
of the commenters supported allowing the Enterprises' guarantee to be
an acceptable form of risk retention in accordance with the original
proposal.
Many of the comments that supported the original proposal noted
that the capital support by the United States government, coupled with
the Enterprises' guarantee, equated to 100 percent risk retention by
the Enterprises. Others believed the treatment of the Enterprises in
the original proposal was important to support the mortgage market and
to ensure adequate credit in the mortgage markets, especially for low
down payment loans. One commenter representing community banks stated
that, without the provision for the Enterprises in the original
proposal, many community banks would have difficulty allocating capital
to support risk retention and, by extension, continued mortgage
activity. A few commenters specifically supported the original
proposal's exception for the Enterprises from the prohibitions on
hedging. These commenters asserted that preventing the Enterprise from
hedging would be unduly burdensome, taking into consideration the 100
percent guarantee of the Enterprises, while other sponsors would only
be required to meet a 5 percent risk retention requirement. At least
one commenter noted that applying the hedging prohibition to the
Enterprises could have negative consequences for taxpayers, given the
capital support from the United States.
A number of the commenters said that, even though they supported
the original proposal, they believed that it could create an advantage
for the Enterprises over private lenders. These commenters recommended
that the agencies adopt a broader definition for QRM to address any
potential disadvantages for private lenders, rather than change the
risk retention option proposed for the Enterprises.\77\
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\77\ The comments that relate to the QRM definition are
addressed in Part VI of this Supplementary Information, which
discusses the proposed QRM definition.
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Those commenters that opposed the treatment of the Enterprises in
the original proposal generally believed that it would provide the
Enterprises with an unfair advantage over private capital, and asserted
that it would be inconsistent with the intent of section 15G of the
Exchange Act. Many of these commenters stated that this aspect of the
original proposal, if adopted, would prevent private capital from
returning to the mortgage markets and would otherwise make it difficult
to institute reform of the Enterprises. One commenter believed the
original proposal interfered with free market competition and placed
U.S. government proprietary interests ahead of the broader economic
interests of the American people. Other comments suggested that the
original proposal's treatment of the Enterprises could have negative
consequences for taxpayers.
b. Proposed Treatment
The agencies have carefully considered the comments received with
respect to the original proposal's provision for the Enterprises. While
the agencies understand the issues involved with the Enterprises'
participation in the mortgage market, the agencies continue to believe
that it is appropriate, from a public policy perspective, to recognize
the guarantee of the Enterprises as fulfilling their risk retention
requirement under section 15G of the Exchange Act, while in
conservatorship or receivership with the capital support of the United
States. The authority and oversight of the FHFA over the operations of
the Enterprises or any successor limited-life regulated entity during a
conservatorship or receivership,\78\ the full guarantee provided by
these entities on the timely payment of principal and interest on the
mortgage-backed securities that they issue, and the capital support
provided
[[Page 57961]]
by Treasury under the PSPAs \79\ provide a reasonable basis consistent
with the goals and intent of section 15G for recognizing the Enterprise
guarantee as meeting the Enterprises' risk retention requirement.
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\78\ In this regard, FHFA is engaged in several initiatives to
contract the Enterprises presence in the mortgage markets, including
increasing and changing the structure of the guarantee fees charged
by the Enterprises and requiring the Enterprises to develop risk-
sharing transactions to transfer credit risk to the private sector.
See, e.g., FHFA 2012 Annual Report to Congress, at 7-11 (June 2013),
available at http://www.FHFA.gov (FHFA 2012 Report).
\79\ By its terms, a PSPA with an Enterprise may not be
assigned, transferred, inure to the benefit of, any limited-life,
regulated entity established with respect to the Enterprise without
the prior written consistent of Treasury.
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Accordingly, the agencies are now proposing the same treatment for
the Enterprises as under the original proposal, without modification.
Consistent with the original proposal, if any of the conditions in the
proposed rule cease to apply, the Enterprises or any successor
organization would no longer be able to rely on its guarantee to meet
the risk retention requirement under section 15G of the Exchange Act
and would need to retain risk in accordance with one of the other
applicable sections of this risk retention proposal.
For similar reasons, the restrictions and prohibitions on hedging
and transfers of retained interests in the proposal (like the original
proposal) would not apply to the Enterprises or any successor limited-
life regulated entities, as long as the Enterprise (or, as applicable,
successor entity) is operating consistent with the conditions set out
in the rule. In the past, the Enterprises have sometimes acquired pool
insurance to cover a percentage of losses on the mortgage loans
comprising the pool.\80\ FHFA also has made risk-sharing through a
variety of alternative mechanisms to be a major goal of its Strategic
Plan for the Enterprise Conservatorships.\81\ Because the proposed rule
would require each Enterprise, while in conservatorship or
receivership, to hold 100 percent of the credit risk on mortgage-backed
securities that it issues, the prohibition on hedging in the proposal
related to the credit risk that the retaining sponsor is required to
retain would limit the ability of the Enterprises to require such pool
insurance in the future or take other reasonable actions to limit
losses that would otherwise arise from the Enterprises' 100 percent
exposure to the credit risk of the securities that they issue. Because
the proposal would apply only so long as the relevant Enterprise
operates under the authority and control of FHFA and with capital
support from the United States, the agencies continue to believe that
the proposed treatment of the Enterprises as meeting the risk retention
requirement of section 15G of the Exchange Act should be consistent
with the maintenance of quality underwriting standards, in the public
interest, and consistent with the protection of investors.\82\
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\80\ Typically, insurers would pay the first losses on a pool of
loans, up to 1 or 2 percent of the aggregate unpaid principal
balance of the pool.
\81\ See, e.g., FHFA 2012 Report at 7-11.
\82\ See Original Proposal, 76 FR at 24112.
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As explained in the original proposal and noted above, the agencies
recognize both the need for, and importance of, reform of the
Enterprises, and expect to revisit and, if appropriate, modify the
proposed rule after the future of the Enterprises and of the statutory
and regulatory framework for the Enterprises becomes clearer.
7. Open Market Collateralized Loan Obligations
a. Overview of Original Proposal and Public Comment
In the original proposal, the agencies observed that, in the
context of CLOs, the CLO manager generally acts as the sponsor by
selecting the commercial loans to be purchased by the CLO issuing
entity (the special purpose vehicle that holds the CLO's collateral
assets and issues the CLO's securities) and then manages the
securitized assets once deposited in the CLO structure.\83\
Accordingly, the original proposal required the CLO manager to satisfy
the minimum risk retention requirement for each CLO securitization
transaction that it manages. The original proposal did not include a
form of risk retention designed specifically for CLO securitizations.
Accordingly, CLO managers generally would have been required to satisfy
the minimum risk retention requirement by holding a sufficient amount
of standard risk retention in horizontal, vertical, or L-shaped form.
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\83\ See id. at 24098 n. 42.
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Many commenters, including several participants in CLOs, raised
concerns regarding the impact of the proposal on certain types of CLO
securitizations, particularly CLOs that are securitizations of
commercial loans originated and syndicated by third parties and
selected for purchase on the open market by asset managers unaffiliated
with the originators of the loans (open market CLOs). Some commenters
asserted that most asset management firms currently serving as open
market CLO managers do not have the balance sheet capacity to fund 5
percent horizontal or vertical slices of the CLO. Thus, they argued,
imposing standard risk retention requirements on these managers could
cause independent CLO managers to exit the market or be acquired by
larger firms, thereby limiting the number of participants in the market
and raising barriers to entry. According to these commenters, the
resulting erosion in market competition could increase the cost of
credit for large, non-investment grade companies represented in CLO
portfolios above the level that would be consistent with the credit
quality of these companies.
Certain commenters also asserted that open market CLO managers are
not ``securitizers'' under section 15G of the Exchange Act. These
commenters argued that because the CLO managers themselves would never
legally own, sell, or transfer the loans that comprised the CLO's
collateral pool, but only direct which assets would be purchased by the
CLO issuing entity, they should not be ``securitizers'' as defined in
section 15G. Thus, these commenters argued that the agencies' proposal
to impose a sponsor's risk retention requirement on open market CLO
managers is contrary to the statute.\84\
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\84\ See Part II.A.2 of this Supplementary Information for a
discussion of the definition of ``securitizer'' under section 15G of
the Exchange Act.
---------------------------------------------------------------------------
One commenter argued that CLO underwriters (typically investment
banks) are ``securitizers'' for risk retention purposes and agent banks
of the underlying loans are ``originators.'' This commenter noted that
the CLO underwriter typically finances the accumulation of most of the
initial loan assets until the CLO securities are issued. According to
this commenter, the CLO manager selects the loans, but the CLO
underwriter legally transfers them and takes the market value risk of
the accumulating loan portfolio should the CLO transaction fail to
close. However, other commenters argued that no party within the open
market CLO structure constitutes a ``securitizer'' under section 15G.
These commenters stated that they did not view the underwriter as a
``securitizer'' because it does not select or manage the loans
securitized in a CLO transaction or transfer them to the issuer. These
commenters requested that the agencies establish an exemption from the
risk retention requirement for certain open market CLOs.
In addition to the above comments, a commenter proposed that
subordinated collateral management fees and incentive fees tied to the
internal rate of return received by investors in the CLO's equity
tranche be counted towards the CLO manager's risk retention
requirement, as receipt of these fees is contingent upon the
satisfactory performance of the CLO and
[[Page 57962]]
timely payment of interest to CLO bondholders, thereby aligning the
interest of CLO managers and investors.
b. Proposed Requirement
The agencies have considered the concerns raised by commenters with
respect to the original proposal and CLOs. As explained in the original
proposal, the agencies believe that the CLO manager is a
``securitizer'' under section 15G of the Exchange Act because it
selects the commercial loans to be purchased by the CLO issuing entity
for inclusion in the CLO collateral pool, and then manages the
securitized assets once deposited in the CLO structure. The agencies
believe this is consistent with part (B) of the definition of
securitizer which includes ``a person who organizes and initiates an
asset-backed securities transaction by selling or transferring assets,
either directly or indirectly, including through an affiliate, to the
issuer.'' \85\ The CLO manager typically organizes and initiates the
transaction as it has control over the formation of the CLO collateral
pool, the essential aspect of the securitization transaction. It also
indirectly transfers the underlying assets to the CLO issuing entity
typically by selecting the assets and directing the CLO issuing entity
to purchase and sell those assets.
---------------------------------------------------------------------------
\85\ See 15 U.S.C. 78o-11(a)(3)(B).
---------------------------------------------------------------------------
The agencies believe that reading the definition of ``securitizer''
to include a typical CLO manager or other collateral asset manager that
performs such functions is consistent with the purposes of the statute
and principles of statutory interpretation. The agencies believe that
the text itself supports the interpretation that a CLO manager is a
securitizer because, as explained above, the agencies believe that the
CLO manager organizes and initiates a securitization transaction by
indirectly transferring assets to the issuing entity. However, in the
case that any ambiguity exists regarding the statutory meaning of
``transfer'' and whether or not it means a legal sale or purchase, the
agencies may look to the rest of the statute, including the context,
when interpreting its meaning. Furthermore, as stated by the Supreme
Court, ``a statute should be construed so that effect is given to all
its provisions, so that no part will be inoperative or superfluous,
void or insignificant.'' \86\
---------------------------------------------------------------------------
\86\ See, e.g. Corley v. United States, 556 U.S. 303, 129 S.Ct
1558, 1566, 173 L.Ed.2d 443 (2009).
---------------------------------------------------------------------------
It is clear from the statutory text and legislative history of
section 15G of the Exchange Act that Congress intended for risk
retention to be held by collateral asset managers (such as CLO or CDO
managers), who are the parties who determine the credit risk profile of
securitized assets in many types of securitization transactions and
therefore should be subject to a regulatory incentive to monitor the
quality of the assets they cause to be transferred to an issuing
entity.\87\ Additionally, the agencies believe a narrow reading could
enable market participants to evade the operation of the statute by
employing an agent to select assets to be purchased and securitized.
This could potentially render section 15G of the Exchange Act
practically inoperative for any transaction where this structuring
could be achieved, and would have an adverse impact on competition and
efficiency by permitting market participants to do indirectly what they
are prohibited from doing directly.
---------------------------------------------------------------------------
\87\ S. Rep. No. 111-176 (April 30, 2010).
---------------------------------------------------------------------------
The agencies also recognize that the standard forms of risk
retention in the original proposal could, if applied to open market CLO
managers, result in fewer CLO issuances and less competition in this
sector. The agencies therefore have developed a revised proposal that
is designed to allow meaningful risk retention to be held by a party
that has significant control over the underwriting of assets that are
typically securitized in CLOs, without causing significant disruption
to the CLO market. The agencies' goal in proposing this alternative
risk retention option is to avoid having the general risk retention
requirements create unnecessary barriers to potential open market CLO
managers sponsoring CLO securitizations. The agencies believe that this
alternate risk retention option could benefit commercial borrowers by
making additional credit available in the syndicated loan market.
Under the proposal, an open market CLO would be defined as a CLO
whose assets consist of senior, secured syndicated loans acquired by
such CLO directly from sellers in open market transactions and
servicing assets, and that holds less than 50 percent of its assets by
aggregate outstanding principal amount in loans syndicated by lead
arrangers that are affiliates of the CLO or originated by originators
that are affiliates of the CLO. Accordingly, this definition would not
include CLOs (often referred to as ``balance sheet'' CLOs) where the
CLO obtains a majority of its assets from entities that control or
influence its portfolio selection. Sponsors of balance sheet CLOs,
would be subject to the standard risk retention options in the proposed
rule because the particular considerations for risk retention relevant
to an open market CLO (as discussed above) should not affect sponsors
of balance sheet CLOs in the same manner. Furthermore, as commenters on
the original proposal indicated, sponsors of balance sheet CLOs should
be able to obtain sufficient support to meet any risk retention
requirement from the affiliate that is the originator of the
securitized loans in a balance sheet CLO.
Under the proposal, in addition to the standard options for
vertical or horizontal risk retention, an open market CLO could satisfy
the risk retention requirement if the firm serving as lead arranger for
each loan purchased by the CLO were to retain at the origination of the
syndicated loan at least 5 percent of the face amount of the term loan
tranche purchased by the CLO. The lead arranger would be required to
retain this portion of the loan tranche until the repayment, maturity,
involuntary and unscheduled acceleration, payment default, or
bankruptcy default of the loan. This requirement would apply regardless
of whether the loan tranche was purchased on the primary or secondary
market, or was held at any particular time by an open market CLO
issuing entity.
The sponsor of an open market CLO could presumably negotiate that
the lead arranger of each loan tranche purchased for the CLO portfolio
retain a portion of the relevant loan tranche at origination. However,
the sponsors of open market CLOs have frequently arranged for the
purchase of loans in the secondary market as well as from originators.
For purchases on the secondary market, negotiation of risk retention in
connection with such purchases would likely be impractical.
Accordingly, the proposal contemplates that specific senior, secured
term loan tranches within a broader syndicated credit facility would be
designated as ``CLO-eligible'' at the time of origination if the lead
arranger committed to retain 5 percent of each such CLO-eligible
tranche, beginning on the closing date of the syndicated credit
facility.
A CLO-eligible tranche could be identical in its terms to a tranche
not so designated, and could be sized based on anticipated demand by
open market CLOs. For the life of the facility, loans that are part of
the CLO-eligible tranche could then trade in the secondary market among
both open market CLOs and other investors. The agencies acknowledge
that this approach may result in the retention by loan originators of
risk associated with assets that are no longer held in securitizations,
but have narrowly
[[Page 57963]]
tailored this option to eliminate that result as much as possible.
In order to ensure that a lead arranger retaining risk had a
meaningful level of influence on loan underwriting terms, the lead
arranger would be required to have taken an initial allocation of at
least 20 percent of the face amount of the broader syndicated credit
facility, with no other member of the syndicate assuming a larger
allocation or commitment. Additionally, a retaining lead arranger would
be required to comply with the same sales and hedging restrictions as
sponsors of other securitizations until the repayment, maturity,
involuntary and unscheduled acceleration, payment default, or
bankruptcy default of the loan tranche.
Under the proposal, a lead arranger retaining a ``CLO-eligible''
loan tranche must be identified at the time of the syndication of the
broader credit facility, and legal documents governing the origination
of the syndicated credit facility must include covenants by the lead
arranger with respect to satisfaction of requirements described above.
Voting rights within the broader syndicated credit facility must
also be defined in such a way that holders of the ``CLO-eligible'' loan
tranche had, at a minimum, consent rights with respect to any waivers
and amendments of the legal documents governing the underlying CLO-
eligible loan tranche that can adversely affect the fundamental terms
of that tranche. This is intended to prevent the possible erosion of
the economic terms, maturity, priority of payment, security, voting
provisions or other terms affecting the desirability of the CLO-
eligible loan tranche by subsequent modifications to loan documents.
Additionally, the pro rata provisions, voting provisions and security
associated with the CLO-eligible loan tranche could not be materially
less advantageous to the holders of that tranche than the terms of
other tranches of comparable seniority in the broader syndicated credit
facility.
Under the proposal, the sponsor of an open market CLO could avail
itself of the option for open market CLOs only if: (1) The CLO does not
hold or acquire any assets other than CLO-eligible loan tranches
(discussed above) and servicing assets (as defined in the proposed
rule); (2) the CLO does not invest in ABS interests or credit
derivatives (other than permitted hedges of interest rate or currency
risk); and (3) all purchases of assets by the CLO issuing entity
(directly or through a warehouse facility used to accumulate the loans
prior to the issuance of the CLO's liabilities) are made in open market
transactions. The governing documents of the open market CLO would
require, at all times, that the assets of the open market CLO consist
only of CLO-eligible loan tranches and servicing assets.
The proposed option for open market CLOs is intended to allocate
risk retention to the parties that originate the underlying loans and
that likely exert the greatest influence on how the loans are
underwritten, which is an integral component of ensuring the quality of
assets that are securitized. In developing the proposed risk retention
option for open market CLOs, the agencies have considered the factors
set forth in section 15G(d)(2) of the Exchange Act.\88\ Section 15G
permits the agencies to allow an originator (rather than a sponsor) to
retain the required amount of credit risk and to reduce the amount of
credit risk required of the sponsor by the amount retained by the
originator.\89\
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\88\ 15 U.S.C. 78o-11(d)(2). These factors are whether the
assets sold to the securitizer have terms, conditions, and
characteristics that reflect low credit risk; whether the form or
volume of transactions in securitization markets creates incentives
for imprudent origination of the type of loan or asset to be sold to
the securitizer; and the potential impact of risk retention
obligations on the access of consumers and business to credit on
reasonable terms, which may not include the transfer of credit risk
to a third party.
\89\ See id. at Section 78o-11(c)(G)(iv) and (d) (permitting the
Commission and Federal banking agencies to allow the allocation of
risk retention from a sponsor to an originator).
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The terms of the proposed option for eligible open market CLOs
include conditions designed to provide incentive to lead arrangers to
monitor the underwriting of loans they syndicate that may be sold to an
eligible open market CLO by requiring that lead arrangers retain risk
on these leveraged loans that could be securitized through CLOs. The
agencies believe that this proposed risk retention option for open
market CLOs would meaningfully align the incentives of the party most
involved with the credit quality of these loans--the lead arranger--
with the interests of investors. Alternatively, incentive would be
placed on the CLO manager to monitor the credit quality of loans it
securitizes if it retains risk under the standard risk retention
option.
In response to commenter requests that the agencies recognize
incentive fees as risk retention, the agencies recognize that
management fees incorporate credit risk sensitivity and contribute to
aligning the interests of the CLO manager and investors with respect to
the quality of the securitized loans. However, these fees do not appear
to provide an adequate substitute for risk retention because they
typically have small expected value (estimated as equivalent to a
horizontal tranche of less than 1 percent), especially given that CLOs
securitize leveraged loans, which carry higher risk than many other
securitized assets. Additionally, these fees are not funded in cash at
closing and therefore may not be available to absorb losses as
expected. Generally, the agencies have declined to recognize unfunded
forms of risk retention for purposes of the proposal (such as fees or
guarantees), except in the case of the Enterprises under the conditions
specified with regard to their guarantees.
Under the option for open market CLOs, the sponsor relying on the
option would be required to provide, or cause to be provided, certain
disclosures to potential investors. The sponsor would be required to
disclose this information a reasonable period of time prior to the sale
of the asset-backed securities in the securitization transaction (and
at least annually with respect to information regarding the assets held
by the CLO) and, upon request, to the Commission and its appropriate
Federal banking agency, if any. First, a sponsor relying on the CLO
option would need to disclose a complete list of every asset held by an
open market CLO (or before the CLO's closing, in a warehouse facility
in anticipation of transfer into the CLO at closing). This list would
need to include the following information (i) the full legal name and
Standard Industrial Classification category code of the obligor of the
loan or asset; (ii) the full name of the specific loan tranche held by
the CLO; (iii) the face amount of the loan tranche held by the CLO;
(iv) the price at which the loan tranche was acquired by the CLO; and
(v) for each loan tranche, the full legal name of the lead arranger
subject to the sales and hedging restrictions of Sec. ----.12 of the
proposed rule. Second, the sponsor would need to disclose the full
legal name and form of organization of the CLO manager.
Request for Comment
50(a). Does the proposed CLO risk retention option present a
reasonable allocation of risk retention among the parties that
originate, purchase, and sell assets in a CLO securitization? 50(b).
Are there any changes that should be made in order to better align the
interests of CLO sponsors and CLO investors?
51. Are there technical changes to the proposed CLO option that
would be needed or desirable in order for lead arrangers to be able to
retain the risk as proposed, and for CLO sponsors to be able to rely on
this option?
[[Page 57964]]
52(a). Who should assume responsibility for ensuring that lead
arrangers comply with requirement to retain an interest in CLO-eligible
tranches? 52(b). Would some sort of ongoing reporting or periodic
certification by the lead arranger to holders of the CLO-eligible
tranche be feasible? 52(c). Why or why not?
53(a). The agencies would welcome suggestions for alternate or
additional criteria for identifying lead arrangers. 53(b). Do loan
syndications typically have more than one lead arranger who has
significant influence over the underwriting and documentation of the
loan? 53(c). If so, should the risk retention requirement be permitted
to be shared among more than one lead arranger? 53(d). What practical
difficulties would this present, including for the monitoring of
compliance with the retention requirement? 53(e). How could the rule
assure that each lead arranger's retained interest is significant
enough to influence its underwriting of the loan?
54(a). Is the requirement for the lead arranger to take an initial
allocation of 20 percent of the broader syndicated credit facility
sufficiently large to ensure that the lead arranger can exert a
meaningful level of influence on loan underwriting terms? 54(b). Could
a smaller required allocation accomplish the same purpose?
55(a). The proposal permits lead arrangers to sell or hedge their
retained interest in a CLO-eligible loan tranche if those loans
experience a payment or bankruptcy default or are accelerated. Would
the knowledge that it could sell or hedge a defaulted loan in those
circumstances unduly diminish the lead arranger's incentive to
underwrite and structure the loan prudently at origination? 55(b).
Should the agencies restrict the ability of lead arrangers to sell or
hedge their retained interest under these circumstances? 55(c). Why or
why not?
56(a). Should the lead arranger role for ``CLO-eligible'' loan
tranches be limited to federally supervised lending institutions, which
are subject to regulatory guidance on leveraged lending? 56(b). Why or
why not?
57(a). Should additional qualitative criteria be placed on CLO-
eligible loan tranches to ensure that they have lower credit risk
relative to the broader leveraged loan market? 57(b). What such
criteria would be appropriate?
58(a). Should managers of open market CLOs be required to invest
principal in some minimal percentage of the CLO's first loss piece in
addition to meeting other requirements for open market CLOs proposed
herein? 58(b). Why or why not?
59(a). Is the requirement that all assets (other than servicing
assets) consist of CLO-eligible loan tranches appropriate? 59(b). To
what extent could this requirement impede the ability of a CLO sponsor
to diversify its assets or its ability to rely on this option? 59(c).
Does this requirement present any practical difficulties with reliance
on this option, particularly the ability of CLO sponsors to accumulate
a sufficient number of assets from CLO-eligible loan tranches to meet
this requirement? 59(d). If so, what are they? 59(e). Would it be
appropriate for the agencies to provide a transition period (for
example, two years) after the effective date of the rule to allow some
investment in corporate or other obligations other than CLO-eligible
loan tranches or servicing assets while the market adjusts to the new
standards? 59(f). What transition would be appropriate? 59(g). Would
allowing a relatively high percentage of investment in such other
assets in the early years following the effective date (such as 10
percent), followed by a gradual reduction, facilitate the ability of
the market to utilize the proposed option? 59(h). Why or why not?
59(i). What other transition arrangements might be appropriate?
60(a). Should an open market CLO be allowed permanently to hold
some de minimis percentage of its collateral assets in corporate
obligations other than CLO-eligible loan tranches under the option?
60(b). If so, how much?
61(a). Is the requirement that permitted hedging transactions be
limited to interest rate and currency risks appropriate? 61(b). Are
there other derivative transactions that CLO issuing entities engage in
to hedge particular risks arising from the loans they hold and not as
means of gaining synthetic exposures?
62(a). Is the requirement that the holders of a CLO-eligible loan
tranche have consent rights with respect to any material waivers and
amendments of the underlying legal documents affecting their tranche
appropriate? 62(b). How should waivers and amendments that affect all
tranches (such as waivers of defaults or amendments to covenants) be
treated for this purpose? 62(c). Should holders of CLO-eligible loan
tranches be required to receive special rights with respect those
matters, or are their interests sufficiently aligned with other
lenders?
63. How would the proposed option facilitate (or not facilitate)
the continuance of open market CLO issuances?
64(a). What percentage of currently outstanding CLOs, if any, have
securitized assets that consist entirely of syndicated loans? 64(b).
What percentage of securitized assets of currently outstanding CLOs
consist of syndicated loans?
65(a). Should unfunded portions of revolving credit facilities be
allowed in open market CLO collateral portfolios, subject to some
limit, as is current market practice? 65(b). If yes, what form should
risk retention take? 65(c). Would the retention of 5 percent of an
unfunded revolving commitment to lend (plus 5 percent of any
outstanding funded amounts) provide the originator with incentives
similar to those provided by retention of 5 percent of a funded term
loan? 65(d). Why or why not?
66(a). Would a requirement for the CLO manager to retain risk in
the form of unfunded notes and equity securities, as proposed by an
industry commenter, be a reasonable alternative for the above proposal?
66(b). How would this meet the requirements and purposes of section 15G
of the Exchange Act?
8. Municipal Bond ``Repackaging'' Securitizations
Several commenters on the original proposal requested that the
agencies exempt municipal bond repackagings securitizations from risk
retention requirements, the most common form of which are often
referred to as ``tender option bonds'' (TOBs).\90\ These commenters
argued that these transactions should be exempt from risk retention for
the following reasons:
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\90\ As described by one commenter, a typical TOBs transaction
consists of the deposit of a single issue of highly rated, long-term
municipal bonds in a trust and the issuance by the trust of two
classes of securities: A floating rate, puttable security (the
``floaters''), and an inverse floating rate security (the
``residual''). No tranching is involved. The holders of floaters
have the right, generally on a daily or weekly basis, to put the
floaters for purchase at par, which put right is supported by a
liquidity facility delivered by a highly rated provider and causes
the floaters to be a short-term security. The floaters are in large
part purchased and held by money market mutual funds. The residual
is held by a longer term investor (bank, insurance company, mutual
fund, hedge fund, etc.). The residual investors take all of the
market and structural risk related to the TOBs structure, with the
floaters investors only taking limited, well-defined insolvency and
default risks associated with the underlying municipal bonds, which
risks are equivalent to those associated with investing in such
municipal bonds directly.
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Securities issued by municipal entities are exempt, so
securitizations involving these securities should also be exempt;
Municipal bond repackagings are not the type of
securitizations that prompted Congress to enact section 15G of the
Exchange Act, but rather are
[[Page 57965]]
securitizations caught in the net cast by the broad definition of ABS.
In fact, the underlying collateral of TOBs has very lower credit risk
and is structured to meet the credit quality requirements of Rule 2a-7
under the Investment Company Act of 1940; \91\
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\91\ 17 CFR 270.2a-7.
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Imposing risk retention in the TOBs market would reduce
the liquidity of municipal bonds, which would lead to an increase in
borrowing costs for municipalities and other issuers of municipal
bonds, as well a decrease the short-term investments available for tax-
exempt money market funds; and
TOB programs are financing vehicles that are used because
more traditional forms of securities financing are inefficient in the
municipal securities market; TOB programs are not intended to, and do
not, transfer material investment risk from the securitizer to
investors. The securitizer in a TOB program (whether the TOB program
sponsor or a third-party investor) has ``skin in the game'' by virtue
of (i) the nature of the TOB inverse floater interest it owns, which
represents ownership of the underlying municipal securities and is not
analogous to other types of ABS programs, or (ii) its provision of
liquidity coverage or credit enhancement, or its obligation to
reimburse the provider of liquidity coverage or credit enhancement for
any losses.
Another commenter asserted that TOBs and other types of municipal
repackaging transactions continue to offer an important financing
option for municipal issuers by providing access to a more diverse
investor base, a more liquid market and the potential for lower
interest rates. According to this commenter, if TOBs were subject to
the risk retention requirements of the proposal, the cost of such
financing would increase significantly, sponsor banks would likely
scale back the issuance of TOBs, and as a result the availability of
tax-exempt investments in the market would decrease.
In order to reflect and incorporate the risk retention mechanisms
currently implemented by the market, the agencies are proposing to
provide two additional risk retention options for certain municipal
bond repackagings. The proposed rule closely tracks certain
requirements for these repackagings, outlined in IRS Revenue Procedure
2003-84, that are relevant to risk retention.\92\ Specifically, the re-
proposed rule proposes additional risk retention options for certain
municipal bond repackagings in which:
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\92\ Revenue Procedure 2003-84, 2003-48 I.R.B. 1159.
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Only two classes of securities are issued: A tender option
bond and a residual interest;
The tender option bond qualifies for purchase by money
market funds under Rule 2a-7 under the Investment Company Act of 1940;
The holder of a tender option bond must have the right to
tender such bonds to the issuing entity for purchase at any time upon
no more than 30 days' notice;
The collateral consists solely of servicing assets and
municipal securities as defined in Section 3(a)(29) of the Securities
Exchange Act of 1934 and all of those securities have the same
municipal issuer and the same underlying obligor or source of payment;
Each of the tender option bond, the residual interest and
the underlying municipal security are issued in compliance with the
Internal Revenue Code of 1986, as amended (the ``IRS Code''), such that
the interest payments made on those securities are excludable from the
gross income of the owners;
The issuing entity has a legally binding commitment from a
regulated liquidity provider to provide 100 percent guarantee or
liquidity coverage with respect to all of the issuing entity's
outstanding tender option bonds; \93\ and
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\93\ The agencies received very few comments with respect to the
definition of regulated liquidity provider included in the original
proposal with respect to the proposed ABCP option. The proposed rule
includes the same definition and defines a regulated liquidity
provider as a depository institution (as defined in section 3 of the
Federal Deposit Insurance Act (12 U.S.C. 1813)); a bank holding
company (as defined in 12 U.S.C. 1841) or a subsidiary thereof; a
savings and loan holding company (as defined in 12 U.S.C. 1467a)
provided all or substantially all of the holding company's
activities are permissible for a financial holding company under 12
U.S.C. 1843(k) or a subsidiary thereof; or a foreign bank (or a
subsidiary thereof) whose home country supervisor (as defined in
Sec. 211.21 of the Federal Reserve Board's Regulation K (12 CFR
211.21)) has adopted capital standards consistent with the Capital
Accord of the Basel Committee on Banking Supervision, as amended,
provided the foreign bank is subject to such standards.
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The issuing entity qualifies for monthly closing elections
pursuant to IRS Revenue Procedure 2003-84, as amended or supplemented
from time to time.
An issuing entity that meets these qualifications would be a Qualified
Tender Option Bond Entity.
The sponsor of a Qualified Tender Option Bond Entity may satisfy
its risk retention requirements under section 10 of the proposed rule
if it retains an interest that upon issuance meets the requirements of
an eligible horizontal residual interest but that upon the occurrence
of a ``tender option termination event'' as defined in section 4.01(5)
of IRS Revenue Procedure 2003-84, as amended or supplemented from time
to time, will meet requirements of an eligible vertical interest.\94\
The agencies believe that the proposed requirements for both an
eligible horizontal residual interest and an eligible vertical interest
adequately align the incentives of sponsors and investors.
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\94\ Section 4.01(5) of IRS Revenue Procedure 2003-84 defines a
tender option termination event as: (1) A bankruptcy filing by or
against a tax-exempt bond issuer; (2) a downgrade in the credit-
rating of a tax-exempt bond and a downgrade in the credit rating of
any guarantor of the tax-exempt bond, if applicable, below
investment grade; (3) a payment default on a tax-exempt bond; (4) a
final judicial determination or a final IRS administrative
determination of taxability of a tax-exempt bond for Federal default
on the underlying municipal securities and credit enhancement, where
applicable; (5) a credit rating downgrade below investment grade;
(6) the bankruptcy of the issuer and, when applicable, the credit
enhancer; or (7) the determination that the municipal securities are
taxable.
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The sponsor of a Qualified Tender Option Bond Entity may also
satisfy its risk retention requirements under this Section if it holds
municipal securities from the same issuance of municipal securities
deposited in the Qualified Tender Option Bond Entity, the face value of
which retained municipal securities is equal to 5 percent of the face
value of the municipal securities deposited in the Qualified Tender
Option Bond Entity. The prohibitions on transfer and hedging set forth
in section 12 of the proposed rule would apply to any municipal
securities retained by the sponsor of a Qualified Tender Option Bond
Entity in satisfactions of its risk retention requirements under this
section.
The sponsor of a Qualified Tender Option Bond Entity could also
satisfy its risk retention requirements under subpart B of the proposed
rule using any of the other risk retention options in this proposal,
provided the sponsor meets the requirements of that option.
Request for Comment
67(a). Do each of the additional options proposed with respect to
repackagings of municipal securities accommodate existing market
practice for issuers and sponsors of tender option bonds? 67(b). If
not, are there any technical adjustments that need to be made in order
to accommodate existing market practice?
68(a). Do each of the additional options proposed with respect to
repackagings of municipal securities adequately align the incentives of
sponsors and investors? 68(b). If not, are
[[Page 57966]]
there any additional requirements that should be added in order to
better align those incentives?
9. Premium Capture Cash Reserve Account
a. Overview of Original Proposal and Public Comment
In the original proposal, the agencies were concerned with two
different forms of evasive behavior by sponsors to reduce the
effectiveness of risk retention. First, in the context of horizontal
risk retention, it could have been difficult to measure how much risk a
sponsor was retaining where the risk retention requirement was measured
using the ``par value'' of the transaction. In particular, a first loss
piece could be structured with a face value of 5 percent, but might
have a market value of only cents on the dollar. As the sponsor might
not have to put significant amounts of its own funds at risk to acquire
the horizontal interest, there was concern that the sponsor could
structure around its risk retention requirements and thereby evade a
purpose of section 15G.
Second, in many securitization transactions, particularly those
involving residential and commercial mortgages, conducted prior to the
financial crisis, sponsors sold premium or interest-only tranches in
the issuing entity to investors, as well as more traditional
obligations that paid both principal and interest received on the
underlying assets. By selling premium or interest-only tranches,
sponsors could thereby monetize at the inception of a securitization
transaction the ``excess spread'' that was expected to be generated by
the securitized assets over time and diminish the value, relative to
par value, of the most subordinated credit tranche. By monetizing
excess spread before the performance of the securitized assets could be
observed and unexpected losses realized, sponsors were able to reduce
the impact of any economic interest they may have retained in the
outcome of the transaction and in the credit quality of the assets they
securitized. This created incentives to maximize securitization scale
and complexity, and encouraged unsound underwriting practices.
In order to achieve the goals of risk retention, the original
proposal would have increased the required amount of risk retention by
the amount of proceeds in excess of 95 percent of the par value of ABS
interests, or otherwise required the sponsor to deposit the difference
into a first-loss premium capture cash reserve account. The amount
placed into the premium capture cash reserve account would have been
separate from and in addition to the sponsor's base risk retention
requirement, and would have been used to cover losses on the underlying
assets before such losses were allocated to any other interest or
account. As a likely consequence to those proposed requirements, the
agencies expected that few, if any, securitizations would require the
establishment of a premium capture cash reserve account, as sponsors
would simply adjust by holding more risk retention.
The agencies requested comment on the effectiveness and
appropriateness of the premium capture cash reserve account and sought
input on any alternative methods. Several commenters were supportive of
the concept behind the premium capture cash reserve account to prevent
sponsors from structuring around the risk retention requirement.
However, most commenters generally objected to the premium capture cash
reserve account. Many commenters expressed concern that the premium
capture cash reserve account would prevent sponsors and originators
from recouping the costs of origination and hedging activities, give
sponsors an incentive to earn compensation in the form of fees from the
borrower instead of cash from deal proceeds, and potentially cause the
sponsor to consolidate the entire securitization vehicle for accounting
purposes.
Commenters stated that these potential negative effects would
ultimately make securitizations uneconomical for many sponsors, and
therefore would have a significant adverse impact on the cost and
availability of credit. Some commenters also argued that the premium
capture cash reserve account exceeded the statutory mandate and
legislative intent of the Dodd-Frank Act.
b. Proposed Treatment
After careful consideration of all the comments regarding the
premium capture cash reserve account, and in consideration of the use
of fair value in the measurement of the standard risk retention amount
in the proposed rule (as opposed to the par value measurement in the
original proposal), the agencies have decided not to include a premium
capture cash reserve account provision in the proposed rule. The
agencies still consider it important to ensure that there is meaningful
risk retention and that sponsors cannot effectively negate or reduce
the economic exposure they are required to retain under the proposed
rule. However, the proposal to use fair value to measure the amount of
risk retention should meaningfully mitigate the ability of a sponsor to
evade the risk retention requirement through the use of deal
structures. The agencies also took into consideration the potential
negative unintended consequences the premium capture cash reserve
account might cause for securitizations and lending markets. The
elimination of the premium capture cash reserve account should reduce
the potential for the proposed rule to negatively affect the
availability and cost of credit to consumers and businesses.
Request for Comment
69(a). Should the proposed rule require a sponsor to fund all or
part of its risk retention requirement with own funds, instead of using
proceeds from the sale of ABS interests to investors? 69(b). Would risk
retention be more effective if sponsors had to fund it entirely with
their own funds? 69(c). Why or why not?
70(a). Should the agencies require a higher amount of risk
retention specifically for transaction structures which rely on premium
proceeds, or for assets classes like RMBS and CMBS which have relied
historically on the use of premium proceeds? 70(b). If so, how should
this additional risk requirement be sized in order to ensure risk
retention achieves the right balance of cost versus effectiveness?
C. Allocation to the Originator
1. Overview of Original Proposal and Public Comment
As a general matter, the original proposal was structured so that
the sponsor of a securitization transaction would be solely responsible
for complying with the risk retention requirements established under
section 15G of the Exchange Act and the proposed implementing
regulations, consistent with that statutory provision. However, subject
to a number of considerations, section 15G authorizes the agencies to
allow a sponsor to allocate at least a portion of the credit risk it is
required to retain to the originator(s) of securitized assets.\95\
Accordingly, subject to conditions and restrictions discussed below,
the original proposal would have permitted a sponsor to reduce its
required risk retention obligations in a securitization transaction by
the portion of risk
[[Page 57967]]
retention obligations assumed by the originators of the securitized
assets.
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\95\ As discussed above, 15 U.S.C. 78o-11(a)(4) defines the term
``originator'' as a person who, through the extension of credit or
otherwise, creates a financial asset that collateralizes an asset-
backed security; and who sells an asset directly or indirectly to a
securitizer (i.e., a sponsor or depositor).
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When determining how to allocate the risk retention requirements,
the agencies are directed to consider whether the assets sold to the
sponsor have terms, conditions, and characteristics that reflect low
credit risk; whether the form or volume of the transactions in
securitization markets creates incentives for imprudent origination of
the type of loan or asset to be sold to the sponsor; and the potential
impact of the risk retention obligations on the access of consumers and
businesses to credit on reasonable terms, which may not include the
transfer of credit risk to a third party.\96\
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\96\ 15 U.S.C. 78o-11(d)(2). The agencies note that section
15G(d) appears to contain an erroneous cross-reference.
Specifically, the reference at the beginning of section 15G(d) to
``subsection (c)(1)(E)(iv)'' is read to mean ``subsection
(c)(1)(G)(iv)'', as the former subsection does not pertain to
allocation, while the latter is the subsection that permits the
agencies to provide for the allocation of risk retention obligations
between a securitizer and an originator in the case of a securitizer
that purchases assets from an originator.
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In the original proposal, the agencies proposed a framework that
would have permitted a sponsor of a securitization to allocate a
portion of its risk retention obligation to an originator that
contributed a significant amount of assets to the underlying asset
pool. The agencies endeavored to create appropriate incentives for both
the securitization sponsor and the originator(s) to maintain and
monitor appropriate underwriting standards without creating undue
complexity, which potentially could mislead investors and confound
supervisory efforts to monitor compliance. Importantly, the original
proposal did not require allocation to an originator. Therefore, it did
not raise the types of concerns about credit availability that might
arise if certain originators, such as mortgage brokers or small
community banks (that may experience difficulty obtaining funding to
retain risk positions), were required to fulfill a sponsor's risk
retention requirement.
The allocation to originator option in the original proposal was
designed to work in tandem with the base vertical or horizontal risk
retention options that were set forth in that proposal. The provision
would have made the allocation to originator option available to a
sponsor that held all of the retained interest under the vertical
option or all of the retained interest under the horizontal option, but
would not have made the option available to a sponsor that satisfied
the risk retention requirement by retaining a combination of vertical
and horizontal interests.
Additionally, the original proposal would have permitted a
securitization sponsor to allocate a portion of its risk retention
obligation to any originator of the underlying assets that contributed
at least 20 percent of the underlying assets in the pool. The amount of
the retention interest held by each originator that was allocated
credit risk in accordance with the proposal was required to be at least
20 percent, but not in excess of the percentage of the securitized
assets it originated. The originator would have been required to hold
its allocated share of the risk retention obligation in the same manner
as would have been required of the sponsor, and subject to the same
restrictions on transferring, hedging, and financing the retained
interest. Thus, for example, if the sponsor satisfied its risk
retention requirements by acquiring an eligible horizontal residual
interest, an originator allocated risk would have been required to
acquire a portion of that horizontal first-loss interest, in an amount
not exceeding the percentage of pool assets created by the originator.
The sponsor's risk retention requirements would have been reduced by
the amount allocated to the originator. Finally, the original proposal
would have made the sponsor responsible for any failure of an
originator to abide by the transfer and hedging restrictions included
in the proposed rule.
Several commenters opposed the original proposal on allocation to
originators in its entirety for a variety of reasons. A common reason
stated was that originators would be placed in an unequal bargaining
position with sponsors. Other commenters supported the proposed
provision, but many urged that it be revised. Several commenters stated
that requiring that the originator use the same form of risk retention
as the sponsor should be removed, while one commenter proposed that if
a sponsor desired to allocate a portion of risk retention to an
originator, only the horizontal retention option should be used. Many
commenters stated that the proposed 20 percent origination threshold
required in order for the option to be used was too high. One commenter
urged that an originator that originated more than 50 percent of the
securitized assets be required to retain at least 50 percent of the
required retention. Another commenter suggested that an originator
retaining a portion of the required interest be allocated only a
percentage of the loans it originated, rather than an allocation of the
entire pool, as proposed. The agencies also received comments that the
definition of ``originator'' ought to include parties that purchase
assets from entities that create the assets and that allocation to
originators should be permitted where the L-shaped option or horizontal
cash reserve account option was used as a form of risk retention.
2. Proposed Treatment
The agencies have carefully considered the concerns raised by
commenters with respect to the original proposal on allocation to
originators. The agencies do not believe, however, that a significant
expansion of the allocation to originator option would be appropriate
and that allocation limits on originators are necessary to realize the
agencies' goal of better aligning securitizers' and investors'
interests.
Therefore, the agencies are proposing an allocation to originator
provision that is substantially similar to the provision in the
original proposal. The only modifications to this option would be
technical changes that reflect the proposed flexible standard risk
retention (discussed above in Part III.B.1 of this SUPPLEMENTARY
INFORMATION). The rule, like the original proposal, would require that
an originator to which a portion of the sponsor's risk retention
obligation is allocated acquire and retain ABS interests or eligible
horizontal residual interests in the same manner as would have been
retained by the sponsor. Under the proposed rule, this condition would
require an originator to acquire horizontal and vertical interests in
the securitization transaction in the same proportion as the interests
originally established by the sponsor. This requirement helps to align
the interests of originators and sponsors, as both face the same
likelihood and degree of losses if the collateralized assets begin to
default.
In addition, the proposed rule would permit a sponsor that uses a
horizontal cash reserve account to use this option. Finally, consistent
with the change in the general risk retention from par value to fair
value (discussed above in Part III.B.1 of this Supplementary
Information) in determining the maximum amount of risk retention that
could be allocated to an originator, the current NPR refers to the fair
value, rather than the dollar amount (or corresponding amount in the
foreign currency in which the ABS are issued, as applicable), of the
retained interests.
As explained in the original proposal, by limiting this option to
originators that originate at least 20 percent of the asset pool, the
agencies seek to ensure that the originator retains risk in an amount
significant enough to function as an actual incentive for the
originator
[[Page 57968]]
to monitor the quality of all the assets being securitized (and to
which it would retain some credit risk exposure). In addition, by
restricting originators to holding no more than their proportional
share of the risk retention obligation, the proposal seeks to prevent
sponsors from circumventing the purpose of the risk retention
obligation by transferring an outsized portion of the obligation to an
originator that may have been seeking to acquire a speculative
investment. These requirements are also intended to reduce the
proposal's potential complexity and facilitate investor and regulatory
monitoring.
The re-proposal again requires that an originator hold retained
interests in the same manner as the sponsor. As noted, the proposed
rule provides the sponsor with significant flexibility in determining
the mix of vertical and horizontal interests that it would hold to meet
its risk retention requirement. In addition, unlike the original
proposal, the proposed rule would permit a sponsor that holds a
combination of vertical and horizontal interests to utilize the
allocation to originator option. If originators were permitted to
retain their share of the sponsor's risk retention obligation in a
proportion that is different from the sponsor's mix of the vertical and
horizontal interests, investor and regulatory monitoring could become
very complex.
The re-proposal does not incorporate commenters' suggestion that an
originator be allocated retention in only the loans that it originated.
The operational burden on both securitization sponsors and federal
supervisors to ensure that retention is held by originators on the
correct individual loans would be exceedingly high. Therefore, the
proposal continues to require that originators allocated a portion of
the risk retention requirement be allocated a share of the entire
securitization pool.
The agencies are not proposing a definition of originator modified
from the original proposal and are not proposing to include persons
that acquire loans and transfer them to a sponsor. The agencies
continue to believe that the definition of the term originator in
section 15G \97\ does not provide the agencies with flexibility to make
this change. This definition limits an originator to a person that
``through the extension of credit or otherwise, creates a financial
asset.'' A person that acquires an asset created by another person
would not be the ``creator'' of such asset.
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\97\ 15 U.S.C. 78o-11(a)(4).
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The agencies are not proposing to eliminate the allocation to
originator provision, as some commenters suggested. Although the
agencies are sensitive to concerns that smaller originators might be
forced to accept allocations from sponsors due to unequal bargaining
power, the 20 percent threshold would make the allocation option
available only for entities whose assets form a significant portion of
a pool and who, thus, ordinarily could be expected to have some
bargaining power with a sponsor.
Finally, the agencies do not believe that it is necessary, as some
commenters suggested, to require retention by a non-sponsor originator
which provides more than half of the securitized asset pool. In most
circumstances, such an originator would be a sponsor. In any
circumstance where such an originator was not the sponsor, the agencies
believe that risk retention goals would be adequately served by
retention by the sponsor, if allocation to the originator did not
otherwise occur.
Request for Comment
71(a). If originators were allocated risk only as to the loans they
originate, would it be operationally feasible to allocate losses on a
loan-by-loan basis? 71(b). What would be the degree of burden to
implement such a system and accurately track and allocate losses?
D. Hedging, Transfer, and Financing Restrictions
1. Overview of the Original Proposal and Public Comment
Section 15G(c)(1)(A) provides that the risk retention regulations
prescribed shall prohibit a securitizer from directly or indirectly
hedging or otherwise transferring the credit risk that the securitizer
is required to retain with respect to an asset. Consistent with this
statutory directive, the original proposal prohibited a sponsor from
transferring any interest or assets that it was required to retain
under the rule to any person other than an affiliate whose financial
statements are consolidated with those of the sponsor (a consolidated
affiliate). An issuing entity, however, would not be deemed a
consolidated affiliate of the sponsor for the securitization even if
its financial statements were consolidated with those of the sponsor
under applicable accounting standards.
In addition to the transfer restrictions, the original proposal
prohibited a sponsor or any consolidated affiliate from hedging the
credit risk the sponsor was required to retain under the rule. However,
hedge positions that are not materially related to the credit risk of
the particular ABS interests or exposures required to be retained by
the sponsor or its affiliate would not have been prohibited under the
original proposal. The original proposal also prohibited a sponsor and
a consolidated affiliate from pledging as collateral for any obligation
any interest or asset that the sponsor was required to retain unless
the obligation was with full recourse to the sponsor or consolidated
affiliate.
Commenters generally expressed support for the proposed
restrictions in the original proposal as they felt that the
restrictions were appropriately structured. However, several commenters
recommended that sponsors only be required to maintain a fixed
percentage of exposure to a securitization over time rather than a
fixed amount of exposure. Some commenters also recommended that the
transfer restriction be modified so that not only could sponsors
transfer retained interests or assets to consolidated affiliates, but
consolidated affiliates could hold the risk retention initially as
well.
2. Proposed Treatment
The agencies have carefully considered the comments received with
respect to the original proposal's hedging, transfer, and financing
restrictions, and the agencies do not believe that any significant
changes to these restrictions would be appropriate (other than the
exemptions provided for CMBS and duration of the hedging and transfer
restrictions, as described in Part IV.F of this Supplementary
Information).
The agencies are, however, proposing changes in connection with the
consolidated affiliate treatment. As noted above, the ``consolidated
affiliate'' definition would be operative in two respects. First, the
original proposal would have permitted transfers of the risk retention
interest to a consolidated affiliate. The agencies proposed this
treatment under the rationale that financial losses are shared equally
within a group of consolidated entities; therefore, a sponsor would not
``avoid'' losses by transferring the required risk retention asset to
an affiliate. Upon further consideration, the agencies are concerned
that, under current accounting standards, consolidation of an entity
can occur under circumstances in which a significant portion of the
economic losses of one entity will not, in economic terms, be suffered
by its consolidated affiliate.
To avoid this outcome, the current proposal introduces the concept
of a
[[Page 57969]]
``majority-owned affiliate,'' which would be defined under the proposal
as an entity that, directly or indirectly, majority controls, is
majority controlled by, or is under common majority control with,
another entity For purposes of this definition, majority control would
mean ownership of more than 50 percent of the equity of an entity or
ownership of any other controlling financial interest in the entity (as
determined under GAAP). The agencies are also, in response to
commenters, revising the proposal to allow risk retention to be
retained as an initial matter by a majority-owned affiliate; in other
words, it would not be necessary for the sponsor to go through the
steps of holding the required retention interest for a moment in time
before moving it to the affiliate.
Second, the original proposal prohibited a consolidated affiliate
of the sponsor from hedging a risk retention interest required to be
retained under the rule. Again, the rationale was that the sponsor's
consolidated affiliate would obtain the benefits of the hedging
transaction and they would offset any losses sustained by the sponsor.
In the current proposal, the agencies are eliminating the concept of
the ``consolidated'' affiliate and instead applying the hedging
prohibition to any affiliate of the sponsor.
In all other respects, the agencies are again proposing the same
hedging, transfer, and financing restrictions as under the original
proposal, without modification. The proposal would prohibit a sponsor
or any affiliate from hedging the credit risk the sponsor is required
to retain under the rule or from purchasing or selling a security or
other financial instrument, or entering into an agreement (including an
insurance contract), derivative or other position, with any other
person if: (i) Payments on the security or other financial instrument
or under the agreement, derivative, or position are materially related
to the credit risk of one or more particular ABS interests that the
retaining sponsor is required to retain, or one or more of the
particular securitized assets that collateralize the asset-backed
securities; and (ii) the security, instrument, agreement, derivative,
or position in any way reduces or limits the financial exposure of the
sponsor to the credit risk of one or more of the particular ABS
interests or one or more of the particular securitized assets that
collateralize the asset-backed securities.
Similar to the original proposal, under the proposed rule holding a
security tied to the return of an index (such as the subprime ABX.HE
index) would not be considered a prohibited hedge by the retaining
sponsor so long as: (1) Any class of ABS interests in the issuing
entity that were issued in connection with the securitization
transaction and that are included in the index represented no more than
10 percent of the dollar-weighted average of all instruments included
in the index, and (2) all classes of ABS interests in all issuing
entities that were issued in connection with any securitization
transaction in which the sponsor was required to retain an interest
pursuant to the proposal and that are included in the index represent,
in the aggregate, no more than 20 percent of the dollar-weighted
average of all instruments included in the index.
Such positions would include hedges related to overall market
movements, such as movements of market interest rates (but not the
specific interest rate risk, also known as spread risk, associated with
the ABS interest that is otherwise considered part of the credit risk),
currency exchange rates, home prices, or of the overall value of a
particular broad category of asset-backed securities. Likewise, hedges
tied to securities that are backed by similar assets originated and
securitized by other sponsors, also would not be prohibited. On the
other hand, a security, instrument, derivative or contract generally
would be ``materially related'' to the particular interests or assets
that the sponsor is required to retain if the security, instrument,
derivative or contract refers to those particular interests or assets
or requires payment in circumstances where there is or could reasonably
be expected to be a loss due to the credit risk of such interests or
assets (e.g., a credit default swap for which the particular interest
or asset is the reference asset).
Consistent with the original proposal, the proposed rule would
prohibit a sponsor and any affiliate from pledging as collateral for
any obligation (including a loan, repurchase agreement, or other
financing transaction) any ABS interest that the sponsor is required to
retain unless the obligation is with full recourse to the sponsor or a
pledging affiliate (as applicable). Because the lender of a loan that
is not with full recourse to the borrower has limited rights against
the borrower on default, and may rely more heavily on the collateral
pledged (rather than the borrower's assets generally) for repayment, a
limited recourse financing supported by a sponsor's risk retention
interest may transfer some of the risk of the retained interest to the
lender during the term of the loan. If the sponsor or affiliate pledged
the interest or asset to support recourse financing and subsequently
allowed (whether by consent, pursuant to the exercise of remedies by
the counterparty or otherwise) the interest or asset to be taken by the
counterparty to the financing transaction, the sponsor will have
violated the prohibition on transfer.
Similar to the original proposal, the proposed rule would not
prohibit an issuing entity from engaging in hedging activities itself
when such activities would be for the benefit of all investors in the
asset-backed securities. However, any credit protection by or hedging
protection obtained by an issuing entity could not cover any ABS
interest or asset that the sponsor is required to retain under the
proposed rule. For example, if the sponsor retained a 5 percent
eligible vertical interest, an issuing entity may purchase (or benefit
from) a credit insurance wrap that covers up to 95 percent of the
tranches, but not the 5 percent of such tranches required to be
retained by the sponsor.
Request for Comment
72(a). Is the scope of the proposed restriction relating to
majority-owned affiliates, and affiliates generally, appropriate to
prevent sponsors from avoiding losses arising from a risk retention
asset? 72(b). Should the agencies, instead of the majority-owned
affiliate approach, increase the 50 percent ownership requirement to a
100 percent ownership threshold under a wholly-owned approach?
IV. General Exemptions
Section 15G(c)(1)(G) and section 15G(e) of the Exchange Act require
the agencies to provide a total or partial exemption from the risk
retention requirements for certain types of ABS or securitization
transactions.\98\ In addition, section 15G(e)(1) permits the agencies
jointly to adopt or issue additional exemptions, exceptions, or
adjustments to the risk retention requirements of the rules, including
exemptions, exceptions, or adjustments for classes of institutions or
assets, if the exemption, exception, or adjustment would: (A) Help
ensure high quality underwriting standards for the securitizers and
originators of assets that are securitized or available for
securitization; and (B) encourage appropriate risk management practices
by the securitizers and originators of assets, improve the access of
consumers and businesses to credit on reasonable terms, or otherwise be
in the public
[[Page 57970]]
interest and for the protection of investors.
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\98\ 15 U.S.C. 78o-11(c)(1)(G) and (e).
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Consistent with these provisions, the original proposal would have
exempted certain types of ABS or securitization transactions from the
credit risk retention requirements of the rule, each as discussed
below, along with the comments and the new or revised proposals of the
proposed rule.
A. Exemption for Federally Insured or Guaranteed Residential,
Multifamily, and Health Care Mortgage Loan Assets
The original proposal would have implemented section 15G(e)(3)(B)
of the Exchange Act by exempting from the risk retention requirements
any securitization transaction that is collateralized solely by
residential, multifamily, or health care facility mortgage loan assets
if the assets are insured or guaranteed as to the payment of principal
and interest by the United States or an agency of the United
States.\99\ Also, the original proposal would have exempted any
securitization transaction that involves the issuance of ABS if the ABS
are insured or guaranteed as to the payment of principal and interest
by the United States or an agency of the United States and that are
collateralized solely by residential, multifamily, or health care
facility mortgage loan assets, or interests in such assets.
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\99\ Id. at section 78o-11(e)(3)(B).
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Commenters on the original proposal generally believed the agencies
had appropriately proposed to implement this statutory exemption from
the risk retention requirement. Some commenters remarked that the broad
exemptions granted to government institutions and programs, which are
unrelated to prudent underwriting, are another reason that transactions
securitizing loans with private mortgage insurance should be exempted
because, without including private mortgage insurance, the rule may
encourage excessive reliance on such exemption and undermine the
effectiveness of risk retention.
Commenters also generally believed that the agencies were correct
in believing the federal department or agency issuing, insuring or
guaranteeing the ABS or collateral would monitor the quality of the
assets securitized. One commenter noted that, in its experience,
federal programs are sufficiently monitored to ensure the safety and
consistency of the securitization and public interest. One commenter
said that it would seem that any U.S. guarantee or insurance program
should be exempt if it provides at least the same amount of coverage as
the risk retention requirement, and another commenter said that the
exemption should be broad enough to cover all federal insurance and
guarantee programs. One commenter noted that the exemption seemed to
prevent the mixing of U.S. direct obligations and U.S. insured or
guaranteed obligations because the proposed rule would only allow an
exemption for transactions collateralized either solely by U.S. direct
obligations or solely by assets that are fully insured or guaranteed as
to the payment of principal and interest by the U.S. Certain commenters
urged the agencies to extend the government-backed exemptions to ABS
backed by foreign governments, similar to the European Union's risk
retention regime which includes a general exemption for transactions
backed by ``central government'' claims without restriction.
Several commenters urged the agencies to revise the government
institutions and programs exemption to include an exemption for
securitizations consisting of student loans made under the Federal
Family Education Loan Program (``FFELP''). In particular, these
commenters believe an exemption is warranted because FFELP loans have a
U.S.-backed guarantee on 97 percent to 100 percent of defaulted
principal and interest under the FFELP guarantee programs administered
by the Department of Education. These commenters noted that FFELP loans
benefit from a higher level of federal government support than Veterans
Administration loans (25 percent to 50 percent) and Department of
Agriculture Rural Development loans (up to 90 percent). These
commenters also noted that risk retention would have no effect on the
underwriting standards since these loans have been funded already and
the program is no longer underwriting new loans. A securitizer of
student loans also noted that the Department of Education set the
standards by which FFELP loans were originated and serviced. Some
commenters said that, if the agencies do not entirely exclude FFELP
loan securitizations from the risk retention requirement, at a minimum
the agencies should only require risk retention on the non-FFELP
portion of the ABS portfolio.\100\
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\100\ One commenter requested an exemption for the sponsor of
short-term notes issued by Straight-A Funding, LLC. As Straight-A
Funding, LLC will not have ABS interests outstanding after January
19, 2014, such an exemption is not necessary.
---------------------------------------------------------------------------
Two commenters on the original proposal urged the agencies to
include an exemption for ABS collateralized by any credit instrument
extended under the federal guarantee program for bonds and notes issued
for eligible community or economic development purposes established
under the Community Development Financial Institutions (``CDFI'') bond
program. Therefore, because credit risk retention was addressed and
tailored specifically for the CDFI program, it was this commenter's
view that the CDFI program transactions were designed to be exempt from
the final credit risk retention requirements of section 15G of the
Exchange Act in accordance with section 94l(b) of the Dodd-Frank Act.
The agencies are again proposing, without changes from the original
proposal, the exemption from the risk retention requirements for any
securitization transaction that is collateralized solely by
residential, multifamily, or health care facility mortgage loan assets
if the assets are insured or guaranteed in whole or in part as to the
payment of principal and interest by the United States or an agency of
the United States. The agencies are also proposing, without changes
from the original proposal, the exemption from the risk retention
requirements for any securitization transaction that involves the
issuance of ABS if the ABS are insured or guaranteed as to the payment
of principal and interest by the United States or an agency of the
United States and that are collateralized solely by residential,
multifamily, or health care facility mortgage loan assets, or interests
in such assets.
In addition, taking into consideration comments received on the
original proposal, the agencies are proposing a separate provision for
securitization transactions that are collateralized by FFELP loans.
Under the proposed rule, a securitization transaction that is
collateralized (excluding servicing assets) solely by FFELP loans that
are guaranteed as to 100 percent of defaulted principal and accrued
interest (i.e., FFELP loans with first disbursement prior to October
1993 or pursuant to certain limited circumstances where a full
guarantee was required) would be exempt from the risk retention
requirements. A securitization transaction that is collateralized
solely (excluding servicing assets) by FFELP loans that are guaranteed
as to at least 98 percent of defaulted principal and accrued interest
would have its risk retention requirement reduced to 2 percent.\101\
This means that if the lowest guaranteed
[[Page 57971]]
amount for any FFELP loan in the pool is 98 percent (i.e., a FFELP loan
with first disbursement between October 1993 and June 2006), the risk
retention requirement for the entire transaction would be 2 percent.
Similarly, under the proposed rule, a securitization transaction that
is collateralized solely (excluding servicing assets) by FFELP loans
that are guaranteed as to at least 97 percent of defaulted principal
and accrued interest (in other words, all other securitizations
collateralized solely by FFELP loans) would have its risk retention
requirement reduced to 3 percent. Accordingly, if the lowest guaranteed
amount for any FFELP loan in the pool is 97 percent (i.e., a FFELP loan
with first disbursement of July 2006 or later), the risk retention
requirement for the entire transaction would be 3 percent.
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\101\ The definition of ``servicing assets'' is discussed in
Part II.B of this SUPPLEMENTARY INFORMATION.
---------------------------------------------------------------------------
The agencies believe this reduction in the risk retention
requirement is appropriate because FFELP loans have a guarantee on 97
percent to 100 percent of defaulted principal and interest under the
FFELP guarantee programs backed by the U.S. Department of Education.
Further, fairly extensive post-default servicing must be properly
performed under FFELP rules as a prerequisite to guarantee payment.
Sponsors would therefore be encouraged to select assets for
securitization with high quality underwriting standards. Furthermore,
appropriate risk management practices would be encouraged as such
proper post-default servicing will be required to restore the loan to
payment status or successfully collect upon the guarantee.
The agencies generally are not proposing to expand general
exemptions from risk retention for other types of assets, as described
in commenters' requests above. The agencies are not creating an
exemption for short-term promissory notes issued by the Straight-A
Funding program. The agencies do not believe such an exemption is
appropriate because of the termination of the FFELP program and the
presence in the market of other sources of funding for student lending.
Additionally, the agencies are not proposing to exempt securitization
transactions that employ a mix of government-guaranteed and direct
government obligations from risk retention requirements, because the
agencies have not found evidence that such securitization transactions
currently exist in the market and the agencies have concerns about the
development of such transactions for regulatory arbitrage purposes.
The agencies are not proposing an exemption from risk retention for
securitizations of assets issued, guaranteed or insured by foreign
government entities. The agencies do not believe it would be
appropriate to exempt such transactions from risk retention if they
were offered in the United States to U.S. investors.
Finally, the agencies are not proposing an exemption for the CDFI
program, because the agencies do not believe such an exemption is
necessary. It does not appear that CDFI program bonds are ABS. Although
the proceeds of the bonds flow to CDFIs for use in funding community
development lending, and the community development loans are ultimately
the source of repayment on the bond, they do not collateralize the
bonds. Furthermore, even if the bonds were ABS, the bonds are fully
guaranteed by the U.S. government and therefore would qualify for other
exemptions from risk retention contemplated by section 15G of the
Exchange Act, discussed below.
B. Exemption for Securitizations of Assets Issued, Insured, or
Guaranteed by the United States or Any Agency of the United States and
Other Exemptions
Section 15G(c)(1)(G)(ii) of the Exchange Act requires that the
agencies, in implementing risk retention regulations, provide for a
total or partial exemption from risk retention for securitizations of
assets that are issued or guaranteed by the United States or an agency
of the United States, as the agencies jointly determine appropriate in
the public interest and the protection of investors.\102\ The original
proposal would have contained full exemptions from risk retention for
any securitization transaction if the ABS issued in the transaction
were (1) collateralized solely (excluding cash and cash equivalents) by
obligations issued by the United States or an agency of the United
States; (2) collateralized solely (excluding cash and cash equivalents)
by assets that are fully insured or guaranteed as to the payment of
principal and interest by the United States or an agency of the United
States (other than residential, multifamily, or health care facility
mortgage loan securitizations discussed above); or (3) fully guaranteed
as to the timely payment of principal and interest by the United States
or any agency of the United States.
---------------------------------------------------------------------------
\102\ Id. at 78o-11(c)(1)(G).
---------------------------------------------------------------------------
Consistent with section 15G(e)(3)(A) of the Exchange Act, the
original proposal also would have provided an exemption from risk
retention for any securitization transaction that is collateralized
solely (excluding cash and cash equivalents) by loans or other assets
made, insured, guaranteed, or purchased by any institution that is
subject to the supervision of the Farm Credit Administration, including
the Federal Agricultural Mortgage Corporation.\103\ Additionally, the
original proposal provided an exemption from risk retention, consistent
with section 15G(c)(1)(G)(iii) of the Exchange Act,\104\ for securities
(1) issued or guaranteed by any state of the United States, or by any
political subdivision of a state or territory, or by any public
instrumentality of a state or territory that is exempt from the
registration requirements of the Securities Act by reason of section
3(a)(2) of the Securities Act or (2) defined as a qualified scholarship
funding bond in section 150(d)(2) of the Internal Revenue Code of 1986.
---------------------------------------------------------------------------
\103\ Id. at 78o-11(e)(3)(A).
\104\ Id. at 78o-11(c)(1)(G)(iii).
---------------------------------------------------------------------------
Commenters on the original proposal generally believed that the
proposed exemptions would appropriately implement the relevant
provisions of the Exchange Act. Two commenters requested that the final
rule clarify that this exemption extends to securities issued on a
federally taxable as well as on a federal tax-exempt basis. Similarly,
another commenter requested that the agencies make it clear that, in
order to satisfy the qualified scholarship funding bond exemption, it
is sufficient that the issuer be the type of entity described in the
definition of qualified scholarship funding bond. One commenter did not
support the broad exemption for municipal and government entities
because it believed the exemption would provide an unfair advantage to
public mortgage insurance that is not otherwise available to private
mortgage insurance. Three commenters requested that the municipal
exemption be broadened to include special purpose entities created by
municipal entities because such special purpose entities are fully
accountable to the public and are generally created to accomplish
purposes consistent with the mission of the municipal entity.
Another commenter said that the exemption should be broadened to
cover securities issued by entities on behalf of municipal sponsors
because the Commission has historically, through no-action letters,
deemed such securities to be exempt under section 3(a)(2) of the
Securities Act. This commenter also asked that the final rule or
adopting release clarify that any ``separate security'' under Rule 131
under the Securities Act would also be exempt under the risk retention
rule.
[[Page 57972]]
One commenter stated that an exemption was appropriate in this
circumstance because state and municipal issuers are required by state
constitutions to carry out a ``public purpose,'' which excludes a
profit motive.
Several commenters recommended the agencies broaden the exemption
so that all state agency and nonprofit student lenders (regardless of
section 150(d) qualification) would be exempt from the rule. In
general, these commenters stated that an exemption would be appropriate
because requiring risk retention by these entities would be unnecessary
and will cause them financial distress, thus impairing their ability to
carry out their public-interest mission. One commenter said that the
original proposal would make an erroneous distinction between nonprofit
lenders that use section 150(d) and those who do not because both types
of nonprofit student lenders offer the same level of retained risk.
Also, the group noted that nonprofit and state agency student lenders
are chartered to perform a specific public purpose--to provide
financing to prospective students who want to enroll in higher
education institutions. However, one commenter did not support a broad
exemption for nonprofit student lenders because there did not appear to
be anything inherent in a nonprofit structure that would protect
investors in securitizations. Further, this commenter noted that there
have been nonprofit private education lenders whose business model
differs little from for-profit lenders.
After considering the comments received, the agencies are again
proposing the exemptions under section 15G(c)(1)(G)(ii) of the Exchange
Act without substantive modifications from the original proposal. The
agencies believe that broadening the scope of the exemption to cover
private entities that are affiliated with municipal entities, but that
are not themselves municipal entities, would go beyond the statutory
scope of section 15G(c)(1)(G)(iii) of the Exchange Act. Similarly, the
agencies are not expanding the originally proposed exemptions to cover
nonprofit student loan lenders. The agencies believe that nonprofit
student loan lending differs little from for-profit student loan
lending and that there does not appear to be anything inherent in the
underwriting practices of nonprofit student loan lending to suggest
that these securitizations align interests of securitizers with
interests of investors so that an exemption would be appropriate under
section 15G(c)(1)(G) or section 15G(e) of the Exchange Act.
C. Exemption for Certain Resecuritization Transactions
Under the original proposal, certain ABS issued in resecuritization
transactions \105\ (resecuritization ABS) would have been exempted from
the credit risk retention requirements if they met two conditions.
First, the transaction had to be collateralized solely by existing ABS
issued in a securitization transaction for which credit risk was
retained as required under the original proposal, or which was
otherwise exempted from credit risk retention requirements (compliant
ABS). Second, the transaction had to be structured so that it involved
the issuance of only a single class of ABS interests and provided for a
pass through of all principal and interest payments received on the
underlying ABS (net of expenses of the issuing entity) to the holders
of such class of ABS. Because the holder of a resecuritization ABS
structured as a single-class pass-through security would have a
fractional undivided interest in the pool of underlying ABS and in the
distributions of principal and interest (including prepayments) from
these underlying ABS, the agencies reasoned that a resecuritization ABS
meeting these requirements would not alter the level or allocation of
credit and interest rate risk on the underlying ABS.
---------------------------------------------------------------------------
\105\ In a resecuritization transaction, the asset pool
underlying the ABS issued in the transaction comprises one or more
asset-backed securities.
---------------------------------------------------------------------------
In the original proposal, the agencies proposed to adopt this
exemption under the general exemption provisions of section 15G(e)(1)
of the Exchange Act.\106\ The agencies noted that a resecuritization
transaction that created a single-class pass-through would neither
increase nor reallocate the credit risk inherent in that underlying
compliant ABS, and that the transaction could allow for the combination
of ABS backed by smaller pools, and the creation of ABS that may be
backed by more geographically diverse pools than those that can be
achieved by the pooling of individual assets. As a result, the
exemption for this type of resecuritization could improve the access of
consumers and businesses to credit on reasonable terms.\107\
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\106\ As discussed above in Part IV of this SUPPLEMENTARY
INFORMATION, the agencies may jointly adopt or issue exemptions,
exceptions, or adjustments to the risk retention rules, if such
exemption, exception, or adjustment would: (A) Help ensure high
quality underwriting standards for the securitizers and originators
of assets that are securitized or available for securitization; and
(B) encourage appropriate risk management practices by the
securitizers and originators of assets, improve the access of
consumers and businesses to credit on reasonable terms, or otherwise
be in the public interest and for the protection of investors. 15
U.S.C. 78o-11(e)(1).
\107\ See Original Proposal, 76 FR at 24138.
---------------------------------------------------------------------------
Under the original proposal, sponsors of resecuritizations that
were not structured purely as single-class pass-through transactions
would have been required to meet the credit risk retention requirements
with respect to such resecuritizations unless another exemption for the
resecuritization was available. Thus, the originally proposed rule
would subject resecuritizations to separate risk retention requirements
that separate the credit or pre-payment risk of the underlying ABS into
new tranches.\108\
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\108\ For example, under the proposed rules, the sponsor of a
CDO would not meet the proposed conditions of the exemption and
therefore would be required to retain risk in accordance with the
rule with respect to the CDO, regardless of whether the underlying
ABS have been drawn exclusively from compliant ABS. See 15 U.S.C.
78o-11(c)(1)(F). In a typical CDO transaction, a securitizer pools
interests in the mezzanine tranches from many existing ABS and uses
that pool to collateralize the CDO. Repayments of principal on the
underlying ABS interests are allocated so as to create a senior
tranche, as well as supporting mezzanine and equity tranches of
increasing credit risk. Specifically, as periodic principal payments
on the underlying ABS are received, they are distributed first to
the senior tranche of the CDO and then to the mezzanine and equity
tranches in order of increasing credit risk, with any shortfalls
being borne by the most subordinate tranche then outstanding.
Similarly, with regard to ABS structured to protect against pre-
payment risk or that are structured to achieve sequential paydown of
tranches, the agencies reasoned that although losses on the
underlying ABS would be allocated to holders in the resecuritization
on a pro rata basis, holders of longer duration classes in the
resecuritization could be exposed to a higher level of credit risk
than holders of shorter duration classes. See Original Proposal, 76
FR at 24138 n.193.
---------------------------------------------------------------------------
The agencies received a number of comments on the resecuritization
exemption in the original proposal, principally but not exclusively
from financial entities and financial trade organizations. The
commenters, including investor members of one trade organization,
generally favored expanding the resecuritization exemption and allowing
greater flexibility in these transactions, although individual
commenters differed in how broad a new exemption should be. Further,
while many commenters generally supported the first criterion for the
proposed exemption that the ABS used in the resecuritization must be
compliant with, or exempt from, the risk retention rules, they did not
support the second criterion that only a single class pass-through be
issued in the resecuritization transaction for the proposed exemption
to apply. In particular, they did not believe that this condition would
[[Page 57973]]
further the goal of improving underwriting of the underlying assets,
although they believed that it would unnecessarily restrict a source of
liquidity in the market place.
A few commenters asserted that applying risk retention to
resecuritization of ABS that are already in the market place, whether
or not the interests are compliant ABS, cannot alter the incentives for
the original ABS sponsor to create high-quality assets. Some commenters
also stated that resecuritizations allowed the creation of specific
tranches of ABS interests, such as planned asset class securities, or
principal or interest only strips, that are structured to meet specific
demands of investors, so that subjecting such transactions to
additional risk retention (possibly discouraging the issuance of such
securities) could prevent markets from efficiently fulfilling investor
needs. Commenters also noted that resecuritization transactions allow
investors to sell ABS interests that they may no longer want by
creating assets that are more highly valued by other investors, thereby
improving the liquidity of these assets. Another commenter advised that
the rule should encourage resecuritizations that provided additional
collateral or enhancements such as insurance policies for the
resecuritization ABS. Another commenter noted that resecuritizations of
mortgage backed securities were an important technical factor in the
recent run up in prices and that requiring additional risk retention
would chill the market unnecessarily.
Some comments suggested that the agencies should expand the
exemption to some common types of resecuritizations, but not apply it
to CDOs. To distinguish which should be subject to the exemption,
commenters suggested not extending the exemption to transactions with
managed pools of collateral, or limiting the types or classes of ABS
that could be resecuritized, and the derivatives an issuing entity
could use. A few commenters specifically stated that the
resecuritization exemption should be extended to include sequential pay
resecuritizations or resecuritizations structured to address prepayment
risk, if they were collateralized by compliant ABS. Another commenter
recommended that the exemption include any tranched resecuritizations
(such as typical collateralized mortgage obligations) of ABS issued or
guaranteed by the U.S. government, the Government National Mortgage
Associations or the Enterprises, as these instruments were an important
source of liquidity for the underlying assets.
Finally, one commenter requested clarification as to whether the
resecuritizations of Enterprise ABS, guaranteed by the Enterprises,
would be covered by the provision for Enterprises in the original
proposal. The agencies are clarifying that to the extent the
Enterprises act as sponsor for a resecuritization of their ABS, fully
guarantee the resulting securities as to principal and interest, and
meet the other conditions the agencies are again proposing, that
provision would apply to the Enterprise securitization
transaction.\109\
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\109\ See proposed rule at Sec. ----.8. The wording of the
provision as proposed is not limited to just initial Enterprise-
sponsored securitization transactions but would also apply to ABS
created by Enterprise-sponsored resecuritizations, as long as all
the proposed conditions are met.
---------------------------------------------------------------------------
The agencies continue to believe that the resecuritization
exemption from the original proposal is appropriate for the reasons
discussed in that proposal, and above. Accordingly, the agencies are
again proposing this provision without substantive change.
Additionally, the agencies have carefully considered comments asking
for expansion of the resecuritization exemption. In this respect, the
agencies have considered that sponsors of resecuritization transactions
would have considerable flexibility in choosing what ABS interests to
include in an underlying pool as well as in creating the specific
structures. This choice of securities is essentially the underwriting
of those securities for selection in the underlying pool. The agencies
consider it appropriate, therefore, to propose rules that would provide
sponsors with sufficient incentive to choose ABS that have lower levels
of credit risk and to not use a resecuritization to obscure what might
have been sub-par credit performance of certain ABS. It is also
appropriate to apply the risk retention requirements in
resecuritization transactions because resecuritization transactions can
result in re-allocating the credit risk of the underlying ABS interest.
Taking into account these considerations, the agencies believe that
requiring additional risk retention as the standard for most
resecuritization transactions is consistent with the intent of section
15G of the Exchange Act, both in light of recent history and the
specific statutory requirement that the agencies adopt risk retention
standards for CDOs, and similar instruments collateralized by ABS.\110\
---------------------------------------------------------------------------
\110\ See 15 U.S.C. 78o-11(c)(1)(F).
---------------------------------------------------------------------------
The agencies note that to qualify for the proposed resecuritization
exemptions, the ABS that are resecuritized would have to be compliant
ABS. As the agencies noted in the original proposal, section 15G of the
Exchange Act would not apply to ABS issued before the effective date of
the agencies' final rules,\111\ and that as a practical matter,
private-label ABS issued before the effective date of the final rules
would typically not be compliant ABS. ABS issued before the effective
date that meet the terms of an exemption from the proposed rule or that
are guaranteed by the Enterprises, however, could qualify as compliant
ABS.
---------------------------------------------------------------------------
\111\ See id. at section 78o-11(i) (regulations become effective
with respect to residential mortgage-backed ABS one year after
publication of the final rules in the Federal Register, and two
years for all other ABS).
---------------------------------------------------------------------------
The agencies also do not believe that many of the commenters'
suggestions for distinguishing ``typical'' resecuritizations from CDOs
or other higher risk transactions could be applied consistently across
transactions. The agencies, however, are proposing a modification to
the original proposal in an effort to address comments about liquidity
provision to the underlying markets and access to credit on reasonable
terms while remaining consistent with the purpose of the statute.
Certain RMBS resecuritizations are designed to address pre-payment risk
for RMBS, because RMBS tend to have longer maturities than other types
of ABS and high pre-payment risk. In this market, investors often seek
securities structured to protect against pre-payment risk and have
greater certainty as to expected life. At the same time, these
resecuritizations do not divide again the credit risk of the underlying
ABS with new tranches of differing subordination and therefore do not
give rise to the same concerns as CDOs and similar resecuritizations
that involve a subsequent tranching of credit risk.
Accordingly, the agencies are proposing a limited expansion of the
resecuritization exemption to include certain resecuritizations of RMBS
that are structured to address pre-payment risk, but that do not re-
allocate credit risk by tranching and subordination structures. To
qualify for this exemption, the transaction would be required to meet
all of the conditions set out in the proposed rule. First, the
transaction must be a resecuritization of first-pay classes of ABS,
which are themselves collateralized by first-lien residential mortgage
located in a state of the United States or its territories.\112\
[[Page 57974]]
The proposal would define ``first-pay class'' as a class of ABS
interests for which all interests in the class are entitled to the same
priority of principal payment and that, at the time of closing of the
transaction, are entitled to repayments of principal and payments of
interest prior to or pro-rata, except for principal-only and interest
only tranches that are prior in payment, with all other classes of
securities collateralized by the same pool of first-lien residential
mortgages until such class has no principal or notional balance
remaining.\113\ The proposed rule also would allow a pool
collateralizing an exempted resecuritization to contain servicing
assets.\114\
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\112\ Section 2 of the proposed rule defines ``state'' as having
the same meaning as in section 3(a)(16) of the Securities Exchange
Act of 1934 (15 U.S.C. 78c(a)(16)). Thus, the mortgages underlying
the ABS interest that would be re-securitized in a transaction
exempted under this provision must be on property located in a state
of the United States, the District of Columbia, Puerto Rico, the
Virgin Islands, or any other possession of the United States.
\113\ A single class pass-through ABS under which an investor
would have a fractional, undivided interest in the pool of mortgages
collateralizing the ABS would qualify as a ``first pay class'' under
this definition.
\114\ The proposed definition of ``servicing assets'' is
discussed in Part II of this Supplementary Information.
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In addition, the proposed rule would require that the first-pay
classes of ABS used in the resecuritization transaction consist of
compliant ABS. Further, to qualify for the exemption any ABS interest
issued in the resecuritization would be required to share pro rata in
any realized principal losses with all other ABS holders of ABS
interests issued in the resecuritization based on the unpaid principal
balance of such interest at the time the loss is realized.
The proposed rule would also require the transaction to be
structured to reallocate pre-payment risk and specifically would
prohibit any structure which re-allocates credit risk (other than
credit risk reallocated only as a collateral consequence of
reallocating pre-payment risk). It would also prohibit the issuance of
an inverse floater or any similarly structured class of ABS as part of
the exempt resecuritization transaction. The proposal would define
``inverse floater'' as an ABS interest issued as part of a
securitization transaction for which interest or other income is
payable to the holder based on a rate or formula that varies inversely
to a reference rate of interest.
The exclusion from the proposed exemption of transactions involving
the issuance of an inverse floater class would address the high risk of
loss that has been associated with these instruments.
The agencies are proposing the expanded exemptions from risk
retention for resecuritizations of first-pay classes of RMBS under the
general exemption provisions of section 15G(e)(1) of the Exchange Act,
and believe that the provision is consistent with the requirements of
this section. The provisions that would limit the exemption to
resecuritizations of first-pay classes of RMBS, and the specific
prohibitions on structures that re-allocate credit risk, would also
help minimize credit risk associated with the resecuritization ABS and
prevent the transaction from reallocating existing credit risk.
Request for Comment
73(a). Would the issuance of an inverse floater class of ABS be
necessary to properly structure other classes of ABS to provide
adequate pre-payment protection for investors as part of the
resecuritization transaction? 73(b). Would this prohibition frustrate
the goals of the proposed exemption?
D. Other Exemptions From Risk Retention Requirements
In the original proposal, the agencies' requested comment about
whether there were other securitization transactions not covered by the
exemptions in the original proposal that should be exempted from risk
retention. The agencies received requests from commenters for
exemptions from risk retention for some types of assets, as discussed
below. After carefully considering the comments, the agencies are
proposing some additional exemptions from risk retention that were not
included in the original proposal.
1. Utility Legislative Securitizations
Some commenters on the original proposal requested that the
agencies exempt ABS issued by regulated electric utilities that are
backed by stranded costs, transition property, system restoration
property and other types of property specifically created or defined
for regulated utility-related securitizations by state legislatures
(utility legislative securitizations). These commenters asserted that
risk retention for these transactions would not encourage better
underwriting or otherwise promote the purposes of the risk retention
requirement, because a utility legislative securitization can generally
only occur after findings by a state legislature and a public service
commission that it is desirable in the interest of utility consumers
and after utility executives representing the utility's investors seek
such financing. According to commenters, the structure is used to
minimize the costs of financing significant utility-related costs, and
the increase in the cost of such financing that would result from risk
retention would not be warranted, because it would not affect credit
quality of the underlying assets. Further, commenters asserted that
this type of financing avoids the risk of poor underwriting standards,
adverse selection and minimizes credit risk, because the utility
sponsor does not choose among its customers for inclusion or exclusion
from the transaction and because the financing order mechanism, or
choose order of repayment.
The agencies have considered these comments and are proposing to
provide an exemption from risk retention for utility legislative
securitizations. Specifically, the re-proposed rule would exempt any
securitization transaction where the ABS are issued by an entity that
is wholly owned, directly or indirectly, by an investor-owned utility
company that is subject to the regulatory authority of a state public
utility commission or other appropriate state agency. Additionally, ABS
issued in an exempted transaction would be required to be secured by
the intangible property right to collect charges for the recovery of
specified costs and such other assets of the issuing entity. The
proposed rule would define ``specified cost'' to mean any cost
identified by a state legislature as appropriate for recovery through
securitization pursuant to ``specified cost recovery legislation,''
which is legislation enacted by a state that:
Authorizes the investor-owned utility company to apply
for, and authorized the public utility commission or other appropriate
state agency to issue, a financing order determining the amount of
specified costs the utility will be allowed to recover;
Provides that pursuant to a financing order, the utility
acquires an intangible property right to charge, collect, and receive
amounts necessary to provide for the full recovery of the specified
costs determined to be recoverable, and assures that the charges are
non-bypassable and will be paid by customers within the utility's
historic service territory who receive utility goods or services
through the utility's transmission and distribution system, even if
those customers elect to purchase these goods or services from a third
party; and
Guarantees that neither the state nor any of its agencies
has the authority to
[[Page 57975]]
rescind or amend the financing order, to revise the amount of specified
costs, or in any way to reduce or impair the value of the intangible
property right, except as may be contemplated by periodic adjustments
authorized by the specified cost recovery legislation.\115\
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\115\ The eligibility standards for the exemption are similar to
certain requirements for these securitizations outlined in IRS
Revenue Procedure 2005-62, 2005-2 C.B. 507, that are relevant to
risk retention. This Revenue Procedure outlines the Internal Revenue
Service's requirements in order to treat the securities issued in
these securitizations as debt for tax purposes, which is the primary
motivation for states and public utilities to engage in such
securitizations.
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As a general matter, the agencies believe that, although it falls
somewhat short of being an explicit state guarantee, the financing
order mechanism typical in utility legislative securitizations (by
which, under state law, the state periodically adjusts the amount the
utility is authorized to collect from users of its distribution
network) would ensure to a sufficient degree that adequate funds are
available to repay investors.
2. Seasoned Loans
Some commenters on the original proposal urged the agencies to
create an exemption for securitizations of loans that were originated a
significant period of time prior to securitization (seasoned loans) and
that had remained current, because underwriting quality would no longer
be as relevant to the credit performance of such loans. Commenters
representing different groups provided different suggestions on the
length of time required for a loan to be seasoned: sponsors
representing issuers suggested a two-year seasoning period for all
loans, whereas commenters representing investors suggested fully
amortizing fixed-rate loans should be outstanding and performing for
three years and for adjustable-rate loans the time period should depend
on the reset date of the loan.
The agencies believe that risk retention as a regulatory tool to
promote sound underwriting is less relevant after loans have been
performing for an extended period of time. Accordingly, for reasons
similar to the sunset provisions in section 12(f) of the proposed rule
(as discussed in Part IV.F of this Supplementary Information), the
agencies are proposing an exemption from risk retention for
securitizations of seasoned loans that is similar to the sunset
provisions. The proposed rule would exempt any securitization
transaction that is collateralized solely (excluding servicing assets)
by seasoned loans that (1) have not been modified since origination and
(2) have never been delinquent for 30 days or more.\116\ With respect
to residential mortgages, the proposed rule would define ``seasoned
loan'' to mean a residential mortgage loan that either (1) has been
outstanding and performing for the longer of (i) five years or (ii) the
period until the outstanding principal balance of the loan has been
reduced to 25 percent of the original principal balance; or (2) has
been outstanding and performing for at least seven years. For all other
asset classes, the proposed rule would define ``seasoned loan'' to mean
a loan that has been outstanding and performing for the longer of (1)
two years, or (2) the period until the outstanding principal balance of
the loan has been reduced to 33 percent of the original principal
balance.
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\116\ The definition of ``servicing assets'' is discussed in
Part II.B of this SUPPLEMENTARY INFORMATION.
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3. Legacy Loan Securitizations
Some commenters on the original proposal recommended an exemption
from risk retention for securitizations and resecuritizations of loans
made before the effectiveness of the final rule, or legacy loans,
arguing that risk retention would not affect the underwriting standards
used to create those loans.
The agencies are not proposing to provide an exemption from risk
retention for securitizations of loans originated before the effective
date of the rule (legacy loans). The agencies do not believe that such
securitizations should be exempt from risk retention because
underwriting occurred before the effective date of the rule. The
agencies believe that requiring risk retention does affect the quality
of the loans that are selected for a securitization transaction, as the
risk retention requirements are designed to incentivize securitizers to
select well-underwritten loans, regardless of when those loans were
underwritten. Furthermore, the agencies do not believe that exempting
securitizations of legacy loans from risk retention would satisfy the
statutory criteria for an exemption under 15G(e) of the Exchange
Act.\117\
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\117\ See 15 U.S.C. 78o-11(e).
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4. Corporate Debt Repackagings
Several commenters urged the agencies to adopt an exemption from
risk retention for ``corporate debt repackaging'' \118\ securitization
transactions. One commenter asserted that currently in corporate debt
repackaging transactions, depositors and sponsors do not hold any
interest in the repackaging vehicle. These commenters asserted that
sponsors would not pursue corporate debt repackagings if they were
required to retain risk, because it would fundamentally change the
dynamics of these transactions and could raise accounting and other
issues. Another commenter observed that corporate debt obligations are,
generally, full recourse obligations of the issuing company and the
issuer of the corporate bonds bears 100 percent of the credit risk. The
commenters stated that adding an additional layer of risk retention to
a repackaging of obligations that are themselves the subject of 100
percent risk retention by requiring the sponsor of the repackaging
transaction to retain an additional 5 percent of the credit risk would
serve no regulatory purpose. Another commenter asserted that not
granting an exemption for corporate debt repackagings would reduce the
ability of investors to invest in tailored repackaged securities and
likewise reduce funding and liquidity to the detriment of access of
businesses to credit on reasonable terms.
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\118\ According to commenters, corporate debt repackagings are
created by the deposit of corporate debt securities purchased by the
sponsoring institution in the secondary market into a trust which
issues certificates backed by cash flows on the underlying corporate
bonds.
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The agencies are not proposing an exemption from risk retention for
corporate debt repackagings. The agencies do not believe an exemption
is warranted because the underlying assets (the corporate bonds) are
not ABS. Regardless of the level of credit risk a corporate debt issuer
believes it holds on its underlying corporate bonds, the risk retention
requirement would apply at the securitization level, and the sponsor of
the securitization should be required to hold 5 percent of the credit
risk of the securitization transaction. Risk retention at the
securitization level for corporate debt repackagings aligns the
sponsor's interests in selecting the bonds in the pool with investors
in the securitization, who are often retail investors.
5. ``Non-Conduit'' CMBS Transactions
Some commenters on the original proposal requested that the
agencies include an exemption or special treatment for ``non-conduit''
CMBS transactions. Examples of ``non-conduit'' CMBS transactions
include single-asset transactions; single-borrower transactions; large
loan transactions (fixed and floating) with pools of one to 10 loans;
and large loan transactions having only an investment-grade component.
Commenters asserted that, because such transactions involve very small
pools of loans (or a single loan), a prospective investor is able to
[[Page 57976]]
scrutinize each loan and risk retention would be unnecessary for
investor protection. In particular, commenters noted that the CMBS menu
option would work only for ``conduit'' CMBS securitizations in which
originators of commercial mortgage loans aggregate loan pools of 10 to
100 loans. Suggestions for the treatment of ``non-conduit'' CMBS
transactions included:
Providing a complete exemption for single-asset
transactions; single-borrower transactions; large loan transactions
(fixed and floating) with pools of one to 10 loans; and large loan
transactions having only an investment-grade component;
Allowing mezzanine loans in single borrower and floating
rate CMBS transactions to satisfy the risk retention requirement and
any PCCRA requirements; and
Exempting single borrower and large loan transactions with
less than a certain number of loans.
The agencies are not proposing an exemption from risk retention for
``non-conduit'' CMBS securitizations. While the agencies do not dispute
that the smaller pools of loans in these transaction allow for fuller
asset-level disclosure in offering documents and could allow
prospective investors the opportunity to review each loan in the pool,
the agencies do not believe that this fact alone is sufficient grounds
to satisfy the exemption standards of section 15G of the Exchange Act.
Furthermore, the agencies do not believe that there are significant
differences between ``conduit'' and ``non-conduit'' CMBS to warrant a
special exemption for ``non-conduit'' CMBS.
6. Tax Lien-Backed Securities Sponsored by a Municipal Entity
One commenter on the original proposal asserted that tax lien-
backed securitizations are not ABS under the Exchange Act and should
not be subject to risk retention requirement. According to this
commenter, under state and municipal law, all property taxes,
assessment and sewer and water charges become liens on the day they
become due and payable if unpaid. These taxes, assessments and charges,
and any related tax liens, arise by operation of law and do not involve
an extension of credit by any party or any underwriting decision on the
party of the city. If the agencies disagreed with the position that tax
lien securitizations are not ABS, this commenter requested that the
agencies provide a narrowly tailored exemption for any tax lien-backed
securitization transactions sponsored by a municipality. In this
regard, the commenter argued that such securitizations do not involve
any of the public policy concerns underlying the risk retention
requirement because the tax liens arise by operation of law and do not
involve an extension of credit or underwriting decisions on the part of
the city. As a result, this commenter stated that applying the credit
risk retention rules would not further the agencies' stated goals of
encouraging prudent underwriting standards and ensuring the quality of
the assets underlying a securitization transaction.
The agencies are not proposing an exemption from risk retention for
securitizations of tax lien-backed securities sponsored by municipal
entities. The agencies believe that there is insufficient data to
justify granting a specific exemption. Furthermore, the agencies are
concerned that this type of exemption could end up being overly broad
in its application and be used to exempt sponsors of securitizations of
securities from programs, such as Property Assessed Clean Energy
programs, that use a securitized ``tax lien'' structure to fund and
collect consensual financing for property improvements desired by
private property owners.
7. Rental Car Securitizations
One commenter on the original proposal requested that the agencies
exempt rental car securitizations because of the extensive
overcollateralization required to support a rental car securitization,
the on-going structural protections with respect to collateral
valuation, and the importance of the vehicles to the business
operations of the car rental operating company.
The agencies are not proposing an exemption from risk retention for
rental car securitizations. Risk retention is required of other
sponsors that similarly rely on securitization for funding and that
sponsor securitizations with similar overcollateralization protections
and structural features. The agencies do not believe that there are
particular features of this type of securitization that would warrant
an exemption under the factors that the agencies must consider in
section 15G(e) of the Exchange Act.
E. Safe Harbor for Foreign Securitization Transactions
The original proposal included a ``safe harbor'' provision for
certain securitization transactions based on the limited nature of the
transactions' connections with the United States and U.S. investors
(foreign securitization transactions). The safe harbor was intended to
exclude from the proposed risk retention requirements transactions in
which the effects on U.S. interests are sufficiently remote so as not
to significantly impact underwriting standards and risk management
practices in the United States or the interests of U.S. investors.
Accordingly, the conditions for use of the safe harbor limited
involvement by persons in the United States with respect to both assets
being securitized and the ABS sold in connection with the transaction.
Finally, as originally proposed, the safe harbor would not have been
available for any transaction or series of transactions that, although
in technical compliance with the conditions of the safe harbor, was
part of a plan or scheme to evade the requirements of section 15G
Exchange Act and the proposed rules.
As set forth in the original proposal, the risk retention
requirement would not apply to a securitization transaction if: (1) The
securitization transaction is not required to be and is not registered
under the Securities Act; (2) no more than 10 percent of the dollar
value by proceeds (or equivalent if sold in a foreign currency) of all
classes of ABS interests sold in the securitization transaction are
sold to U.S. persons or for the account or benefit of U.S. persons; (3)
neither the sponsor of the securitization transaction nor the issuing
entity is (i) chartered, incorporated, or organized under the laws of
the United States, or a U.S. state or territory or (ii) the
unincorporated branch or office located in the United States of an
entity not chartered, incorporated, or organized under the laws of the
United States, or a U.S. state or territory (collectively, a U.S.-
located entity); (4) no more than 25 percent of the assets
collateralizing the ABS sold in the securitization transaction were
acquired by the sponsor, directly or indirectly, from a consolidated
affiliate of the sponsor or issuing entity that is a U.S.-located
entity.\119\
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\119\ See infra note 112 for the definition of ``state.''
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Commenters on the original proposal generally favored the creation
of a safe harbor for certain foreign securitizations. Several
commenters, however, requested that the exemption be broadened.
Specifically, several commenters noted that the U.S. risk retention
rules may be incompatible with foreign risk retention requirements,
such as the European Union risk retention requirements, and requested
that the safe harbor be modified to more readily facilitate cross-
border compliance with varied foreign risk retention requirements.
[[Page 57977]]
Several commenters supported a mutual recognition system for some
cross-border offerings. For example, commenters recommended various
methodologies for establishing a mutual recognition framework that
would permit non-U.S. securitizers to either satisfy or be exempt from
U.S. risk retention requirements if a sufficient minimum amount of a
foreign securitization complies with foreign risk retention
requirements that would be recognized under such a framework. A few
commenters recommended that in the absence of a mutual recognition
framework, a higher proceeds limit threshold of 30 percent, or as much
as 33 percent, would be more appropriate to preserve cross-border
market liquidity, in at least some circumstances. A few commenters also
requested clarification of how the percentage value of ABS sold to U.S.
investors under the 10 percent proceeds limit should be calculated.
The agencies are proposing a foreign safe harbor that is similar to
the original proposal but modified to address some commenter concerns.
The proposal makes a revision to the safe harbor eligibility
calculation to clarify that interests retained by the sponsor may be
included in calculating the percentage of ABS interests sold in the
securitization transaction that are sold to U.S. persons or for the
account or benefit of U.S. persons. The proposed safe harbor
eligibility calculation also would clarify that any ABS transferred to
U.S. persons or for the account or benefit of U.S. persons, including
U.S. affiliates of non-U.S. sponsors, must be included in calculating
eligibility for the safe harbor.
The agencies are again proposing a 10 percent limit on the value of
classes of ABS sold to U.S. persons for safe harbor eligibility,
similar to the original proposal. The agencies continue to believe that
the proposed 10 percent limit appropriately aligns the safe harbor with
the objective of the rule, which is to exclude only those transactions
with limited effect on U.S. interests, underwriting standards, risk
management practices, or U.S. investors.
In addition, the agencies are concerned that expansion of the 10
percent limit would not effectively address the concerns of foreign
securitization sponsors, some of whom rely extensively on U.S.
investors for liquidity. However, the agencies also believe that the
proposed rule incorporates sufficient flexibility for sponsors with
respect to forms of eligible risk retention to permit foreign sponsors
seeking a significant U.S. investor base to retain risk in a format
that satisfies home country and U.S. regulatory requirements. For
example, in response to comments from mortgage securitizers in the
United Kingdom who use revolving trust structures, the agencies are
proposing to permit seller's interest to qualify as risk retention for
revolving master trusts securitized by non-revolving assets. The
agencies' revisions to the original proposal that are designed to
provide flexibility to foreign securitization sponsors that use the
revolving master trust structure are discussed in detail in Part
III.B.2 of this SUPPLEMENTARY INFORMATION.
The agencies considered the comments requesting a mutual
recognition framework and observe that such a framework has not been
generally adopted in non-U.S. jurisdictions with risk retention
requirements. The agencies believe that given the many differences
between jurisdictions, finding comparability among securitization
frameworks that place the obligation to comply with risk retention
requirements upon different parties in the securitization transaction,
have different requirements for hedging, risk transfer, or unfunded
risk retention, or otherwise vary materially, it likely would not be
practicable to construct such a ``mutual recognition'' system that
would meet all the requirements of section 15G of the Exchange Act.
Moreover, in several such jurisdictions, the risk retention framework
recognizes unfunded forms of risk retention, such as standby letters of
credit, which the agencies do not believe provide sufficient alignment
of incentives and have rejected as eligible forms of risk retention
under the U.S. framework.
Request for Comment
74. Are there any extra or special considerations relating to these
circumstances that the agencies should take into account?
75(a). Should the more than 10 percent proceeds trigger be higher
or lower (e.g., 0 percent, 5 percent, 15 percent, or 20 percent)?
75(b). If so, what should the trigger be and why? 75(c). Are the
eligibility calculations appropriate? 75(d). If not, how should they be
modified?
F. Sunset on Hedging and Transfer Restrictions
As discussed in Part III.D of this SUPPLEMENTARY INFORMATION,
Section 15G(c)(1)(A) of the Exchange Act provides that sponsors may not
hedge or transfer the risk retention interest they are required to
hold.\120\
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\120\ 15 U.S.C. 78o-11(c)(1)(A). As with other provisions of
risk retention, the agencies could provide an exemption under
section 15G(e) of the Exchange Act if certain findings were met. See
id. at section 78o-11(e).
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The agencies originally proposed that sponsors generally would have
to hold risk retention for the duration of a securitization
transaction. The proposal did not provide any sunset provisions after
which the prohibitions on sale and hedging of retained interests would
expire, though the proposal did specifically include a question related
to including a sunset provision in the final rule and requested
commenter feedback.
While a few commenters representing the investor community
expressed support for risk retention for the life of the security, the
majority of commenters who discussed this topic in their letters
opposed risk retention lasting for the duration of the transaction.
Generally, these commenters argued that credit losses on underlying
assets due to poor underwriting tend to occur in the first few years of
the securitization and that defaults occur less frequently as the
assets are seasoned. Additionally, they asserted that the risk
retention requirement as proposed would reduce liquidity in the
financial system and increase the amount of capital banks would be
required to hold, thereby reducing credit availability and raising
borrowing costs for consumers and businesses. Thus, they argued, a
sunset provision should be included in the final rule to help offset
the costs and burden created by the retention requirement. After the
mandated risk retention period, sponsors or their consolidated
affiliates would be allowed to hedge or transfer to an unaffiliated
third party the retained interest or assets.
Commenters proposed a variety of suggestions for incorporating a
sunset provision in the final rule. Some favored a blanket risk
retention provision, whereby retention of the interest would no longer
be required after a certain period of time, regardless of the asset
class. They stated that a blanket sunset requirement would be the
easiest to implement and dovetails with the agencies' stated goal of
reducing regulatory complexity. Among those commenters advocating for a
blanket sunset, most stated that a three year sunset provision would be
ideal. A subset of these commenters acknowledged that three years could
be too long for some asset classes (such as automobile ABS), however
they maintained that historical loss rates show that this duration
would be appropriate for some of the largest asset classes, in
particular CMBS and RMBS. They stated that, after three years, losses
[[Page 57978]]
related to underwriting defects have already occurred and any future
credit losses are typically attributed to financial events or, in the
case of RMBS, life events such as illness or unemployment, unrelated to
the underwriting quality. One commenter estimated that a three-year
sunset would reduce the costs associated with risk retention by 50
percent.
Other commenters suggested that the sunset provision should vary by
asset class. While this might be more operationally complex to
implement than a blanket sunset provision, they stated it would be more
risk sensitive as it would take into account the fact that different
asset classes have varying default rates and underlying exposure
durations (for example, 30 years for a standard residential mortgage
versus five years for a typical automobile loan). For example,
commenters suggested a range of risk retention durations for RMBS,
stating that anywhere from two to five years would be appropriate.
Another commenter advocated that the risk retention requirement for
RMBS should end at the later of five years or when the pool is reduced
to 25 percent of its original balance. Similarly for CMBS, some
commenters suggested requiring risk retention for only two or three
years in the final rule. A few commenters stated that a sunset
provision should be based upon the duration of the asset in question.
For instance, one commenter stated that automobile ABS should have a
sunset provision of less than five years since automobile loans are of
such a short duration, while another commenter advocated using the
average pool duration to determine the length of required risk
retention.
The agencies have carefully considered the comments, as well as
other information on credit defaults for various asset classes in
contemplating whether a limit on the duration of the risk retention
requirement would be appropriate. The agencies have concluded that the
primary purpose of risk retention--sound underwriting--is less likely
to be effectively promoted by risk retention requirements after a
certain period of time has passed and a peak number of delinquencies
for an asset class has occurred.
Accordingly, the agencies are proposing two categories of duration
for the transfer and hedging restrictions under the proposed rule--one
for RMBS and one for other types of ABS. For all ABS other than RMBS,
the transfer and hedging restrictions under the rule would expire on or
after the date that is the latest of (1) the date on which the total
unpaid principal balance of the securitized assets that collateralize
the securitization is reduced to 33 percent of the original unpaid
principal balance as of the date of the closing of the securitization,
(2) the date on which the total unpaid principal obligations under the
ABS interests issued in the securitization is reduced to 33 percent of
the original unpaid principal obligations at the closing of the
securitization transaction, or (3) two years after the date of the
closing of the securitization transaction.
Similarly, the agencies are proposing, as an exception to the
transfer and hedging restrictions of the proposed rule and section 15G
of the Exchange Act, to permit the transfer of the retained B-piece
interest from a CMBS transaction by the sponsor or initial third-party
purchaser to another third-party purchaser five years after the date of
the closing of the securitization transaction, provided that the
transferee satisfies each of the conditions applicable to the initial
third-party purchaser under the CMBS option (as described above in Part
III.B.5 of this SUPPLEMENTARY INFORMATION).
The agencies believe the exemptions to the prohibitions on transfer
and hedging for both non-residential mortgage ABS and CMBS would help
ensure high quality underwriting standards for the securitizers and
originators of non-residential mortgage ABS and CMBS, would improve the
access of consumers and businesses to credit on reasonable terms, and
are in the public interest and for the protection of investors--and
thus satisfy the conditions for exceptions to the rule.\121\ After
losses due to underwriting quality occur in the initial years following
a securitization transaction, risk retention does little to improve the
underwriting quality of ABS as most subsequent losses are related to
financial events or, in the case of RMBS, life events not captured in
the underwriting process. In addition, these exemptions would improve
access to credit for consumer and business borrowers by increasing
potential liquidity in the non-residential mortgage ABS and CMBS
markets.
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\121\ 15 U.S.C. 78o-11(e)(2).
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Because residential mortgages typically have a longer duration than
other assets, weaknesses in underwriting may show up later than in
other asset classes and can be masked by strong housing markets.
Moreover, residential mortgage pools are uniquely sensitive to adverse
selection through prepayments: If market interest rates fall, borrowers
refinance their mortgages and prepay their existing mortgages, but
refinancing is not available to borrowers whose credit has
deteriorated, so the weaker credits become concentrated in the RMBS
pool in later years. Accordingly, the agencies are proposing a
different sunset provision for RMBS backed by residential mortgages
that are subject to risk retention. Under the rule, risk retention
requirements with respect to RMBS would end on or after the date that
is the later of (1) five years after the date of the closing of the
securitization transaction or (2) the date on which the total unpaid
principal balance of the residential mortgages that collateralize the
securitization is reduced to 25 percent of the original unpaid
principal balance as of the date of the closing of the securitization.
In any event, risk retention requirements for RMBS would expire no
later than seven years after the date of the closing of the
securitizations transaction.
The proposal also makes clear that the proposed rule's restrictions
on transfer and hedging end if a conservator or receiver of a sponsor
or other holder of risk retention is appointed pursuant to federal or
state law.
Request for Comment
76(a). Are the sunset provisions appropriately calibrated for RMBS
(i.e., later of five years or 25 percent, but no later than seven
years) and all other asset classes (i.e., later of two years or 33
percent)? 76(b). If not, please provide alternative sunset provision
calibrations and any relevant analysis to support your assertions.
77(a). Is it appropriate to provide a sunset provision for all
RMBS, as opposed to only amortizing RMBS? 77(b). Why or why not? 77(c).
What effects might this have on securitization market practices?
G. Federal Deposit Insurance Corporation Securitizations
The agencies are proposing an additional exemption from risk
retention for securitization transactions that are sponsored by the
FDIC acting as conservator or receiver under any provision of the
Federal Deposit Insurance Act or Title II of the Dodd-Frank Act. This
new exemption is being proposed because such exemption would help
ensure high quality underwriting and is in the public interest and for
the protection of investors.\122\ These receivers and conservators
perform a function that benefits creditors in liquidating and
maximizing the value of assets of failed financial institutions for the
benefit of creditors and, accordingly, their actions are guided by
sound underwriting
[[Page 57979]]
practices. Such receivers and conservators do not originate loans or
other assets and thus are not engaged in ``originate to distribute''
activities that led to poorly underwritten loans and that were a
significant reason for the passage of section 941 of the Dodd-Frank
Act. The quality of the assets securitized by these receivers and
conservators and the ABS collateralized by those assets will be
carefully monitored and structured so as to be consistent with the
relevant statutory authority. Moreover, this exemption is in the public
interest because it would, for example, allow the FDIC to maximize the
value of assets of a conservatorship or receivership and thereby reduce
the potential costs of financial institution failures to creditors.
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\122\ See 15 U.S.C. 78o-11(e).
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V. Reduced Risk Retention Requirements and Underwriting Standards for
ABS Backed by Qualifying Commercial, Commercial Real Estate, or
Automobile Loans
As contemplated by section 15G of the Exchange Act, the original
proposal included a zero risk retention requirement, or exemption, for
securitizations of commercial loans, commercial real estate loans, and
automobile loans that met specific proposed underwriting
standards.\123\ All three categories of proposed underwriting standards
contained two identical requirements. First, a securitization exempt
from risk retention under these proposed provisions could be backed
only by a pool consisting entirely of assets that met the underwriting
standards. Second, sponsors would be required to repurchase any assets
that were found not to have met the underwriting criteria at
origination.
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\123\ Pursuant to section 15G, only the Federal banking agencies
are proposing the underwriting definitions in Sec. ----.14 (except
the asset class definitions of automobile loan, commercial loan, and
commercial real estate loan, which are being proposed by the Federal
banking agencies and the Commission), and the exemption and
underwriting standards in Sec. Sec. ----.15 through ----.18 of the
proposed rules.
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The agencies note the concern expressed by some commenters with
respect to all three of these asset classes that, for the residential
mortgage asset class and QRM, a significant portion of the existing
market would qualify for an exemption from risk retention, whereas in
proposing the underwriting standards for qualifying commercial loans,
commercial real estate loans, and automobile loans, the agencies have
proposed conservative underwriting criteria that will not capture an
equivalent portion of the respective markets. The agencies believe this
is appropriate because the homogeneity in the securitized residential
mortgage loan market is dissimilar to the securitization market for
commercial loan or commercial real estate loan asset classes.
Commercial loans and commercial real estate loans typically focus on a
common set of borrower and collateral metrics, but they are
individually underwritten and tailored to a specific borrower or
property, and often certain terms developed in view not only of the
borrower's financial position but also the general business cycle,
industry business cycle, and standards for appropriate leverage in that
industry sub-sector. The agencies believe the additional complexity
needed to create underwriting standards for every major type of
business in every economic cycle would be so great that originators
would almost certainly be dissuaded from attempting to implement them
or attempting to stay abreast of the numerous regulatory revisions the
agencies would be required to issue from time to time.
Moreover, the proposed underwriting standards establish clear
requirements, which are necessary to enable originators, sponsors, and
investors to be certain as to whether any particular loan meets the
rule's requirements for an exemption. For the agencies to expand the
underwriting criteria in the fashion suggested by some commenters, the
rules would need to accommodate numerous relative standards. The
resulting uncertainty on behalf of market participants whether any
particular loan was actually correctly designated on a particular point
of those relative standards to qualify for an exemption would be
expected to eliminate the market's willingness to rely on the
exemption.
While there may be more homogeneity in the securitized automobile
loan class, the agencies are concerned that attempting to accommodate a
significantly large share of the current automobile loan securitization
market would require weakening the underwriting standards to the point
where the agencies are skeptical that they would consistently reflect
loans of a low credit risk. For example, the agencies note that current
automobile lending often involves no or small down payments, financing
in excess of the value of the automobile (which is itself a quickly
depreciating asset) to accommodate taxes and fees, and a credit score
in lieu of an analysis of the borrower's ability to repay. These
concerns as to credit quality are evidenced by the high levels of
credit support automobile securitization sponsors build into their ABS,
even for so-called ``prime'' automobile loans. Moreover, securitizers
from the automobile sector explicitly disavowed any interest in using
any underwriting-based exemptive approach unless the agencies
incorporated the industry's current model, which relies almost
exclusively on matrices of credit scores (like FICO) and LTV. As is
discussed in the agencies' original proposal, the agencies are not
persuaded that it would be appropriate for the underwriting-based
exemptions under the rule to incorporate a credit score metric.
Request for Comment
78(a). In light of the significant expansion of the proposed
definition of QRM, should the agencies similarly significantly expand
the type of loans that would meet the qualifying commercial, commercial
real estate and automobile loan exemptions? 78(b). If so, please
provide sufficient detailed data regarding loan underwriting criteria
for each type of loan.
A. Qualifying Commercial Loans
The original proposal included definitions and underwriting
standards for qualifying commercial loans (QCL), that, when securitized
in a pool of solely QCLs, would have been exempt from the risk
retention requirements. The proposed definition of commercial loan
generally would have included any business loan that did not fit the
definition of a commercial real estate loan or 1-4 family residential
real estate loan.
The proposed criteria for a QCL included reviewing two years of
past data; forecasting two years of future data; a total liabilities
ratio less than or equal to 50 percent; a leverage ratio of less than
or equal to 3.0 percent; a debt service coverage ratio of greater than
or equal to 1.5 percent; a straight-line amortizing payment; fixed
interest rates; a maximum five-year, fully amortizing loan term; and
representations and warranties against the borrower taking on
additional debt. Additional standards were proposed for QCLs that are
backed by collateral, including lien perfection and collateral
inspection.
Commenters generally asserted the proposed criteria were too strict
in one or more areas. These commenters proposed a general loosening of
the QCL standards to incorporate more loans, and suggested the agencies
develop underwriting standards that would encompass 20 to 30 percent of
loans currently issued. One commenter asserted that if the criteria
were not loosened, the small chance a loan might qualify as a QCL would
not incentivize
[[Page 57980]]
lenders to go through all the initial tests and perform burdensome
monitoring after origination.
Comments on the specific underwriting criteria included an
observation that some commercial loans are offered with 15- or 20-year
terms, with adjustable interest rates that reset every five years, and
that such loans should qualify for the exemption. Another commenter
suggested allowing second lien loans to qualify if they met all other
underwriting criteria. A third commenter suggested requiring qualifying
appraisals for all tangible or intangible assets collateralizing a
qualified commercial loan.
In developing the underwriting standards for the original proposal,
the agencies intended for the standards to be reflective of very high-
quality loans because the loans would be completely exempt from risk
retention. The agencies have carefully considered the comments on the
original proposal, and generally believe that the high standards
proposed are appropriate for an exemption from risk retention for
commercial loans. In addition, while commercial loans do exist with
longer terms, the agencies do not believe such long-term commercial
loans are necessarily as safe as shorter-term commercial loans, as
longer loans involve more uncertainty about continued repayment
ability. Accordingly, the agencies are proposing underwriting standards
for QCLs similar to those in the original proposal. However, as
discussed below, the agencies are proposing to allow blended pools to
facilitate the origination and securitization of QCLs.
The agencies are proposing some modifications to the standards in
the original proposal for QCLs. Under the proposal, junior liens may
collateralize a QCL. However, if the purpose of the commercial loan is
to finance the acquisition of tangible or intangible property, or to
refinance such a loan, the lender would be required to obtain a first
lien on the property for the loan to qualify as a QCL. While a
commercial lender should consider the appropriate value of the
collateral to the extent it is a factor in the repayment of the
obligation, the agencies are declining to propose a requirement of a
qualifying appraisal, so as not to increase the burden associated with
underwriting a QCL.
Request for Comment
79(a). Are the revisions to the qualifying commercial loan
exemption appropriate? 79(b). Should other revisions be made?
80(a). In evaluating the amortization term for qualifying
commercial loans, is full amortization appropriate? 80(b). If not, what
would be an appropriate amortization period or amount for high-quality
commercial loans?
B. Qualifying Commercial Real Estate Loans
The original proposal included underwriting standards for CRE loans
that would have been exempt from risk retention (qualifying CRE loans,
or QCRE loans). The proposed standards focused predominately on the
following criteria: The borrower's capacity to repay the loan; the
value of, and the originator's security interest in, the collateral;
the loan-to-value (LTV) ratio; and, whether the loan documentation
includes the appropriate covenants to protect the value of the
collateral.
Commenters generally supported the exemption from risk retention in
the original proposal for QCRE loans. However, many questioned whether
the QCRE loan exemption would be practicable, due to the stringency of
the qualifying criteria proposed by the agencies. Some commenters
asserted that less than 0.4 percent of conduit loans that have been
securitized since the beginning of the CMBS market would meet the
criteria. Most commenters requested that the agencies loosen the QCRE
loan criteria to allow more loans to qualify for the exemption.
In the original proposal, a commercial real estate (CRE) loan would
have been defined as any loan secured by a property of five or more
residential units or by non-residential real property, where the
primary source of repayment would come from the proceeds of sale or
refinancing of the property or rental income from entities not
affiliated with the borrower. In addition, the definition would have
specifically excluded land loans and loans to real estate investment
trusts (REITs).
Three main concerns were expressed by commenters with respect to
the definition of CRE loans in the original proposal. First, some
commenters questioned why CRE loans must be repaid from funds that do
not include rental income from an affiliate of the borrower. These
commenters said that in numerous commercial settings, particularly
hotels and hospitals, entities often rent commercial properties from
affiliated borrowers, and those rental proceeds are used to repay the
underlying loans. These commenters strongly encouraged the agencies to
remove the affiliate rent prohibition.
Second, some commenters questioned the exclusion of certain land
loans from the definition of CRE in the original proposal.
Specifically, these commenters stated that numerous CMBS
securitizations include loans to owners of a fee interest in land that
is ground leased to a third party who owns the improvements and whose
ground lease payments are a source of income for debt service payments
on the loan. These commenters suggested that the agencies clarify that
the exclusion did not apply to such loans.
Third, many commenters criticized the agencies for excluding loans
to REITs from the definition of CRE loans in the original proposal.
These commenters asserted that mortgage loans on commercial properties
where the borrower was a REIT are no riskier than similar loans where
the borrower was a non-REIT partnership or corporation and that a
significant portion of the CMBS market involves underlying loans to
finance buildings owned by REITs. These commenters requested that the
agencies delete the restriction against REITs, or in the alternative
clarify that the prohibition only applies to loans to REITs that are
not secured by mortgages on specific commercial real estate.
The agencies are proposing the CRE definition from the original
proposal again, with some modifications to address the commenter
concerns discussed above. Regarding affiliate rental income, the
agencies were concerned when developing the original proposal that a
parent company might lease a building to an affiliate and manipulate
the rental income so that the loan on the building would meet the
requirements for a qualifying CRE loan. However, the agencies did not
intend to exclude the types of hotel loans mentioned by commenters from
the CRE loan definition, because the agencies do not consider income
from hotel guests to be derived from an affiliate. The agencies are
therefore proposing to specify that ``rental income'' in the CRE loan
definition would be any income derived from a party who is not an
affiliate of the borrower, or who is an affiliate but the ultimate
income stream for repayment comes from unaffiliated parties (for
example, in a hotel, dormitory, nursing home, or similar property).
Regarding land loans, the agencies are concerned that weakening any
restriction on land loans would allow for riskier QCRE loans, as
separate parties could own the land and the building on the land and
could make servicing and foreclosure on the loan more difficult.
Therefore, the agencies are continuing to propose to exclude all land
loans from the CRE loan definition.
[[Page 57981]]
Finally, in developing the original proposal, the agencies intended
to not allow unsecured loans to REITs, or loans secured by general
pools of REIT assets rather than by specific properties, to be
qualifying CRE loans. However, the agencies did not intend to exclude
otherwise valid CRE loans from the definition solely because the
borrower was organized as a REIT structure. After reviewing the
comments and the definition of CRE loan, the agencies have decided to
remove the language excluding REITs in the proposed definition.
The agencies divided the underwriting criteria in the original
proposal into four categories: Ability to repay, loan-to-value
requirement, valuation of the collateral, and risk management and
monitoring.
1. Ability To Repay
The agencies proposed in the original proposal a number of criteria
relating to the borrower's ability to repay in order for a loan to
qualify as QCRE. The borrower would have been required to have a debt
service coverage (DSC) ratio of at least 1.7, or at least 1.5 for
certain residential properties or certain commercial properties with at
least 80 percent triple-net leases.\124\ The proposed standards also
would have required reviewing two years of historical financial data
and two years of prospective financial data of the borrower. The loan
would have been required to have either a fixed interest rate or a
floating rate that was effectively fixed under a related swap
agreement. The loan document also would have had to prohibit any
deferral of principal or interest payments and any interest reserve
fund. The loan payment amount had to be based on straight-line
amortization over the term of the loan not to exceed 20 years, with
payments made at least monthly for at least 10 years of the loan's
term.
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\124\ The original proposal defined a triple-net lease as one in
which the lessee, not the lessor, is obligated to pay for taxes,
insurance, and maintenance on the leased property.
---------------------------------------------------------------------------
Numerous commenters objected to the agencies' proposed DSC ratios
as too conservative, and proposed eliminating the DSC ratio, lowering
qualifying DSC ratios to a range between 1.15 and 1.40, or establishing
criteria similar to those used by Fannie Mae or Freddie Mac to fund
multifamily real estate loans.
Many commenters stated that, if the agencies retained the DSC
ratios, they should remove the triple-net-lease requirement. Many of
these commenters stated that full service gross leases, rather than
triple-net leases, are used more often in the industry.\125\
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\125\ In a full-service gross lease, the lessor pays for taxes,
maintenance, and insurance (presumably covering the additional costs
by charging a higher rental amount to the lessee than under a
triple-net lease).
---------------------------------------------------------------------------
Some commenters supported replacing the proposed requirement to
examine two years of past and future borrower data with one to gather
two or three years of historical financial data on the property, not
attempt to forecast two years of future data and to allow new
properties with no operating history to qualify. Many commenters
supported the requirement for fixed interest rate loans for QCRE.
However, some commenters suggested expanding the types of derivatives
allowed to convert a floating rate into a fixed rate. Many commenters
also supported the restrictions on deferrals of principal and interest
and on interest reserve funds. However, a few commenters supported
allowing some interest-only loans or interest-only periods, in
connection with a lower LTV ratio (such at 50 percent).
Many commenters objected to the minimum length and amortization of
QCRE loans. These commenters said that 3, 5, and 7-year CRE loans have
become common in the industry, and so a minimum 10-year term would
disqualify numerous loans. In addition, most commenters supported a
longer amortization period for QCRE loans, such as 25 or 30 years. Some
commenters also proposed replacing the amortization requirement with a
maximum LTV at maturity (based on value at origination) that is lower
than LTV at origination, which would require some amortization of the
loan principal.
After considering the comments on the underwriting criteria for
QCREs, the agencies are proposing criteria similar to that of the
original proposal, with some modifications. Based on a review of
underwriting standards and performance data for multifamily loans
purchased by the Enterprises, the agencies are proposing to require a
1.25 DSCR for multifamily properties to be QCRE.\126\ After review of
the comments and the Federal banking agencies' historical standards for
conservative CRE lending,\127\ for loans other than qualifying
multifamily property loans, the agencies are proposing to retain the
1.5 DSCR for leased QCRE loans and 1.7 for all other QCREs. As
discussed below, removing the criterion on triple-net leases should
allow more loans to qualify for an exemption with the 1.5 DSCR
requirement, rather than the 1.7 DSCR requirement that would have
applied under the original proposal.
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\126\ The agencies reviewed origination volume and performance
history, as tracked by the TREPP CMBS database, for multifamily
loans securitized from 2000 through 2011.
\127\ These standards include the ``Interagency Guidelines for
Real Estate Lending.'' 12 CFR part 34, subpart D, Appendix A (OCC);
12 CFR part 208, subpart C, Appendix A (FRB); 12 CFR part 365,
Appendix A (FDIC).
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The agencies considered the comments requesting a debt yield
requirement, but have decided not to include that in the proposed rule.
Historically, DSCR has been, and continues to be, widely used in CRE
lending. Debt yield is a relatively recent concept that was not tracked
in many historic CMBS deals, which makes it difficult for the agencies
to calculate historical performance and determine what the appropriate
level should be for a CRE loan exempt from risk retention. The agencies
recognize that the DSCR is not a perfect measure, particularly in low
interest rate environments. However, the agencies also do not want to
introduce a relatively new methodology into the CRE market without
long-term data to support the appropriateness of that measure.
Based on the agencies' further review of applicable data, it
appears that a significant number of leases are written as full-service
gross leases, not triple-net leases, and that difference should not
preclude treatment as a QCRE loan. Since the proposed underwriting
requirements are based on net operating income (NOI), whether a tenant
has a triple-net lease or full-service gross lease should not
significantly affect the borrower's NOI.
The agencies propose to continue to require that the analysis of
whether a loan is a QCRE be made with respect to the borrower and not
be limited to the property only. While the agencies observe that some
CRE loans are non-recourse, others include guarantees by the borrowers.
The agencies are concerned that focusing solely on the property could
be problematic in cases where the borrower may have other outstanding
commitments that may lead the borrower to siphon cash flow from the
underwritten property to service the other commitments. By analyzing
the borrower's position, and not solely the property's income, the
underwriting should better address this risk. The agencies believe that
two years of historical data collection and two years of forecasted
data are appropriate, and that properties with less than two years of
operating history should not qualify as QCRE loans. The longer a
property has been operating, particularly after the first few years of
operation, the better the originator can assess the stability of cash
flows from the property going
[[Page 57982]]
forward. New properties present significant additional risks and loans
on those properties generally should not be exempt from risk retention.
The proposal would continue to require that the interest rate on a
QCRE loan be fixed or fully convertible into a fixed rate using a
derivative product. The agencies are not proposing to allow other types
of derivatives because of concerns about transparency with other types
of derivative products, including mixed derivative products. For
example, if the agencies allowed a derivative that established an
interest rate cap, it may not be clear to investors whether a loan was
underwritten using the current market rate or the maximum rate allowed
under the interest rate cap. The agencies are also proposing to retain
from the original proposal the requirement not to include interest-only
loans or interest-only periods in QCRE loans. The agencies believe that
interest-only loans or interest-only periods are associated with higher
credit risk. If a borrower is not required to make any form of
principal payment, even with a 25-year amortization period, it raises
questions as to the riskiness of the loan, and would be inappropriate
for qualifying CRE loan treatment.
The agencies are proposing some modifications from the original
proposal to the standards for QCRE loan terms. The agencies recognize
that there are CRE loans with amortization periods in excess of 20
years. Allowing a longer amortization period reduces the amount of
principal paid on the CRE loan before maturity, which can increase
risks related to having to refinance a larger principal amount than
would be the case for a CRE loan with a shorter amortization period.
Because the agencies believe exemptions from risk retention should be
available only for the most prudently underwritten CRE loans, the
agencies believe it is appropriate to consider the risks of an overly
long amortization period for a QCRE. In balancing those risks with
commenters' concerns, the agencies are proposing to increase the
amortization period to 30 years for multifamily residential QCRE loans
and to 25 years for all other QCRE loans.
The agencies are continuing to propose to set a 10-year minimum
maturity for QCRE loans. The agencies are concerned that introducing
terms shorter than 10 years, such as three or five years, may create
improper underwriting incentives and not create the low-risk CRE loans
intended to qualify for the exemption. When making a short-term CRE
loan, an originator may focus only on a short timeframe in evaluating
the stability of the CRE underlying the loan in an industry that might
be at or near the peak of its business cycle. In contrast, a 10-year
maturity CRE loan allows for underwriting through a longer business
cycle, including downturns that may not be appropriately captured when
underwriting to a three-year time horizon.
2. Loan-to-Value Requirement
The agencies proposed in the original proposal that the combined
loan-to-value ratio (CLTV) for QCRE loans be less than or equal to 65
percent (or 60 percent for certain valuation assumptions).
Many commenters recognized the value in setting LTV ratio
requirements in CRE underwriting. While some commenters supported the
agencies' proposed ratios, others did not. Some commenters suggested
that higher LTV ratios should be allowed in the QCRE standards,
generally between 65 percent and 80 percent, particularly for
properties in stable locations with strong historical financial
performance. One commenter suggested lower LTVs for properties that may
be riskier. Numerous commenters suggested taking a different approach
by setting maximum LTVs at origination and maturity, with a maturity
LTV aimed at controlling the risk that the borrower would not be able
to refinance. A number of commenters also objected to setting the CLTV
ratio at 65 percent. These commenters said that many commercial
properties involve some form of subordinate financing. Some commenters
proposed eliminating the CLTV ratio entirely and thus allow borrowers
to use non-collateralized debt to finance the properties. Other
commenters proposed establishing a higher CLTV ratio (such as 80
percent) and allow for non-QCRE second liens on the properties.
The agencies have considered the comments on LTV for QCRE loans and
are proposing to modify this aspect of QCRE underwriting standards from
the standard in the original proposal by proposing to establish a
maximum LTV ratio of 65 percent for QCRE loans. The agencies also are
proposing to allow up to a 70 percent CLTV for QCRE loans. The more
equity a borrower has in a CRE project, generally the lower the lender
or investor's exposure to credit risk. Overreliance on excessive
mezzanine financing instead of equity financing for a CRE property can
significantly reduce the cash flow available to the property, as
investors in mezzanine finance often require high rates of return to
offset the increased risk of their subordinate position. In proposing
underwriting criteria for the safest CRE loans that would be exempt
from risk retention requirements, the agencies believe a 70 percent
CLTV cap is appropriate, which would require the borrower to have at
least 30 percent equity in the project to help protect securitization
investors against losses from declining property values and potential
defaults on the CRE loans.
The agencies are also proposing to retain the requirement that the
maximum CLTV ratio be lowered by 5 percent if the CRE property was
appraised with a low capitalization (cap) rate. Generally, assuming a
low cap rate will inflate the appraised value of the CRE property and
thus increase the amount that can be borrowed given a fixed LTV or
CLTV. Therefore, such a loan would have a maximum 60 percent LTV and 65
percent CLTV. In addition, to address the commenters' concerns about
high cap rates, the agencies are proposing that the cap rates used in
CRE appraisals be disclosed to investors in securitizations that own
CRE loans on those properties.
The agencies are declining to propose requirements for LTVs or
CLTVs at both origination and maturity. The agencies are concerned that
introducing the concept of front-end and back-end LTV ratios, rather
than using straight-line amortization, would allow borrowers to make
nominal principal payments in early years and back-load a large
principal payment toward maturity. The effect would be to significantly
increase the riskiness of the CRE loan at maturity, rather than if the
loan had been underwritten to provide straight-line amortization
throughout its life. Therefore, the agencies have decided not to
propose to include this amortization approach in the revised proposal
and instead continue to propose the straight-line amortization
requirement.
3. Collateral Valuation
In the original proposal, the agencies proposed to require an
appraisal and environmental risk assessment for every property serving
as collateral for a QCRE. Commenters strongly supported both the
valuation appraisal and environmental risk assessment for all QCRE
properties. Many commenters indicated this is already standard industry
practice. The agencies are continuing to include this requirement in
the proposed rule.
4. Risk Management and Monitoring
The original proposal would have required that a QCRE loan
agreement require borrowers to supply certain financial information to
the sponsor and
[[Page 57983]]
servicer. In addition, the agreement would have had to require lenders
to take a first lien in the property and restrict the ability to pledge
the property as collateral for other loans.
Many commenters supported the risk management provisions for
supplying financial information. Some commenters requested
clarification that such information should relate to the property
securing the QCRE loan rather than financial information on the
borrower. These commenters said that most CRE loans are non-recourse,
making the property the sole source of repayment and thus its financial
condition as far more important than the borrower's condition.
Commenters supported the first-lien requirement. In addition, some
commenters requested removing the restriction on granting second liens
on the property to allow borrowers access to subordinate financing.
These commenters suggested establishing a CLTV to restrict the total
debt on the property. Finally, some commenters supported the
requirement that a borrower retain insurance on the property up to the
property value, while other commenters supported a requirement to have
insurance only for the replacement cost of the property.
The agencies are proposing to modify the requirement in the
original proposal that the borrower provide information to the
originator (or any subsequent holder) and the servicer, including
financial statements of the borrower, on an ongoing basis. The agencies
believe that the servicer would be in the best position to collect,
store, and disseminate the required information, and could make that
information available to holders of the CRE loans. Therefore, to reduce
burden on the borrowers, the agencies are not proposing a requirement
to provide this information directly to the originator or any
subsequent holder.
The agencies are retaining the proposed requirement from the
original proposal that the lender obtain a first lien on the financed
property. The agencies note that most CRE loan agreements allow the
lender to receive additional security by taking an assignment of leases
or other occupancy agreements on the CRE property, and the right to
enforce those leases in case of a breach by the borrower. In addition,
the agencies observe that standard CRE loan agreements also often
include a first lien on all interests the borrower has in or arising
out of the property used to operate the building (for example,
furniture in a hotel). The agencies believe these practices enhance
prudent lending and therefore would be appropriate to include this
blanket lien requirement on most types of borrower property to support
a QCRE loan. There would be an exception for purchase-money security
interests in machinery, equipment, or other borrower personal property.
The agencies continue to believe that as long as the machinery and
equipment or other personal property subject to a purchase-money
security interest is also pledged as additional collateral for the QCRE
loan, it would be appropriate to allow such other liens. In addition,
the proposal would restrict junior liens on the underlying real
property and leases, rents, occupancy, franchise and license agreements
unless a total CLTV ratio was satisfied.
The agencies are continuing to propose a requirement that the
borrower maintain insurance against loss on the CRE property at least
up to the amount of the CRE loan. The agencies believe that the
insurance requirement should serve to protect the interests of
investors and the qualifying CRE loan in the event of damage to the
property. Insuring only the replacement cost would not sufficiently
protect investors, who may be exposed to loss on the CRE loan from
significantly diminished cash flows during the period when a damaged
CRE property is being repaired or rebuilt.
Although commenters were concerned that few CMBS issuers will be
able to use this exemption due to the conservative QCRE criteria, the
agencies are keeping many of the same underwriting characteristics for
the reasons discussed at the beginning of Part V of this Supplementary
Information.
Request for Comment
81(a). Is including these requirements in the QCRE exemption
appropriate? 81(b). Why or why not?
82. The agencies request comment on the proposed underwriting
standards, including the proposed definitions and the documentation
requirements
C. Qualifying Automobile Loans
The original proposal included underwriting standards for
automobile loans that would be exempt from risk retention (qualifying
automobile loans, or QALs). Some commenters proposed including an
additional QAL-lite option, which would incorporate less stringent
underwriting standards but be subject to a 2.5 percent risk retention
amount based on a matrix of borrower FICO scores, loan terms and LTVs
of up to 135 percent. The agencies are declining to propose a QAL-lite
standard to avoid imposing a regulatory burden of monitoring multiple
underwriting standards for this asset class. However, as discussed
below, the agencies are proposing to allow blended pools of QALs and
non-QALs, which should help address commenters' concerns. The
definition of automobile loan in the original proposal generally would
have included only first-lien loans on light passenger vehicles
employed for personal use. It specifically would have excluded loans
for vehicles for business use, medium or heavy vehicles (such as
commercial trucks and vans), lease financing, fleet sales, and
recreational vehicles such as motorcycles. The underwriting standards
from the original proposal focused predominately on the borrower's
credit history and a down payment of 20 percent.
While some commenters supported the definition of automobile loan,
others stated it was too narrow. These commenters suggested expanding
the definition to include motorcycles because they may not be used
solely as recreational vehicles. In addition, commenters suggested
allowing vehicles purchased by individuals for business use, as it may
be impossible to monitor the use of a vehicle after sale. Commenters
representing sponsors also supported allowing automobile leases to
qualify as QALs, with corresponding technical changes. In addition, a
few commenters supported expanding the definition to include fleet
purchases or fleet leasing, on the basis that these leases or sales are
generally with corporations or government entities with strong
repayment histories.
The agencies have considered these comments and are proposing a
definition of automobile loans for QAL underwriting standards that is
substantially similar to the definition in the original proposal. The
agencies believe it continues to be appropriate to restrict the
definition of automobile loan to not include loans on vehicles that are
more frequently used for recreational purposes, such as motorcycles or
other recreational vehicles. The agencies also do not believe it would
be appropriate to expand the exemption to include vehicles used for
business purposes, as the risks and underwriting of such loans differ
from those of vehicles used for personal transportation. For example, a
car or truck used in a business may endure significantly more wear and
depreciate much faster than a vehicle used only for normal household
use.
The agencies are not proposing to expand the definition to include
automobile leases. While the difference between an automobile purchase
and a lease may not be significant to a customer, leases represent a
different set of risks to securitization investors. As
[[Page 57984]]
one example, at the end of a lease, a customer has the right to return
the automobile, and the securitization may suffer a loss if the resale
price of that automobile is less than expected. In an automobile loan
securitization, the customer owns the vehicle at the end of the loan
term, and cannot return it to the dealer or the securitization trust.
In the original proposal, the agencies proposed conservative
underwriting standards, including a 36 percent DTI requirement, a 20
percent down payment requirement, and credit history standards.
Generally, commenters opposed the QAL criteria as too conservative, and
asserted that less than 1 percent of automobile loans would qualify.
Even those commenters who otherwise supported the conservative QAL
underwriting suggested some revisions would be necessary to bring them
in line with current market standards. Automobile sponsor commenters
acknowledged that the agencies' proposed terms would be consistent with
very low credit risk, or ``super-prime'' automobile loans, but believed
that the standard should be set at the ``prime'' level, consistent with
low credit risk. In addition, commenters criticized the agencies for
applying to QALs underwriting criteria similar to those they applied to
QRMs and unsecured lending. Automobile sponsor commenters stated that
automobile loans are significantly different from mortgage loans, as
they are smaller and shorter in duration and have readily-salable
collateral. Investor commenters supported a standard that was above
``prime,'' but indicated that they could support a standard that
included loans that did not meet the very conservative ``super-prime''
QAL criteria proposed by the agencies.
Although the agencies have taken into consideration the comments
that these standards do not reflect current underwriting practices, the
agencies generally do not believe it would be appropriate to include a
standard based on FICO scores in the QAL underwriting standards.
Further, as discussed in Part III.B.1 of this SUPPLEMENTARY
INFORMATION, the agencies have revised the risk retention requirements
to address some of the concerns about risk retention for automobile
securitizations to better enable sponsors of automobile securitizations
to comply with the risk retention requirements in a manner consistent
with their existing and current practices.
1. Ability To Repay
The agencies proposed in the original proposal for QALs a debt-to-
income (DTI) ratio not in excess of 36 percent of a borrower's monthly
gross income. Originators would have been required to verify a
borrower's income and debt payments using standard methods. Many
commenters opposed including a DTI ratio as part of the underwriting
criteria for QALs. These commenters believed that the significant
additional burden of collecting documents to verify debts and income
would far outweigh any benefit, and could have the unanticipated result
of only applying the burden to the most creditworthy borrowers whose
loans could potentially qualify for QAL status. A few commenters
asserted that it was nearly impossible to check information such as
required alimony or child support. In addition, these commenters were
concerned about potentially changing DTIs between origination and
securitization. Commenters also asserted that in practice, only the
most marginal of automobile lending used income or employment
verification. Some automobile sponsor commenters said the industry does
not use DTIs in prime automobile origination because they do not
believe it is predictive of default, and that the agencies should
instead adopt the established industry practice of setting FICO score
thresholds as an indicator of ability to repay.
The agencies have considered these comments, but continue to
believe that assessing a borrower's ability to repay is important in
setting underwriting criteria to identify automobile loans that would
not be subject to risk retention. DTI is a meaningful figure in
calculating a customer's ability to repay a loan, and therefore the
agencies continue to propose the same DTI requirement as in the
original proposal. As discussed in more detail, the agencies also
observe that they generally do not believe it would be appropriate to
include a standard based on FICO scores in the QAL underwriting
standards, because it would tie a regulatory requirement to third
party, private industry models.
2. Loan Terms
Under the original proposal, QAL interest rates and payments would
have had to be fixed over the term of the loan. In addition, the loan
would have had to be amortized on a straight-line basis over the term.
Loans could not have exceeded five years (60 months); for used car
loans, the maximum term would have been one year shorter for every year
difference between the current year and the used car's model year.
Furthermore, the terms would have required that the originator, or
agent, to retain physical possession of the title until full repayment.
While commenters supported the proposed requirements for fixed
interest rates and fixed monthly payments, most commenters opposed one
or more of the additional proposed QAL loan terms. The straight-line
amortization requirement was the most problematic issue for commenters.
Commenters asserted that automobile loans are generally amortized using
the simple interest method with fixed, level payments and that the
simple interest method provides that earlier payments would amortize
less principal, and later payments would amortize more principal,
rather than a straight-line amortization as proposed by the agencies.
In addition, many commenters were concerned that numerous states
require the vehicle's owner (borrower) to retain the physical title,
and that some states are moving to issue electronic titles that cannot
have a physical holder. These commenters suggested revising the
proposed rule to either remove the requirement, or condition it on
compliance with applicable state law.
Many commenters also opposed the 60-month maximum loan term,
stating that current industry standards allow for 72-month loans. Some
commenters believed that the used-car restrictions were too harsh,
citing the ``certified pre-owned'' programs available for most used
cars and longer car lives in general. These commenters suggested either
removing the used car term restriction, or else loosening the standard
to exclude from QALs used cars over six years old, rather than over
five years old, as proposed by the agencies. Commenters also suggested
a technical change to require the first payment within 45 days of the
contract date rather than on the closing date.
The agencies have considered these comments and are proposing the
QAL standards with some modifications to the original proposal's
standards. Instead of a straight-line amortization requirement, the
agencies are proposing a requirement that borrowers make level monthly
payments that fully amortize the automobile loan over its term. Second,
the agencies are replacing the requirement in the original proposal
that the originator retain physical title with a proposed requirement
that the lender comply with appropriate state law for recording a lien
on the title. Third, the agencies are proposing to expand the maximum
allowable loan term for QALs to the lesser of six years (72 months) or
10 years less the vehicle's age (current model year less vehicle's
model year). Due to this modification, there would no longer be a
distinction between new vehicles and
[[Page 57985]]
used vehicles for the QAL definition. Finally, the agencies are
proposing that payment timing be based on the contract date.
3. Reviewing Credit History
In the original proposal, an originator would have been required to
verify, within 30 days of originating a QAL, that the borrower was not
30 days or more past due; was not more than 60 days past due over the
past two years; and was not a judgment debtor or in bankruptcy in the
past three years. The agencies also proposed a safe harbor requiring
the originator to review the borrower's credit reports from two
separate agencies, both showing the borrower complies with the past-due
standards. Also, the agencies proposed a requirement that all QALs be
current at the closing of the securitization.
Commenters were concerned that these criteria in the original
proposal were so strict as to require them to follow the safe harbor.
They indicated substantial risk that they may make a QAL, but then
within 30 days after the loan, review the credit history and note a
single 30-day late payment, thus disqualifying the loan for QAL status.
To avoid this outcome, commenters (including some investors) suggested
removing the 30-day past due criteria, also citing their belief that
many otherwise creditworthy borrowers could have inadvertently missed a
single payment within that timeframe. Some sponsor commenters favored
elimination of the credit disqualification standards entirely in favor
of a FICO cutoff; some investor commenters acknowledged the established
role of FICO but favored maintaining most of the disqualification
standards in addition to FICO.
On the assumption that all originators would rely on the credit
report safe harbor, commenters asserted that the requirement to obtain
reports from two separate credit reporting agencies unnecessarily
increased costs. These commenters stated that so much information is
shared among the credit reporting agencies, that two credit reports are
no more predictive than one report of the creditworthiness of a
borrower. The commenters also stated that this report should be
obtained within 30 days of the contract date, rather than within 90
days as proposed.
Some commenters also opposed the requirement in the original
proposal that borrowers remain current when the securitization closes.
These commenters stated that securitizations have a ``cutoff'' date
before the closing date, when all the QALs would be pooled and
information verified. It would be possible for a loan to become late
between the cutoff and closing date without the sponsor knowing until
after closing. Instead, sponsors suggested replacing the proposed rule
requirement with a representation made by the sponsor that no loan in
the securitized pool is more than 30 days past due at cutoff, with the
securitizer being required to verify that representation for each loan
no more than 62 days from the securitization's closing date.
The agencies believe that a QAL should meet conservative
underwriting criteria, including that the borrower not be more than 30
days late. However, to reduce the burden associated with reviewing
credit reports for those delinquencies, the agencies are proposing to
require only one credit report rather than two, and that the report be
reviewed within 30 days of the contract date, as requested by
commenters. The agencies are proposing the same requirements as in the
original proposal for verification that the automobile loan is current
when it is securitized. The agencies believe a securitization exempt
from risk retention should contain only current automobile loans.
Finally, the agencies are not proposing requirements that would
rely on proprietary credit scoring systems or underwriting systems. The
agencies recognize that much of the current automobile lending industry
relies heavily or solely on a FICO score to approve automobile loans.
However, the agencies do not believe that a credit score alone is
sufficient underwriting for a conservative automobile loan with a low
risk of default. Furthermore, the agencies do not believe it is
appropriate to establish regulatory requirements that use a specific
credit scoring product from a private company, especially one not
subject to any government oversight or investor review of its scoring
model. The agencies believe that the risks to investors of trusting in
such proprietary systems and models weighs against this alternative,
and does not provide the transparency of the bright line underwriting
standards proposed by the agencies.
4. Loan-to-Value
In the original proposal, the agencies proposed to require
automobile loan borrowers to pay 100 percent of the taxes, title costs,
and fees, in addition to 20 percent of the net purchase price (gross
price less manufacturer and dealer discounts) of the car. For used
cars, the purchase price would have been the lesser of the actual
purchase price or a value from a national pricing service.
Most commenters opposed the down payment and loan-to-value
requirements. These commenters cited current automobile industry
practices where up to 100 percent of the purchase price of the car is
financed, along with taxes, title costs, dealer fees, accessories, and
warranties. Some commenters proposed eliminating the LTV entirely, or
replacing it with a less conservative standard.
The agencies have considered the comments and the underwriting
standards and have concluded that a lower down payment could be
required without a significant decline in the credit quality of a QAL.
Therefore, the agencies are proposing a down payment of at least 10
percent of the purchase price of the vehicle, plus 100 percent of all
taxes, fees, and extended warranties. The agencies do not believe that
a collateralized loan with an LTV over 90 percent would be low-risk,
and that a customer should put some of the customer's own cash into the
deal to reduce risks for strategic default and incent repayment of the
loan. The agencies would also define purchase price consistently across
new and used vehicles to equal the price negotiated with the dealer
less any manufacturer rebates.
Request for Comment
83(a). Are the revisions to the qualifying automobile loan
exemption appropriate? 83(b). If not, how can they be modified to more
appropriately reflect industry standards?
84. Are all the proposed underwriting criteria appropriate?
D. Qualifying Asset Exemption
As discussed above, numerous industry and sponsor commenters on the
original proposal for reduced risk retention requirements for
commercial, CRE, and automobile loans asserted that the requirement
that all assets in a collateral pool must meet the proposed
underwriting standards (qualifying assets) to exempt the securitization
transaction from risk retention was too stringent. These commenters
stated that requiring every asset in a collateral pool to meet the
proposed conservative underwriting requirements would make it difficult
to obtain a large enough pool of qualifying assets to issue a
securitization in a timely manner, and therefore some originators would
not underwrite to the qualifying asset standards. These commenters
suggested that the agencies allow a proportional reduction in required
risk retention for those assets in a collateral pool that met the
proposed underwriting standards. For example, if a pool contained 20
[[Page 57986]]
percent automobile loans that are qualifying assets and 80 percent of
other automobile loans, only 80 percent of the pool would be subject a
risk retention requirement.
Commenters representing investors in securitization transactions
generally opposed blended pools of qualifying assets and other assets.
These investors stated that blending could allow sponsors too much
latitude to mix high-quality qualifying assets, which may pay down
first, with low-quality non-qualifying assets, which would create
significant risk of credit loss for investors over the course of the
transaction.
The agencies have carefully considered the comments and are
proposing to apply a 0 percent risk retention requirement to qualifying
assets, where both qualifying assets and non-qualifying assets secure
an asset-backed security.\128\ Any non-qualifying assets that secure an
asset-backed security would be subject to the full risk retention
requirements in the proposed rule, including hedging and transfer
restrictions.
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\128\ Under 15 U.S.C. 78o-11(c)(1)(B)(ii), the agencies may
require a sponsor to retain less than 5 percent of the credit risk
for an asset that securitizes an asset-backed security, if the asset
meets the underwriting standards established by the agencies under
15 U.S.C. 78o-11(c)(2)(B). Accordingly, the agencies are proposing
to require 0 percent risk retention with respect to any asset
securitizing an asset-backed security that meet the proposed
underwriting standards for automobile loans, commercial loans, or
commercial real estate loans. See 15 U.S.C. 78o-11(c)(1)(B)(ii). The
agencies also believe that exempting qualifying assets from risk
retention would be consistent with 15 U.S.C. 78o-11(e) and the
purposes of the statute. The agencies believe the exemption could,
in a direct manner, help ensure high-quality underwriting standards
for assets that are available for securitization, and create
additional incentives under the risk retention rules for these high-
quality assets to be originated in the market. The agencies further
believe such an exemption would encourage appropriate risk
management practices by securitization sponsors and asset
originators, by establishing rigorous underwriting standards for the
exempt assets and providing additional incentives for these
standards to take hold in the marketplace.
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The agencies believe that applying a 0 percent risk retention
requirement to assets that meet the proposed underwriting standards
would be appropriate given the very high credit quality of such assets.
In addition, allowing both qualifying and non-qualifying assets to
secure an asset-backed security should promote liquidity in the
relevant securitization markets without harming the goals of risk
retention requirement. The agencies understand that a lender may not be
able to originate, or a sponsor aggregate, an entire pool of qualifying
assets within a reasonable amount of time to promote efficient
securitization. The agencies believe that the proposal to apply a 0
percent risk retention requirement to qualifying assets would likely
enhance the liquidity of loans underwritten to the qualifying asset
underwriting standards, thereby encouraging originators to underwrite
more qualifying assets of high credit quality.
The agencies recognize that section 15G is generally structured in
contemplation of pool-level exemptions, and that investors, whom the
statute is designed to protect, expressed some preference during the
agencies' initial proposal for a pool-level approach. The agencies
believe the structure of the proposal could offset these concerns. The
agencies are proposing to reduce the sponsor's 5 percent risk retention
requirement by the ratio of the combined unpaid principal balance (UPB)
of qualified loans bears to the total UPB of the loans in the
pool.\129\ The agencies believe this method is more appropriate than a
system based on the absolute number of qualifying loans in the pool, as
a sponsor could create a pool with a large number of small value
qualifying loans combined with a few low-quality loans with large
principal balances. The agencies have also considered an ``average
balance'' approach as an alternative, but are concerned that it could
be used to reduce overall risk retention on pools of loans with
disparate principal balances skewed towards a few large non-qualified
loans.
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\129\ If a $100 million pool of commercial mortgages included a
sum total of $20 million of qualified commercial mortgages (by UPB),
the ratio would be 1/5, and the sponsor could reduce its 5 percent
risk retention requirement by one-fifth, for a retention holding
requirement of 4 percent.
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To address transparency concerns, the agencies are proposing that
sponsors of asset-backed securities that are secured by both qualifying
and non-qualifying assets disclose to investors, their primary Federal
regulator (as appropriate), and the Commission the manner in which the
sponsor determined the aggregate risk retention requirement for the
pool after including qualifying assets with 0 percent risk retention, a
description of the qualified and nonqualified assets groups, and any
material differences between them with respect to the composition of
each group's loan balances, loan terms, interest rates, borrower credit
information, and characteristics of any loan collateral.
The agencies would not make blended pool treatment available for
securitizations of loans from different asset classes (i.e., automobile
and commercial) that secure the same asset-backed security. The
agencies believe that blending across asset classes would significantly
reduce transparency to investors. In addition, the agencies are also
considering imposing a limit on the amount of qualifying assets a
sponsor could include in any one securitization involving blended pools
through a 2.5 percent risk retention minimum for any securitization
transaction, but the agencies are also considering the possibility of
raising or lowering that limit by 1 or more percent. The agencies
recognize that it might be useful for sponsors acting on a transparent
basis to attempt to allay moderate investor reservations about some
assets in a pool by including other high-quality assets. However, one
consistent theme in the agencies consideration of risk retention has
been to require sponsors to hold a meaningful exposure to all assets
they securitize that are subject to the full risk retention
requirement. The agencies are concerned that providing sponsors
unlimited flexibility with respect to mixing qualifying and non-
qualifying collateral pools could create opportunities for practices
that would be inconsistent with this over-arching principle.
The agencies also acknowledge investor concerns about mixing
qualifying and non-qualifying assets, as noted above. For example, some
investors commenting on the original proposal expressed concern that
sponsors might be able to manipulate such combinations to achieve
advantages that are not easily discernible to investors, such as mixing
high-quality shorter-term assets with lower-quality longer-term assets.
In this regard, the agencies observe the Commission's current proposal
on loan level disclosures to investors in asset-backed securities
represents a mechanism by which investors would obtain a more detailed
view of loans in the pool than they sometimes did in prior
markets.\130\ However the agencies remain concerned about potential
abuses of this aspect of the proposed rule and seek comment on how to
address this issue beyond the disclosure requirements already included
in the proposed rule. For example, an additional requirement that
qualifying assets and non-qualifying assets in the same collateral pool
do not have greater than a one year difference in maturity might
alleviate some investor concerns.
[[Page 57987]]
Additional disclosure requirements might also alleviate this concern.
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\130\ See Asset-Backed Securities, Release Nos. 33-9117, 34-
61858, 75 FR 23328 (May 3, 2010), and Re-proposal of Shelf
Eligibility Conditions for Asset-Backed Securities and Other
Additional Requests for Comment, Release Nos. 33-9244, 34-64968, 76
FR 47948 (August 5, 2011).
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In addition, the agencies are proposing (consistent with the
original proposal) that securitization transactions that are
collateralized solely by qualifying assets (of the same asset class)
and servicing assets would be exempt from the risk retention
requirements of the proposed rule.
Request for Comment
85. Commenters on the QRM approach contained in the agencies'
original proposal requested that the agencies permit blended pools for
RMBS. The agencies invite comment on whether and, if so how, such an
approach may be constructed where the underlying assets are residential
mortgages, given the provisions of paragraph (c)(1)(B)(i)(II) and the
exemption authority in paragraph (c)(2)(B), (e)(1) and (e)(2) of
Section 15G.
86(a). How should the proportional reduction in risk retention be
calculated? 86(b). What additional disclosures should the agencies
require for collateral pools that include both qualifying and non-
qualifying assets? 86(c). How would these additional disclosures
enhance transparency and reduce the risk of sponsors taking advantage
of information asymmetries? 86(d). Should a collateral pool that
secures asset-backed securities be subject to a minimum total risk
retention requirement of 2.5 percent? 86(e). If not, what would be an
appropriate limit on the amount of qualifying assets that may be
included in a collateral pool subject to 0 percent risk retention?
86(f). What other limiting mechanisms would be appropriate for mixed
collateral pools?
87(a). Would a maturity mismatch limit such as the one discussed
above (such that qualifying and non-qualifying assets do not have a
difference in maturity of more than one year) be an appropriate
requirement for collateral pools containing qualifying and non-
qualifying assets? 87(b). How should such a limit be structured? 87(c).
What other limits would be appropriate to address the investor and
agency concerns discussed above?
E. Buyback Requirement
The original proposal provided that, if after issuance of a
qualifying asset securitization, it was discovered that a loan did not
meet the underwriting criteria, the sponsor would have to repurchase
the loan. Industry commenters asserted that if the agencies retained
this requirement, it should include a materiality standard.
Alternately, these groups suggested that the agencies allow curing
deficiencies in the underwriting or loans instead of requiring buyback.
Finally, industry commenters stated that they should not be responsible
for post-origination problems with qualifying loans, and expressed
concern that investors may seek to use the buyback requirement to make
the sponsor repurchase poorly performing assets that met all the
requirements at origination. Investor commenters, on the other hand,
supported the buyback requirement as the sole remedy, and they opposed
relying solely on representations and warranties.
The agencies have observed that during the recent financial crisis,
investors who sought a remedy through representations and warranties
often struggled through litigation with the sponsor or originator.
Requiring the prompt repurchase of non-qualifying loans affords
investors a clear path to remedy problems in the original underwriting.
Therefore, the agencies are again proposing a buyback requirement for
commercial, CRE, and automobile loans subsequently found not to meet
the underwriting requirements for an exemption to the risk retention
requirements. However, the agencies also agree with the sponsor
commenters that buyback should not be the sole remedy, and therefore
are proposing to allow a sponsor the option to cure a defect that
existed at the time of origination to bring the loan into conformity
with the proposed underwriting standards. Curing a loan should put the
investor in no better or worse of a position than if the loan had been
originated correctly. Some origination deficiencies may not be able to
be cured after origination, and so for those deficiencies, buyback
would remain the sole remedy.
The agencies also agree that buyback or cure should occur only when
there are material problems with the qualifying loan that caused it not
to meet the qualifying standards at origination. The agencies are not
proposing any specific materiality standards in the rule, but believe
that sponsors and investors could be guided by standards of
materiality.\131\
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\131\ See, e.g., TSC Industries, Inc. v. Northway, Inc., 426
U.S. 438 (1976).
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Finally, as the agencies explained in the original proposal, the
underwriting requirements need to be met only at the origination of the
loan. Subsequent performance of the loan, absent any failure to meet
the underwriting requirements at origination or failure of the loan to
be current at the time of origination, would not be grounds for a loan
buyback or cure. The borrower's failure to meet its continuing
obligations under the loan document covenants required for qualifying
loan treatment, such as the requirement for periodic financial
statements for CRE loans, would also not be grounds for a buyback or
cure if the loan terms at origination appropriately imposed the
obligation on the borrower.
Request for Comment
88. The agencies request comment on the buyback provision for
qualifying loans, including on the proposed changes discussed above to
allow cure and to incorporate a materiality standard.
VI. Qualified Residential Mortgages
A. Overview of Original Proposal and Public Comments
Section 15G of the Exchange Act exempts sponsors of securitizations
from the risk retention requirements if all of the assets that
collateralize the securities issued in the transaction are QRMs.\132\
Section 15G directs the agencies to define QRM jointly, taking into
consideration underwriting and product features that historical loan
performance data indicate result in a lower risk of default. In
addition, section 15G requires that the definition of a QRM be ``no
broader than'' the definition of a QM.\133\
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\132\ See 15 U.S.C. 78o-11(c)(1)(C)(iii).
\133\ See id. at section 78o-11(e)(4).
---------------------------------------------------------------------------
In developing the definition of a QRM in the original
proposal,\134\ the agencies articulated several goals and principles.
First, the agencies stated that QRMs should be of very high credit
quality, given that Congress exempted QRMs completely from the credit
risk retention requirements. Second, the agencies recognized that
setting fixed underwriting rules to define a QRM could exclude many
mortgages to creditworthy borrowers. In this regard, the agencies
recognized that a trade-off exists between the lower implementation and
regulatory costs of providing fixed and simple eligibility requirements
and the lower probability of default attendant to requirements that
incorporate detailed and compensating underwriting factors. Third, the
agencies sought to preserve a sufficiently large population of non-QRMs
to help enable the market for securities backed by non-QRM mortgages to
be relatively liquid. Fourth, the agencies sought to implement
standards that would be
[[Page 57988]]
transparent and verifiable to participants in the market.
---------------------------------------------------------------------------
\134\ See Original Proposal, 76 FR at 24117.
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The agencies also sought to implement the statutory requirement
that the definition of QRM be no broader than the definition of a QM,
as mandated by the Dodd-Frank Act.\135\ Under the original proposal,
the agencies proposed to incorporate the statutory QM standards, in
addition to other requirements, into the definition of a QRM and apply
those standards strictly in setting the QRM requirements to ensure that
the definition of QRM would be no broader than the definition of a QM.
The agencies noted in the original proposal that they expected to
monitor the rules adopted under TILA to define a QM and review those
rules to determine whether changes to the definition of a QRM would be
necessary or appropriate.
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\135\ See 15 U.S.C. 78o-11(e)(4)(C). At the time of issuance of
the original proposal on April 29, 2011, the Board had sole
rulemaking authority for defining QM, which authority transferred to
CFPB on July 21, 2011, the designated transfer date under the Dodd-
Frank Act.
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In considering how to determine if a mortgage is of sufficient
credit quality, the agencies examined data from several sources.\136\
Based on these and other data, the agencies originally proposed
underwriting and product features that were robust standards designed
to ensure that QRMs would be of very high credit quality.\137\ A
discussion of the full range of factors that the agencies considered in
developing a definition of a QRM can be found in the original
proposal.\138\
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\136\ As provided in the original proposal, the agencies
reviewed data supplied by McDash Analytics, LLC, a wholly owned
subsidiary of Lender Processing Services, Inc. (LPS), on prime
fixed-rate loans originated from 2005 to 2008, which included
underwriting and performance information on approximately 8.9
million mortgages; data from the 1992 to 2007 waves of the triennial
Survey of Consumer Finances (SCF), which focused on respondents who
had purchased their homes either in the survey year or the previous
year, and included information on approximately 1,500 families; and
data regarding loans purchased or securitized by the Enterprises
from 1997 to 2009, which consisted of more than 78 million
mortgages, and included data on loan products and terms, borrower
characteristics (e.g., income and credit score), and performance
data through the third quarter of 2010. See 76 FR at 24152.
\137\ The agencies acknowledged in the original proposal that
any set of fixed underwriting rules likely would exclude some
creditworthy borrowers. For example, a borrower with substantial
liquid assets might be able to sustain an unusually high DTI ratio
above the maximum established for a QRM. As this example indicates,
in many cases sound underwriting practices require judgment about
the relative weight of various risk factors (e.g., the tradeoff
between LTV and DTI ratios). These decisions are usually based on
complex statistical default models or lender judgment, which will
differ across originators and over time. However, incorporating all
of the tradeoffs, that may prudently be made as part of a secured
underwriting process into a regulation would be very difficult
without introducing a level of complexity and cost that could
undermine any incentives for sponsors to securitize, and originators
to originate, QRMs. See Original Proposal, 76 FR at 24118.
\138\ See Original Proposal, 76 FR at 24117-29.
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The agencies originally proposed to define QRM to mean a closed-end
credit transaction to purchase or refinance a one-to-four family
property at least one unit of which is the principal dwelling of a
borrower that was not: (i) Made to finance the initial construction of
a dwelling; (ii) a reverse mortgage; (iii) a temporary or ``bridge''
loan with a term of 12 months or less, such as a loan to purchase a new
dwelling where the borrower plans to sell a current dwelling within 12
months; or (iv) a timeshare plan described in 11 U.S.C. 101(53D).\139\
In addition, under the original proposal, a QRM (i) must be a first
lien transaction with no subordinate liens; (ii) have a mortgage term
that does not exceed 30 years; (iii) have maximum front-end and back-
end DTI ratios of 28 percent and 36 percent, respectively; \140\ (iv)
have a maximum LTV ratio of 80 percent in the case of a purchase
transaction, 75 percent in the case of rate and term refinance
transactions, and 70 percent in the case of cash out refinancings; (v)
include a 20 percent down payment from borrower funds in the case of a
purchase transaction; and (vi) meet certain credit history
restrictions.\141\
---------------------------------------------------------------------------
\139\ See id. at 24166.
\140\ A front-end DTI ratio measures how much of the borrower's
gross (pretax) monthly income is represented by the borrower's
required payment on the first-lien mortgage, including real estate
taxes and insurance. A back-end debt-to-income ratio measures how
much of a borrower's gross (pretax) monthly income would go toward
monthly mortgage and nonmortgage debt service obligations.
\141\ In order to facilitate the use of these standards for QRM
purposes, the original proposal included as an appendix to the
proposed rule (Additional QRM Standards Appendix) all of the
standards in the HUD Handbook 4155-1 that are used for QRM purposes.
(See HUD Handbook, available at http://portal.hud.gov/hudportal/HUD?src=/program_offices/administration/hudclips/handbooks/hsgh/4155.1.) The only modifications made to the relevant standards in
the HUD Handbook would be those necessary to remove those portions
unique to the FHA underwriting process (e.g., TOTAL Scorecard
instructions). See discussion in the Original Proposal, 76 FR at
24119.
---------------------------------------------------------------------------
The agencies sought comment on the overall approach to defining QRM
as well as on the impact of the QRM definition on the securitization
market, mortgage pricing, and credit availability, including to low-to-
moderate income borrowers. The agencies further requested comment on
the proposed eligibility criteria of QRMs, such as the LTV, DTI, and
borrower credit history standards.
The scope of the QRM definition generated a significant number of
comments. Some commenters expressed support for the overall proposed
approach to QRM, including the 20 percent down payment requirement of
the QRM definition. These commenters asserted that an LTV requirement
would be clear, objective, and relatively easy to implement, and
represent an important determinant of a loan's default probability.
However, the overwhelming majority of commenters, including
individuals, industry participants (e.g., real estate brokers, mortgage
bankers, securitization sponsors), insurance companies, public interest
groups, state agencies, financial institutions and trade organizations,
opposed various aspects of the originally proposed approach to defining
QRM. In addition, many members of Congress commented that the proposed
20 percent down payment requirement was inconsistent with legislative
intent, and strongly urged the agencies to eliminate or modify the down
payment requirement.
Many commenters argued that the proposed QRM definition was too
narrow, especially with respect to the LTV and DTI requirements. Many
of these commenters asserted that the proposed QRM definition would
prevent recovery of the housing market by restricting available credit,
and as a result, the number of potential homebuyers. These commenters
also argued that the proposed definition of QRM, especially when
combined with the complexities of the proposed risk retention
requirement that would have applied to non-QRMs, would make it
difficult for private capital to compete with the Enterprises and thus,
impede the return of private capital to the mortgage market. Many also
asserted that the proposed LTV and DTI requirements favored wealthier
persons and disfavored creditworthy low- and moderate-income persons
and first-time homebuyers. A number of commenters believed that LTV and
DTI elements of the proposed QRM definition would not only affect
mortgages originated for securitization, but would likely also be
adopted by portfolio lenders, magnifying the adverse effects described
above. Other commenters claimed that the proposed QRM definition and
proposed risk retention requirements would harm community banks and
credit unions by increasing costs to those who purchase loans
originated by these smaller institutions.
Some commenters urged the agencies to implement a more qualitative
QRM standard with fewer numerical thresholds. Others argued for a
matrix
[[Page 57989]]
system that would weigh compensating factors, instead of using an all-
or-nothing approach to meeting the threshold standards. Commenters
stated that requiring borrowers to put down more cash for a rate-and-
term refinancing may prevent them from refinancing with safer and more
economically desirable terms. Commenters were also critical of the
proposed credit history requirements (in particular, the 30-day past
due restriction), and the points and fees component of the proposed QRM
definition.
Although a few commenters supported the inclusion of servicing
standards in the QRM definition under the original proposal, the
majority of those who submitted comment on this subject opposed the
proposed servicing standards for a variety of reasons. For example,
commenters asserted that servicing standards were not an underwriting
standard or product feature, and were not demonstrated to reduce the
risk of default. In addition, commenters stated that the proposed
standards were too vague for effective compliance, and that the
proposed rule's approach of requiring them to be terms of the mortgage
loan would prevent future improvements in servicing from being
implemented with respect to QRMs.
Many commenters urged the agencies to postpone finalizing the QRM
definition until after the QM definition was finalized. Many commenters
also advocated for the agencies to align the QRM definition to the QM
definition.
B. Approach to Defining QRM
In determining the appropriate scope of the proposed QRM
definition, the agencies carefully weighed a number of factors,
including commenters' concerns, the cost of risk retention, current and
historical data on mortgage lending and performance, and the recently
finalized QM definition and other rules addressing mortgages. For the
reasons discussed more fully below, the agencies are proposing to
broaden and simplify the scope of the QRM exemption from the original
proposal and define ``qualified residential mortgage'' to mean
``qualified mortgage'' as defined in section 129C of TILA \142\ and
implementing regulations, as may be amended from time to time.\143\ The
agencies propose to cross-reference the definition of QM, as defined by
the CFPB in its regulations, to minimize potential for future conflicts
between the QRM standards in the proposed rule and the QM standards
adopted under TILA.
---------------------------------------------------------------------------
\142\ 15 U.S.C. 1639c.
\143\ See Final QM Rule.
---------------------------------------------------------------------------
The risk retention requirements are intended to address problems in
the securitization markets by requiring securitizers to generally
retain some economic interest in the credit risk of the assets they
securitize (i.e., have ``skin in the game''). Section 15G of the
Exchange Act requires the agencies to define a QRM exception from the
credit risk retention requirement, taking into consideration
underwriting and product features that historical loan performance data
indicate result in a lower expected risk of default. The requirements
of the QM definition are designed to help ensure that borrowers are
offered and receive residential mortgage loans on terms that reasonably
reflect their financial capacity to meet the payment obligations
associated with such loans. The QM definition excludes many loans with
riskier product features, such as negative amortization and interest-
only payments, and requires consideration and verification of a
borrower's income or assets and debt. This approach both protects the
consumer and should lead to lower risk of default on loans that qualify
as QM.
As discussed more fully below, the agencies believe a QRM
definition that aligns with the definition of a QM meets the statutory
goals and directive of section 15G of the Exchange Act to limit credit
risk, preserves access to affordable credit, and facilitates
compliance.
1. Limiting Credit Risk
Section 129(C)(a) of TILA, as implemented by 12 CFR 1026.43(c),
requires lenders to make a ``reasonable and good faith determination''
that a borrower has the ability to repay a residential mortgage loan.
The QM rules provide lenders with a presumption of compliance with the
ability-to-repay requirement. Together, the QM rules and the broader
ability-to-repay rules restrict certain product features and lax
underwriting practices that contributed significantly to the
extraordinary surge in mortgage defaults that began in 2007.\144\
---------------------------------------------------------------------------
\144\ See Christopher Mayer, Karen Pence, and Shane M. Sherlund,
``The Rise in Mortgage Defaults, Journal of Economic Perspectives,
23(1), 27-50 (Winter 2009).
---------------------------------------------------------------------------
The QM rule does this, in part, by requiring documentation and
verification of consumers' debt and income.\145\ To obtain the
presumption of compliance with the ability-to-repay requirement as a
QM, the loan must have a loan term not exceeding 30 years; points and
fees that generally do not exceed 3 percent; \146\ and not have risky
product features, such as negative amortization, interest-only and
balloon payments (except for those loans that qualify for the
definition of QM that is only available to eligible small portfolio
lenders).\147\ Formal statistical models indicate that mortgages that
do not meet these aspects of the QM definition rule are associated with
a higher probability of default.\148\
---------------------------------------------------------------------------
\145\ See generally 12 CFR 1026.43(c).
\146\ The QM definition provides a tiered-cap for points and
fees for loan amounts less than $100,000. See id. at 1026.43(e)(3).
\147\ See 78 FR 35430 (June 12, 2013). In addition, the loan
must have consumer debt payments that represent 43 percent or less
of a borrower's income, or the loan must be eligible for purchase,
guarantee or insurance by an Enterprise, HUD, the U.S. Department of
Veteran Affairs, the U.S. Department of Agriculture, or the Rural
Housing Service. See 12 CFR 1026.43(e)(2)(vi).
\148\ See Shane M. Sherlund, ``The Past, Present, and Future of
Subprime Mortgages,'' Finance and Economics Discussion Series, Paper
2008-63 available at http://www.federalreserve.gov/pubs/feds/2008/200863/200863pap.pdf; Ronel Elul, Nicholas S. Souleles, Souphala
Chomsisengphet, Dennis Glennon, and Robert Hunt. ``What `Triggers'
Mortgage Default?'' American Economic Review 100(2), 490-494 (May
2010).
---------------------------------------------------------------------------
Consistent with these statistical models, historical data indicate
that mortgages that meet the QM criteria have a lower probability of
default than mortgages that do not meet the criteria. This pattern is
most pronounced for loans originated near the peak of the housing
bubble, when non-traditional mortgage products and lax underwriting
proliferated. For example, of loans originated from 2005 to 2008, 23
percent of those that met the QM criteria experienced a spell of 90-day
or more delinquency or a foreclosure by the end of 2012, compared with
44 percent of loans that did not meet the QM criteria.\149\
---------------------------------------------------------------------------
\149\ For purposes of this calculation, mortgages that do not
meet the QM criteria are those with negative amortization, balloon,
or interest-only features; those with no documentation; and those
with DTI ratios in excess of 43 percent that were not subsequently
purchased or guaranteed by the Enterprises or the FHA. Because of
data limitations, loans with points and fees in excess of 3 percent
and low-documentation loans that do not comply with the QM
documentation criteria may be erroneously classified as QMs. The
default estimates are based on data collected from mortgage
servicers by Lender Processing Services and from securitized pools
by CoreLogic. These data will under-represent mortgages originated
and held by small depository institutions and adjustable-rate
mortgages guaranteed by the FHA. The difference between delinquency
statistics for QM and non-QM mortgages is consistent with a
comparable tabulation estimated on loans securitized or purchased by
the Enterprises. In the Enterprise analysis for loans originated
from 2005 to 2008, 14 percent of those that met the QM criteria,
compared with 33 percent of loans that did not meet the QM criteria,
experienced a 90-day or more delinquency or a foreclosure by the end
of 2012.
---------------------------------------------------------------------------
In citing these statistics, the agencies are not implying that they
consider a 23
[[Page 57990]]
percent default rate to be an acceptable level of risk. The expansion
in non-traditional mortgages and the lax underwriting during this
period facilitated the steep rise in house prices and the subsequent
sharp drop in house prices and surge in unemployment, and the default
rates reflect this extraordinary macroeconomic environment. This point
is underscored by the superior performance of more recent mortgage
vintages. For example, of prime fixed-rate mortgages that comply with
the QM definition, an estimated 1.4 percent of those originated from
2009 to 2010, compared with 16 percent of those originated from 2005 to
2008, experienced a 90-day or more delinquency or a foreclosure by the
end of 2012.\150\
---------------------------------------------------------------------------
\150\ The higher default rate for the loans originated from 2005
to 2008 may reflect the looser underwriting standards in place at
that time and the greater seasoning of these loans in addition to
the changes in the macroeconomic environment. The estimates are
shown only for prime fixed-rate mortgages because these mortgages
have made up almost all originations since 2008.
---------------------------------------------------------------------------
In the original proposal, the criteria for a QRM included an LTV
ratio of 80 percent or less for purchase mortgages and measures of
solid credit history that evidence low credit risk. Academic research
and the agencies' own analyses indicate that credit history and the LTV
ratio are significant factors in determining the probability of
mortgage default.\151\ However, these additional credit overlays may
have ramifications for the availability of credit that many commenters
argued were not outweighed by the corresponding reductions in
likelihood of default from including these determinants in the QRM
definition.
---------------------------------------------------------------------------
\151\ See Original Proposal, 76 FR at 24120-24124.
---------------------------------------------------------------------------
Moreover, the QM definition provides protections against mortgage
default that are consistent with the statutory requirements. As noted
above, risk retention is intended to align the interests of
securitization sponsors and investors. Misalignment of these interests
is more likely to occur where there is information asymmetry, and is
particularly pronounced for mortgages with limited documentation and
verification of income and debt. Academic studies suggest that
securities collateralized by loans without full documentation of income
and debt performed significantly worse than expected in the aftermath
of the housing boom.\152\
---------------------------------------------------------------------------
\152\ See Benjamin J. Keys, Amit Seru, and Vikrant Vig, ``Lender
Screening and the Role of Securitization: Evidence from Prime and
Subprime Mortgage Markets,'' Review of Financial Studies, 25(7)
(July 2012); Adam Ashcraft, Paul Goldsmith-Pinkham, and James
Vickery, ``MBS Ratings and the Mortgage Credit Boom,'' Federal
Reserve Bank of New York Staff Report 449 (2010), available at
http://www.newyorkfed.org/research/staff_reports/sr449.html.
---------------------------------------------------------------------------
The QM definition limits the scope of this information asymmetry
and misalignment of interests by requiring improved verification of
income and debt. An originator that does not follow these verification
requirements, in addition to other QM criteria, may be subject under
TILA to potential liability and a defense to foreclosure if the
consumer successfully claims he or she did not have the ability to
repay the loan.\153\ The potential risk arising from the consumer's
ability to raise a defense to foreclosure extends to the creditor,
assignee, or other holder of the loan for the life of the loan, and
thereby may provide originators and their assignees with an incentive
to follow verification and other QM requirements scrupulously.\154\
---------------------------------------------------------------------------
\153\ See sections 130(a) and 130(k) of TILA, 15 U.S.C. 1640.
\154\ There are limits on the exposure to avoid unduly
restricting market liquidity.
---------------------------------------------------------------------------
Other proposed and finalized regulatory changes are also intended
to improve the quality and amount of information available to investors
in QRM and non-QRM residential mortgage securitizations and incentivize
originators and servicers to better manage mortgage delinquencies and
potential foreclosures. These improvements may help to lessen the
importance of broad ``skin in the game'' requirements on sponsors as an
additional measure of protection to investors and the financial
markets. For example, the Commission has proposed rules that, if
finalized, would require in registered RMBS transactions disclosure of
detailed loan-level information at the time of issuance and on an
ongoing basis. The proposal also would require that securitizers
provide investors with this information in sufficient time prior to the
first sale of securities so that they can analyze this information when
making their investment decision.\155\ In addition, the CFPB has
finalized loan originator compensation rules that help to reduce the
incentives for loan originators to steer borrowers to unaffordable
mortgages \156\ as well as mortgage servicing rules that provide
procedures and standards that servicers must follow when working with
troubled borrowers in an effort to avoid unnecessary foreclosures.\157\
The Enterprises and the mortgage industry also have improved standards
for due diligence, representations and warrants, appraisals, and loan
delivery data quality and consistency.
---------------------------------------------------------------------------
\155\ See Asset-Backed Securities, Release Nos. 33-9117, 34-
61858 75 FR 23328 at 23335, 23355 (May 3, 2010).
\156\ See Loan Originator Compensation Requirements Under the
Truth in Lending Act (Regulation Z); Final Rules, 78 FR 11280 (Feb.
15, 2013).
\157\ See Mortgage Servicing Rules Under the Truth in Lending
Act (Regulation Z); Final Rule, 78 FR 10902 (Feb. 14, 2013);
Mortgage Servicing Rules Under the Truth in Lending Act (Regulation
Z); Final Rule, 78 FR 10696 (Feb. 14, 2013).
---------------------------------------------------------------------------
2. Preserving Credit Access
Mortgage lending conditions have been tight since 2008, and to date
have shown little sign of easing. Lending conditions have been
particularly restrictive for borrowers with lower credit scores,
limited equity in their homes, or with limited cash reserves. For
example, between 2007 and 2012, originations of prime purchase
mortgages fell about 30 percent for borrowers with credit scores
greater than 780, compared with a drop of about 90 percent for
borrowers with credit scores between 620 and 680.\158\ Originations are
virtually nonexistent for borrowers with credit scores below 620. These
findings are also evident in the results from the Senior Loan Officer
Opinion Survey. In the April 2012 Survey, a large share of lenders
indicated that they were less likely than in 2006 to originate loans to
borrowers with weaker credit profiles. In the April 2013 survey,
lenders indicated that their appetite for making such loans had not
changed materially over the previous year.\159\
---------------------------------------------------------------------------
\158\ These calculations are based on data provided by McDash
Analytics, LLC, a wholly owned subsidiary of Lender Processing
Services, Inc. The underlying data are provided by mortgage
servicers. These servicers classify loans as ``prime,''
``subprime,'' or ``FHA.'' Prime loans include those eligible for
sale to the Enterprises as well as those with favorable credit
characteristics but loan sizes that exceed the Enterprises'
guidelines (``jumbo loans'').
\159\ Data are from the Federal Reserve Board's Senior Loan
Officer Opinion Survey on Bank Lending Practices. The April 2012
report is available at http://www.federalreserve.gov/boarddocs/SnLoanSurvey/201205/default.htm and the April 2013 report is
available at http://www.federalreserve.gov/boarddocs/SnLoanSurvey/201305/default.htm.
---------------------------------------------------------------------------
Market conditions reflect a variety of factors, including various
supervisory, regulatory, and legislative efforts such as the
Enterprises' representations and warrants policies; mortgage servicing
settlements reached with federal regulators and the state attorney
generals; revised capital requirements; and new rules addressing all
aspects of the mortgage lending process. These efforts are far-reaching
and complex, and the interactions and aggregate effect of them on the
market and participants are difficult to predict. Lenders may
[[Page 57991]]
continue to be cautious in their lending decisions until they have
incorporated these regulatory and supervisory changes into their
underwriting and servicing systems and gained experience with the
rules.
The agencies are therefore concerned about the prospect of imposing
further constraints on mortgage credit availability at this time,
especially as such constraints might disproportionately affect groups
that have historically been disadvantaged in the mortgage market, such
as lower-income, minority, or first-time homebuyers.
The effects of the QRM definition on credit pricing and access can
be separated into the direct costs incurred in funding the retained
risk portion and the indirect costs stemming from the interaction of
the QRM rule with existing regulations and current market conditions.
The agencies' estimates suggest that the direct costs incurred by a
sponsor for funding the retained portion should be small. Plausible
estimates by the agencies range from zero to 30 basis points, depending
on the amount and form of incremental sponsor risk retention, and the
amount and form of debt in sponsor funding of incremental risk
retention. The funding costs may be smaller if investors value the
protections associated with risk retention and are thereby willing to
accept tighter spreads on the securities.
However, the indirect costs stemming from the interaction of the
QRM definition with existing regulations and market conditions are more
difficult to quantify and have the potential to be large. The agencies
judge that these costs are most likely to be minimized by aligning the
QM and QRM definitions. The QM definition could result in some
segmentation in the mortgage securitization market, as sponsors may be
reluctant to pool QMs and non-QMs because of the lack of presumption of
compliance available to assignees of non-QMs. As QRMs cannot be
securitized with non-QRMs under the proposed rule,\160\ the QRM
definition has the potential to compound this segmentation if the QM
and QRM definitions are not aligned. Such segmentation could also lead
to an increase in complexity, regulatory burden, and compliance costs,
as lenders might need to set up separate underwriting and
securitization platforms beyond what is already necessitated by the QM
definition. These costs could be passed on to borrowers in the form of
higher interest rates or tighter credit standards. Finally, in addition
to the costs associated with further segmentation of the market,
setting a QRM definition that is distinct from the QM definition may
interact with the raft of other regulatory changes in ways that are
near-impossible to predict. Cross-referencing to the QM definition
should facilitate compliance with QM and reduce these indirect costs.
---------------------------------------------------------------------------
\160\ See 15 U.S.C. 78o-11(c)(1)(B).
---------------------------------------------------------------------------
The agencies recognize that aligning the QRM and QM definitions has
the potential to intensify any existing bifurcation in the mortgage
market between QM and non-QM loans, as securitizations collateralized
by non-QMs could have higher funding costs due to risk retention
requirements in addition to potential risk of legal liability under the
ability-to-repay rule. The agencies acknowledge this risk but judge it
to be smaller than the risk associated with further segmentation of the
market.
If adopted, the agencies intend to review the advantages and
disadvantages of aligning the QRM and QM definitions as the market
evolves to ensure the rule best meets the statutory objectives of
section 15G of the Exchange Act.
Request for Comment
89(a). Is the agencies' approach to considering the QRM definition,
as described above, appropriate? 89(b). Why or why not? 89(c). What
other factors or circumstances should the agencies take into
consideration in defining QRM?
C. Proposed Definition of QRM
As noted above, Section 15G of the Exchange Act requires, among
other things, that the definition of QRM be no broader than the
definition of QM. The Final QM Rule is effective January 10, 2014.\161\
The external parameters of what may constitute a QRM may continue to
evolve as the CFPB clarifies, modifies or adjusts the QM rules.\162\
---------------------------------------------------------------------------
\161\ See Final QM Rule.
\162\ For example, the CFPB recently finalized rules to further
clarify when a loan is eligible for purchase, insurance or guarantee
by an Enterprise or applicable federal agency for purposes of
determining whether a loan is a QM. See Amendments to the 2013
Mortgage Rules under the Real Estate Settlement Procedures Act
(Regulation X) and the Truth in Lending Act (Regulation Z), 78 FR
44686 (July 24, 2013). The CFPB also recently proposed rules that
further address what amounts should be included as loan originator
compensation in certain cases (i.e., manufactured home loans) for
purposes of calculating the 3 percent points and fees threshold
under the QM rules. See Amendments to the 2013 Mortgage Rules under
the Equal Credit Opportunity Act (Regulation B), Real Estate
Settlement Procedures Act (Regulation X), and the Truth in Lending
Act (Regulation Z), 78 FR 39902 (July 2, 2013).
---------------------------------------------------------------------------
Because the definition of QRM incorporates QM by reference, the
proposed QRM definition would expressly exclude home-equity lines of
credit (HELOCs), reverse mortgages, timeshares, and temporary loans or
``bridge'' loans of 12 months or less, consistent with the original
proposal of QRM.\163\ It would also expand the types of loans eligible
as QRMs.\164\ Under the original proposal, a QRM was limited to closed-
end, first-lien mortgages used to purchase or refinance a one-to-four
family property, at least one unit of which is the principal dwelling
of the borrower. By proposing to align the QRM definition to the QM
definition, the scope of loans eligible to qualify as a QRM would be
expanded to include any closed-end loan secured by any dwelling (e.g.,
home purchase, refinances, home equity lines, and second or vacation
homes).\165\ Accordingly, the proposed scope of the QRM definition
would differ from the original proposal because it would include loans
secured by any dwelling (consistent with the definition of QM), not
only loans secured by principal dwellings. In addition, if a
subordinate lien meets the definition of a QM, then it would also be
eligible to qualify as a QRM, whereas under the original proposal QRM-
eligibility was limited to first-liens. The agencies believe the
expansion to permit loans secured by any dwelling, as well as
subordinate liens, is appropriate to preserve credit access and
simplicity in incorporating the QM definition into QRM.
---------------------------------------------------------------------------
\163\ Also excluded would be most loan modifications, unless the
transaction meets the definition of refinancing set forth in section
1026.20(a) of the Final QM rule, and credit extended by certain
community based lending programs, down payment assistance providers,
certain non-profits, and Housing Finance Agencies, as defined under
24 CFR 266.5. For a complete list, see 12 CFR 1026.43(a).
\164\ See 12 CFR 1026.43(e)(2), which provides that QM is a
covered transaction that meets the criteria set forth in Sec. Sec.
1026.43(e)(2), (4), (5), (6) or (f). A ``covered transaction'' is
defined to mean ``a consumer credit transaction that is secured by a
dwelling, as defined in Sec. 1026.2(a)(19), including any real
property attached to a dwelling, other than a transaction exempt
from coverage under [Sec. 1026.43(a)].''
\165\ See 12 CFR 1026.43(a).
---------------------------------------------------------------------------
The CFPB regulations implementing the rules for a QM provide
several definitions of a QM. The agencies propose that a QRM would be a
loan that meets any of the QM definitions.\166\
---------------------------------------------------------------------------
\166\ See 12 CFR 1026.43(e)(2), (e)(4), (e)(5), or (e)(6) or
(f).
---------------------------------------------------------------------------
These include the general QM definition, which provide that a loan
must have:
Regular periodic payments that are substantially equal;
[[Page 57992]]
No negative amortization, interest only, or balloon
features;
A maximum loan term of 30 years;
Total points and fees that do not exceed 3 percent of the
total loan amount, or the applicable amounts specified in the Final QM
Rule, for small loans up to $100,000;
Payments underwritten using the maximum interest rate that
may apply during the first five years after the date on which the first
regular periodic payment is due;
Consideration and verification of the consumer's income
and assets, including employment status if relied upon, and current
debt obligations, mortgage-related obligations, alimony and child
support; and
Total debt-to-income ratio that does not exceed 43
percent.
In recognition of the current mortgage market conditions and
expressed concerns over credit availability, the CFPB also finalized a
second temporary QM definition.\167\ The agencies propose that a QRM
would also include a residential mortgage loan that meets this second
temporary QM definition. This temporary QM definition provides that a
loan must have:
---------------------------------------------------------------------------
\167\ 12 CFR 1026.43(e)(4).
---------------------------------------------------------------------------
Regular periodic payments that are substantially equal;
No negative amortization, interest only, or balloon
features;
A maximum loan term of 30 years;
Total points and fees, that do not exceed 3 percent of the
total loan amount, or the applicable amounts specified for small loans
up to $100,000; and
Be eligible for purchase, guarantee or insurance by an
Enterprise, HUD, the Veterans Administration, U.S. Department of
Agriculture, or Rural Housing Service.\168\
---------------------------------------------------------------------------
\168\ See 12 CFR 1206.43(e)(4)(ii).
---------------------------------------------------------------------------
Lenders that make a QM have a presumption of compliance with the
ability-to-repay requirement under 129C(a) of TILA, as implemented by
Sec. 1026.43(c) of Regulation Z, and therefore obtain some protection
from such potential liability.\169\ However, there are different levels
of protection from TILA liability \170\ depending on whether a QM is
higher-priced or not.\171\ QMs that are not higher-priced loans
received a legal safe harbor for compliance with the ability-to-repay
requirement, whereas QMs that are higher-priced covered transactions
received a rebuttable presumption of compliance.\172\ Both non-higher
priced and higher-priced QMs would be eligible as QRMs without
distinction, and could be pooled together in the same securitization.
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\169\ See section 129C(b)(1) of TILA, 15 U.S.C. 1639c(b)(1).
\170\ Lenders that violate the ability-to-repay requirement may
be liable for actual and statutory damages, plus court and attorney
fees. Consumers can bring a claim for damages within three years
against a creditor. Consumers can also raise a claim for these
damages at any time in a foreclosure action taken by the creditor or
an assignee. The damages are capped to limit the lender's liability.
See sections 130(a), (e), and (k) of TILA, 15 U.S.C. 1640. However,
the level of protection afforded differs depending on the loan's
price. For a detailed discussion of the safe harbor and presumption
of compliance, see 78 FR at 6510-6514.
\171\ For the definition of higher-priced covered transaction,
see 12 CFR 1026.43(b)(4) and accompanying commentary.
\172\ For a detailed discussion of the safe harbor and
presumption of compliance, see 78 FR at 6510-6514.
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The temporary QM definition for loans eligible for purchase or
guarantee by an Enterprise expires once the Enterprise exits
conservatorship.\173\ In addition, the FHA, the U.S. Department of
Veteran Affairs, the U.S. Department of Agriculture, and the Rural
Housing Service each have authority under the Dodd-Frank Act to define
QM for their own loans.\174\ The temporary QM definition for loans
eligible to be insured or guaranteed by one of these federal agencies
expires once the relevant federal agency issues its own QM rules.\175\
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\173\ See 12 CFR 1026.43(e)(4)(iii).
\174\ See section 129C(b)(3)(B)(ii) of TILA; 15 U.S.C. 1639c.
\175\ See 12 CFR 1026.43(e)(4)(iii).
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Finally, the CFPB provided several additional QM definitions to
facilitate credit offered by certain small creditors. The agencies
propose that a QRM would be a QM that meets any of these three special
QM definitions.\176\ The Final QM Rule allows small creditors to
originate loans as QMs with greater underwriting flexibility (e.g., no
quantitative DTI threshold applies) than under the general QM
definition.\177\ However, this third QM definition is available only to
small creditors that meet certain asset and threshold criteria \178\
and hold the QM loans in portfolio for at least three years, with
certain exceptions (e.g., transfer of a loan to another qualifying
small creditor, supervisory sales, and merger and acquisitions).\179\
Accordingly, loans meeting this third ``small creditor'' QM definition
would generally be ineligible as QRMs for three years following
consummation because they could not be sold.
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\176\ See 12 CFR 1026.43(e)(5), 12 CFR 1026.43(e)(6), and 12 CFR
1026.43(f).
\177\ See 12 CFR 1026.43(e)(5).
\178\ An entity qualifies as a ``small creditor'' if it does not
exceed $2 billion in total assets; originates 500 or fewer first-
lien covered transactions in the prior calendar year (including all
affiliates); and holds the QMs in portfolio for at least three
years, with certain exceptions. See 12 CFR 1026.43(e)(5)(i)(D),
discussed in detail in 78 FR at 35480-88 (June 12, 2013).
\179\ See 12 CFR 1026.43(e)(5)(ii).
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The Final QM Rule also provides these eligible small creditors with
a two-year transition period during which they can originate balloon
loans that are generally held in portfolio, and meet certain criteria,
as QMs.\180\ This two-year transition period expires January 10, 2016.
Again, loans meeting this fourth QM definition would generally be
ineligible as QRMs for three years following consummation. Last, the
Final QM Rule allows eligible small creditors that operate
predominantly in rural or underserved areas to originate balloon-
payment loans as QMs if they are generally held in portfolio, and meet
certain other QM criteria.\181\ Loans meeting this third QM definition
would also generally be ineligible for securitization for three years
following consummation because they cannot be sold.
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\180\ See 12 CFR 1026.43(e)(6), discussed in detail at 78 FR at
35488.
\181\ See 12 CFR 1026.43(f).
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For the reasons discussed above, the agencies are not proposing to
incorporate either an LTV ratio requirement or standards related to a
borrower's credit history into the definition of QRM.\182\ Furthermore,
the agencies are not proposing any written appraisal requirement or
assumability requirement as part of QRM. In response to comments, and
as part of the simplification of the QRM exemption from the original
proposal, the agencies are not proposing any servicing standards as
part of QRM.
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\182\ The agencies continue to believe that both LTV and
borrower credit history are important aspects of prudent
underwriting and safe and sound banking.
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Request for Comment
The agencies invite comment on all aspects of the proposal to
equate QRM with QM. In particular,
90. Does the proposal reasonably balance the goals of helping
ensure high quality underwriting and appropriate risk management, on
the one hand, and the public interest in continuing access to credit by
creditworthy borrowers, on the other?
91. Will the proposal, if adopted, likely have a significant effect
on the availability of credit? Please provide data supporting the
proffered view.
92(a). Is the proposed scope of the definition of QRM, which would
include loans secured by subordinate liens, appropriate? 92(b). Why or
why not? 92(c). To what extent do concerns
[[Page 57993]]
about the availability and cost of credit affect your answer?
93(a). Should the definition of QRM be limited to loans that
qualify for certain QM standards in the final QM Rule? 93(b). For
example, should the agencies limit QRMs to those QMs that could qualify
for a safe harbor under 12 CFR 1026.43(e)(1)? Provide justification for
your answer.
D. Exemption for QRMs
In order for a QRM to be exempted from the risk retention
requirement, the proposal includes evaluation and certification
conditions related to QRM status, consistent with statutory
requirements. For a securitization transaction to qualify for the QRM
exemption, each QRM collateralizing the ABS would be required to be
currently performing (i.e., the borrower is not 30 days or more past
due, in whole or in part, on the mortgage) at the closing of the
securitization transaction. Also, the depositor for the securitization
would be required to certify that it evaluated the effectiveness of its
internal supervisory controls to ensure that all of the assets that
collateralize the securities issued out of the transaction are QRMs,
and that it has determined that its internal supervisory controls are
effective. This evaluation would be performed as of a date within 60
days prior to the cut-off date (or similar date) for establishing the
composition of the collateral pool. The sponsor also would be required
to provide, or cause to be provided, a copy of this certification to
potential investors a reasonable period of time prior to the sale of
the securities and, upon request, to the Commission and its appropriate
Federal banking agency, if any.
Request for Comment
94(a). Are the proposed certification requirements appropriate?
94(b). Why or why not?
E. Repurchase of Loans Subsequently Determined To Be Non-Qualified
After Closing
The original proposal provided that, if after the closing of a QRM
securitization transaction, it was discovered that a mortgage did not
meet all of the criteria to be a QRM due to inadvertent error, the
sponsor would have to repurchase the mortgage. The agencies received a
few comments regarding this requirement. Some commenters were
supportive of the proposed requirement, while other commenters
suggested that the agencies allow substitution of mortgages failing to
meet the QRM definition.
The agencies are again proposing a buyback requirement for
mortgages that are determined to not meet the QRM definition by
inadvertent error after the closing of the securitization transaction,
provided that the conditions set forth in section 12 of the proposed
rules are met.\183\ These conditions are intended to provide a sponsor
with the opportunity to correct inadvertent errors by promptly
repurchasing any non-qualifying mortgage loans from the pool. In
addition, this proposed requirement would help ensure that sponsors
have a strong economic incentive to ensure that all mortgages backing a
QRM securitization satisfy all of the conditions applicable to QRMs
prior to closing of the transactions. Subsequent performance of the
loan, absent any failure to meet the QRM requirements at the closing of
the securitization transaction, however, would not trigger the proposed
buyback requirement.
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\183\ Sponsors may choose to repurchase a loan from securitized
pools even if there is no determination that the loan is not a QRM.
The agencies would not view such repurchases as determinative of
whether or not a loan meets the QRM standard.
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Request for Comment
95(a). What difficulties may occur with the proposed repurchase
requirement under the QRM exemption? 95(b). Are there alternative
approaches that would be more effective? 95(c). Provide details and
supporting justification.
E. Request for Comment on Alternative QRM Approach
Although the agencies believe that the proposed approach of
aligning QRM with QM is soundly based, from both a policy and a legal
standpoint, the agencies are seeking public input on its merits. The
agencies are also seeking input on an alternative approach, described
below, that was considered by the agencies, but ultimately not selected
as the preferred approach. The alternative approach would take the QM
criteria as a starting point for the QRM definition, and then
incorporate additional standards that were selected to reduce the risk
of default. Under this approach, significantly fewer loans likely would
qualify as a QRM and, therefore, be exempt from risk retention.
1. Description of Alternative Approach
The alternative approach, referred to as ``QM-plus'' would begin
with the core QM criteria adopted by the CFPB, and then add four
additional factors. Under this ``QM-plus'' approach:
Core QM criteria. A QRM would be required to meet the
CFPB's core criteria for QM, including the requirements for product
type,\184\ loan term,\185\ points and fees,\186\ underwriting,\187\
income and debt verification,\188\ and DTI.\189\ For loans meeting
these requirements, the QM-plus approach would draw no distinction
between those mortgages that fall within the CFPB's ``safe harbor''
versus those that fall within the CFPB's ``presumption of compliance
for higher-priced'' mortgages.\190\ Under QM-plus, either type of
mortgage that meets the CFPB's core criteria for QM would pass this
element of the QM-plus test. Loans that are QM because they meet the
CFPB's provisions for GSE-eligible covered transactions, small creditor
exceptions, or balloon loan provisions would, however, not be
considered QRMs under the QM-plus approach.
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\184\ 12 CFR 1026.43(e)(2)(i).
\185\ 12 CFR 1026.43(e)(2)(ii).
\186\ 12 CFR 1026.43(e)(2)(iii); 12 CFR 1026.43(e)(3).
\187\ 12 CFR 1026.43(e)(2)(iv).
\188\ 12 CFR 1026.43(e)(2)(v).
\189\ 12 CFR 1026.43(e)(2)(vi).
\190\ Cf. 12 CFR 1026.43(e)(1)(i) with 12 CFR 1026.43(e)(1)(ii).
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One-to-four family principal dwelling. In addition, QRM
treatment would only be available for loans secured by one-to-four
family real properties that constitute the principal dwelling of the
borrower.\191\ Other types of loans eligible for QM status, such as
loans secured by a boat used as a residence, or loans secured by a
consumer's vacation home, would not be eligible under the QM-plus
approach.
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\191\ The scope of properties that fall within the meaning of
``one-to-four family property'' and ``principal dwelling'' would be
consistent with the definitions used in the agencies' original QRM
proposal in Sec. --.15(a), including consistent application of the
meaning of the term ``principal dwelling'' as it is used in TILA
(see 12 CFR 1026.2(a)(24) and Official Staff Interpretations to the
Bureau's Regulation Z, comment 2(a)(24)-3).
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Lien requirements. All QRMs would be required to be first-
lien mortgages. For purchase QRMs, the QM-plus approach excludes so-
called ``piggyback'' loans; no other recorded or perfected liens on the
property could exist at closing to the knowledge of the originator. For
refinance QRMs, junior liens would not be prohibited, but would be
included in the LTV calculations described below.\192\
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\192\ These requirements are similar to those in the agencies'
original QRM proposal in Sec. --.15. See Sec. --.15(a)
(definitions of ``combined loan to value ratio'' and ``loan to value
ratio'') and Sec. --.15(d)(2) (subordinate liens).
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Credit history. To be eligible for QRM status, the
originator would be required to determine the borrower was not
currently 30 or more days past due on any debt obligation, and the
borrower had not been 60 or more days
[[Page 57994]]
past due on any debt obligations within the preceding 24 months.
Further, the borrower must not have, within the preceding 36 months,
been a debtor in a bankruptcy proceeding or been subject to a judgment
for collection of an unpaid debt; had personal property repossessed;
had any one-to-four family property foreclosed upon; or engaged in a
short sale or deed in lieu of foreclosure.\193\
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\193\ These credit history criteria would be the same as the one
used in the agencies' original QRM proposal in Sec. --.15(d)(5),
including the safe harbor allowing the originator to make the
required determination by reference to two credit reports.
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Loan to value ratio. To be eligible for QRM status, the
LTV at closing could not exceed 70 percent. Junior liens, which would
only be permitted for non-purchase QRMs as noted above, must be
included in the LTV calculation if known to the originator at the time
of closing, and if the lien secures a HELOC or similar credit plan,
must be included as if fully drawn.\194\ Property value would be
determined by an appraisal, but for purchase QRMs, if the contract
price at closing for the property was lower than the appraised value,
the contract price would be used as the value.\195\
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\194\ These requirements would be consistent with the approach
used in the agencies' original QRM proposal in Sec. Sec. --.15(a)
and ----.15(d)(9), except the same LTV would be used for purchases,
refinancings, and cash-out refinancings. As the agencies discussed
in the original proposal, there is data to suggest that refinance
loans are more sensitive to LTV level. See Original Proposal at
section IV.B.4. This single LTV approach in the QM-plus is
equivalent to the most conservative LTV level (for cash-out
refinancings) included in the original proposal.
\195\ As in the agencies' original proposal, the appraisal would
be required to be a written estimate of the property's market value,
and be performed not more than 90 days prior to the closing of the
mortgage transaction by an appropriately state-certified or state-
licensed appraiser that conforms to generally accepted appraisal
standards as evidenced by the Uniform Standards of Professional
Appraisal Practice promulgated by the Appraisal Standards Board of
the Appraisal Foundation, the appraisal requirements of the Federal
banking agencies, and applicable laws.
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As discussed elsewhere in this Supplementary Information, the
agencies' analysis of mortgage market data led the agencies to conclude
that an approach that aligns QRM with QM covers most of the present
mortgage market, and a significant portion of the historical market,
putting aside non-traditional mortgages related primarily to subprime
lending and lending with little documentation. This QM-plus approach
would cover a significantly smaller portion of the mortgage market.
Securitizers would be required to retain risk for QMs that do not meet
the four factors above.
Request for Comment
96(a). As documented in the initial proposal, academic research and
the agencies' own analyses show that credit history and loan-to-value
ratio are key determinants of mortgage default, along with the product
type factors that are included in the QM definition.\196\ If QRM
criteria do not address credit history and loan-to-value, would
securitizers packaging QRM-eligible mortgages into RMBS have any
financial incentive to be concerned with these factors in selecting
mortgages for inclusion in the RMBS pool? 96(b). Is the incentive that
would be provided by risk retention unnecessary in light of the
securitizer incentives and investor disclosures under an approach that
aligns QRM with QM as described in the previous section of this
Supplementary Information?
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\196\ Original Proposal, section IV.B.2; section IV.B.3; section
IV.B. 4; section IV.B.5; Appendix A to the SUPPLEMENTARY
INFORMATION.
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97(a). Does the QM-plus approach have benefits that exceed the
benefits of the approach discussed above that aligns QRM with QM? For
example, would the QM-plus approach favorably alter the balance of
incentives for extending credit that may not be met by the QM
definition approach or the QRM approach previously proposed? 97(b).
Would the QM-plus approach have benefits for financial stability?
98. Would the QM-plus approach have greater costs, for example in
decreased access to mortgage credit, higher priced credit, or increased
regulatory burden?
99. Other than the different incentives described above, what other
benefits might be obtained under the QM-plus approach?
2. Mortgage Availability and Cost
As discussed above, the overwhelming majority of commenters,
including securitization sponsors, housing industry groups, mortgage
bankers, lenders, consumer groups, and legislators opposed the
agencies' original QRM proposal, recommending instead that almost all
mortgages without features such as negative amortization, balloon
payments, or teaser rates should qualify for an exemption from risk
retention.\197\ The basis for these commenters' objections was a
unified concern that the proposal would result in a decrease in the
availability of non-QRM mortgages and an increase in their cost. The
other strong element of concern was that the original proposal's 20
percent purchase down payment requirement may have become a de facto
market-wide standard, with harsh consequences for borrowers in economic
circumstances that make it extremely difficult to save such sums.
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\197\ Some commenters expressed support for additional factors,
such as less stringent LTV restrictions, reliance on private
mortgage insurance for loans with LTVs in excess of such
restrictions, and different approaches to the agencies' proposed
credit quality restrictions.
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In developing QRM criteria under section 15G, the agencies have
balanced the benefits, including the public interest, with the cost and
the other considerations. To the extent risk retention would impose any
direct restriction on credit availability and price, the agencies
proposed an approach that aligns QRM with QM, which directly reflects
this concern.
There may be concerns, however, that the effect of aligning QRM
with QM could ultimately decrease credit availability as lenders, and
consequently securitizers, would be very reluctant to transact in non-
QM loans. Since the QM criteria have been issued (and even before),
many lenders have indicated they would not make any non-QM mortgages,
expressing concern that they are uncertain of their potential liability
under the TILA ability-to-repay requirements.
Request for Comment
100(a). Would setting the QRM criteria to be the same as QM
criteria give originators additional reasons to have reservations about
lending outside the QM criteria? 100(b). Would the QM-plus approach,
which confers a distinction on a much smaller share of the market than
the approach that aligns QRM with QM, have a different effect?
Numerous commenters on the original QRM proposal asserted that
lenders may charge significantly higher interest rates on non-QRM
loans, with estimates ranging from 75 to 300 basis points. A limited
number of these commenters described or referred to an underlying
analysis of this cost estimate. The agencies take note that a
significant portion of the costs were typically ascribed to provisions
of the risk retention requirements that the agencies have eliminated
from the proposal. As discussed in the previous section of this
Supplementary Information, the agencies are considering the factors
that will drive the incremental cost of risk retention. If the non-QRM
market is small relative to the QRM market, investors might demand a
liquidity premium for holding securities collateralized by non-QRMs.
Investors might also demand a risk premium for holding these securities
if non-QRMs are perceived to be lower-quality mortgages. If the scope
of the non-QRM
[[Page 57995]]
market is sufficiently broad to avoid these types of premiums, the
factors impacting cost will be the amount of additional risk retention
that would be required under the rule, above current market practice,
and the cost to the securitizer of funding and carrying that additional
risk retention asset, reduced by the expected yield on that asset.
There are a significant number of financial institutions that possess
securitization expertise and infrastructure, and that also have
management expertise in carrying the same type of ABS interests they
would be required to retain under the rule; in fact, they have long
carried large volumes of them as part of their business model. They
also compete for securitization business and compete on mortgage
pricing.
Request for Comment
101. In light of these factors, the agencies seek comment on
whether the QM-plus approach would encourage a broader non-QRM market
and thus mitigate concerns about the types of costs associated with a
narrow QRM approach described above. Considering the number of
institutions in the market with securitization capacity and expertise
that already hold RMBS interests presenting the same types of risks as
the RMBS interests the proposed rule now establishes as permissible
forms of risk retention, would the requirement to retain risk in a
greater number of securitizations under the QM-plus approach act as a
restraint on the amount and cost of mortgage credit available in the
market?
3. Private Securitization Activity
In structuring the risk retention rules, the agencies have sought
to minimize impediments to private securitization activity as a source
of market liquidity for lending activity, and this principle has not
been overlooked in the RMBS asset class. To the extent risk retention
would impose any impediment to private securitization activity, the
agencies proposed an approach that aligns QRM with QM to address that
concern.
In response to the agencies' original QRM proposal, comments from
RMBS investors generally supported the kinds of loan-to-value, credit
history, and debt-to-income factors the agencies proposed.\198\ While
there were some investors who expressed concern as to the exact
calibration of the QRM requirements, on balance, these commenters
expressed support for an approach that made risk retention the rule,
not the exception.
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\198\ For example, one such investor stated that the proposed
QRM criteria were appropriate to maintain the proper balance between
incentives for securitizers and mortgage credit availability. SIFMA
Asset Management. Another expressed concern that broadening the QRM
definition will give securitizers less ``skin in the game'' and
increase investors' risk exposure, which is contrary to investors'
long-term interests. Vanguard.
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Additionally, commenters recommended that the agencies examine data
from the private securitization market in addition to the GSE data that
was considered in the original proposal.
The agencies conducted two such analyses.\199\ The first analysis
was based on all securitized subprime and Alt-A loans originated from
2005 to 2008.\200\ That analysis indicated that of such mortgages that
did not meet the QM criteria, 52 percent experienced a serious
delinquency by the end of 2012, where serious delinquency is defined as
90 or more days delinquent or in foreclosure. In contrast, 42 percent
of such mortgages that met the QM criteria experienced a serious
delinquency by the end of 2012.\201\ If the set of QM-eligible
mortgages were limited to those with a loan-to-value ratio of 70
percent or less, the serious delinquency rate falls to 27 percent. As
discussed earlier in this Supplementary Information, these
extraordinarily high delinquency rates reflect the sharp drop in house
prices and surge in unemployment that occurred after the loans were
originated, as well as lax underwriting practices. In addition, Alt-A
and subprime loans are not reflective of the overall market and had
many features that would exclude them from the QM definition, but data
regarding these features were not always captured in the data sets.
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\199\ The two analyses are not perfectly comparable. The first
analysis included some loans with less than full documentation and
the second analysis excluded no documentation loans. The second
analysis used data with cumulative loan-to-value data while the
first did not, and the second analysis used a credit overlay while
the first did not.
\200\ These data are a subset of the same data referenced in
Part VI.B.1 of this Supplementary Information.
\201\ These data do not include information on points and fees
or full information on whether the loan met the QM documentation
requirements. If these factors were taken into account, the
delinquency rate on QM-eligible loans might be lower.
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The second analysis was based on all types of privately securitized
loans originated from 1997 to 2009.\202\ Although these data cover a
broader range of loan types and years than the first analysis, subprime
and Alt-A loans originated towards the end of the housing boom
represent the bulk of all issuance during this period. That analysis
indicated that 48 percent of mortgages that did not meet the QM
criteria experienced a serious delinquency by the end of 2012, compared
with 34 percent of mortgages that met the QM criteria. Limiting the set
of QM-eligible mortgages to those with a loan-to-value ratio of 70
percent or less and a minimum FICO score of 690 resulted in a 12
percent serious delinquency rate, and when that set was further limited
to a combined loan-to-value ratio of 70 percent or less, it resulted in
a 6.4 percent serious delinquency rate.
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\202\ See Part VIII.C.7.c, infra (Commission's Economic
Analysis).
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The agencies also analyzed GSE data to compare delinquency rates of
loans that would have met QM criteria with those of loans that would
have met criteria approximating the QM-plus criteria--those with loan-
to-value ratios of 70 percent or less, minimum FICO scores of 690, and
debt-to-income ratios of no more than 43 percent. Those meeting the
tighter criteria and originated in 2001-2004 had ever 90-day
delinquency rates of 1.1 percent, compared with 3.9 percent for all QM
loans. For loans originated in 2005-2008, the rates were 3.8 percent
and 13.9 percent, respectively.
Request for Comment
102. How would the QM-plus approach influence investors' decisions
about whether or not to invest in private RMBS transactions?
Another factor in investor willingness to invest in private label
RMBS, as well as the willingness of originators to sell mortgages to
private securitizers, concerns the presence of the Enterprises in the
market, operating as they are under the conservatorship of the FHFA and
with capital support by the U.S. Treasury.\203\ Currently, the vast
majority of residential mortgage securitization activity is performed
by the Enterprises, who retain 100 percent of the risk of the mortgages
they securitize.\204\
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\203\ Groups representing securitizers and mortgage originators
have recently expressed the view that restarting the private
securitization market for conforming mortgages is dependent upon
sweeping reform to the current role of the Enterprises. See, e.g.,
American Securitization Forum, White Paper: Policy Proposals to
Increase Private Capital in the U.S. Housing Finance System (April
23, 2013); Mortgage Bankers Association, Key Steps on the Road to
GSE Reform (August 8, 2013).
\204\ Ginnie Mae plays the next largest role.
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Request for Comment
103. How would the QM-plus approach affect or not affect investor
appetite for investing in private label RMBS as opposed to
securitizations guaranteed by the Enterprises?
The agencies note that the proposed requirements for risk retention
have
[[Page 57996]]
been significantly revised in response to commenter concerns about the
original proposal. With respect to the costs of risk retention for
sponsors and the possible effect that a QM-plus approach could have on
their willingness to participate in the securitization market, the
agencies request comment on whether risk retention could be unduly
burdensome for sponsors or whether it would provide meaningful
alignment of incentives between sponsors and investors.
Request for Comment
104. Since more RMBS transactions would be subject to risk
retention under the QM-plus approach, how would the proposed forms of
risk retention affect sponsors' willingness to participate in the
market?
4. Request for Comment About the Terms of the QM-Plus Approach
In addition, to the questions posed above, the agencies request
public comment on a few specific aspects of the QM-plus approach, as
follows.
a. Core QM Criteria
The QM-plus approach would only include mortgages that fall within
the QM safe harbor or presumption of compliance under the core QM
requirements. If a mortgage achieved QM status only by relying on the
CFPB's provisions for GSE-eligible covered transactions, small
creditors, or balloon loans, it would not be eligible for QRM
status.\205\
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\205\ Specifically, the QRM would need to be eligible for the
safe harbor or presumption of compliance for a ``qualified
mortgage,'' as defined in regulations codified at 12 CFR 1026.43(e)
and the associated Official Interpretations published in Supplement
I to Part 1026, without regard to the special rules at 12 CFR
1026.43(e)(4)-(6) or 12 CFR 1026.43(f).
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Request for Comment
105. The agencies request comment whether the QM-plus approach
should also include mortgages that fall within QM status only in
reliance on the CFPB's provisions for GSE-eligible covered
transactions, small creditors, or balloon loans. For all but the GSE-
eligible covered transactions, the CFPB's rules make the mortgages
ineligible for QM status if the originator sells them into the
secondary market within three years of origination. For GSE-eligible
loans, it appears sale to the GSEs may remain the best execution
alternative for small originators (although the agencies are seeking
comment on this point). The agencies request commenters advocating
inclusion of these non-core QMs under the QM-plus approach to address
specifically how inclusion would improve market liquidity for such
loans.
b. Piggyback Loans
For purchase QRMs, the QM-plus approach excludes so-called
``piggyback'' loans; no other recorded or perfected liens on the
property could exist at closing of the purchase mortgage, to the
knowledge of the originator at closing. The CFPB's QM requirements do
not prohibit piggyback loans, but the creditor's evaluation of the
borrower's ability to repay must include consideration of the
obligation on the junior lien (similar to the treatment the QM-plus
approach incorporates for junior liens on refinancing transactions). As
the agencies discussed in the original proposal, the economic
literature concludes that, controlling for other factors, including
combined LTV ratios, the use of junior liens at origination of purchase
mortgages to reduce down payments significantly increases the risk of
default.\206\
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\206\ See Original Proposal at note 132 and accompanying text.
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Request for Comment
106. The agencies request comment whether, notwithstanding the
agencies' concern about this additional risk of default, the agencies
should remove the outright prohibition on piggyback loans from the QM-
plus approach.
107(a). Commenters, including one group representing RMBS
investors, expressed concern that excluding loans to a borrower that is
30 days past due on any obligation at the time of closing from the
definition of QRM would be too conservative.\207\ The QM-plus approach
is based on the view that these 30-day credit derogatories are
typically errors, or oversights by borrowers, that are identified to
borrowers and eliminated during the underwriting process. Thus a 30-day
derogatory that cannot be resolved before closing is an indication of a
borrower who, as he or she approaches closing, is not meeting his or
her obligations in a timely way. The agencies request comments from
originators as to this premise. 107(b). The agencies also request
comment on whether the QM-plus approach should permit a borrower to
have a single 60-day plus past-due at the time of closing, but not two.
107(c). The agencies further request comment on whether this approach
should be included if the borrower's single 60-day past-due is on a
mortgage obligation.
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\207\ ASF Investors.
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In connection with the agencies' discussion elsewhere in this
Supplementary Information notice of underwriting criteria for
commercial loans, commercial mortgages, and auto loans, the agencies
have requested comment about permitting blended pools of qualifying and
non-qualifying assets, with proportional reductions in risk
retention.\208\ Commenters are referred to an invitation to comment on
blended pools with respect to residential mortgage securitizations that
appears at the end of that discussion.
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\208\ See Part V.D of this SUPPLEMENTARY INFORMATION.
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VII. Solicitation of Comments on Use of Plain Language
Section 722 of the Gramm-Leach-Bliley Act, Public Law 106-102, sec.
722, 113 Stat. 1338, 1471 (Nov. 12, 1999), requires the Federal banking
agencies to use plain language in all proposed and final rules
published after January 1, 2000. The Federal banking agencies invite
your comments on how to make this proposal easier to understand. For
example:
Have the agencies organized the material to suit your
needs? If not, how could this material be better organized?
Are the requirements in the proposed regulation clearly
stated? If not, how could the regulation be more clearly stated?
Does the proposed regulation contain language or jargon
that is not clear? If so, which language requires clarification?
Would a different format (grouping and order of sections,
use of headings, paragraphing) make the regulation easier to
understand? If so, what changes to the format would make the regulation
easier to understand?
What else could the agencies do to make the regulation
easier to understand?
VIII. Administrative Law Matters
A. Regulatory Flexibility Act
OCC: The Regulatory Flexibility Act (RFA) generally requires that,
in connection with a notice of proposed rulemaking, an agency prepare
and make available for public comment an initial regulatory flexibility
analysis that describes the impact of a proposed rule on small
entities.\209\ However, the regulatory flexibility analysis otherwise
required under the RFA is not required if an agency certifies that the
rule will not have a significant economic impact on a substantial
number of small entities (defined in regulations promulgated by the
Small Business Administration to include banking organizations with
total assets of less than or equal to $500
[[Page 57997]]
million) and publishes its certification and a short, explanatory
statement in the Federal Register together with the rule.
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\209\ See 5 U.S.C. 601 et seq.
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As discussed in the SUPPLEMENTARY INFORMATION above, section 941 of
the Dodd-Frank Act \210\ generally requires the Federal banking
agencies and the Commission, and, in the case of the securitization of
any residential mortgage asset, together with HUD and FHFA, to jointly
prescribe regulations, that (i) require a securitizer to retain not
less than 5 percent of the credit risk of any asset that the
securitizer, through the issuance of an asset-backed security (ABS),
transfers, sells, or conveys to a third party; and (ii) prohibit a
securitizer from directly or indirectly hedging or otherwise
transferring the credit risk that the securitizer is required to retain
under section 15G. Although the proposed rule would apply directly only
to securitizers, subject to a certain considerations, section 15G
authorizes the agencies to permit securitizers to allocate at least a
portion of the risk retention requirement to the originator(s) of the
securitized assets.
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\210\ Codified at section 15G of the Exchange Act, 17 U.S.C.
78o-11.
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Section 15G provides a total exemption from the risk retention
requirements for securitizers of certain securitization transactions,
such as an ABS issuance collateralized exclusively by QRMs, and further
authorizes the agencies to establish a lower risk retention requirement
for securitizers of ABS issuances collateralized by other asset types,
such as commercial, commercial real estate (CRE), and automobile loans,
which satisfy underwriting standards established by the Federal banking
agencies.
The risk retention requirements of section 15G apply generally to a
``securitizer'' of ABS, where securitizer is defined to mean (i) an
issuer of an ABS; or (ii) a person who organizes and initiates an
asset-backed transaction by selling or transferring assets, either
directly or indirectly, including through an affiliate, to the issuer.
Section 15G also defines an ``originator'' as a person who (i) through
the extension of credit or otherwise, creates a financial asset that
collateralizes an asset-backed security; and (ii) sells an asset
directly or indirectly to a securitizer.
The proposed rule implements the credit risk retention requirements
of section 15G. Section 15G requires the agencies to establish risk
retention requirements for ``securitizers.'' The proposal would, as a
general matter, require that a ``sponsor'' of a securitization
transaction retain the credit risk of the securitized assets in the
form and amount required by the proposed rule. The agencies believe
that imposing the risk retention requirement on the sponsor of the
ABS--as permitted by section 15G--is appropriate in light of the active
and direct role that a sponsor typically has in arranging a
securitization transaction and selecting the assets to be securitized.
Under the proposed rule a sponsor may offset the risk retention
requirement by the amount of any eligible vertical risk retention
interest or eligible horizontal residual interest acquired by an
originator of one or more securitized assets if certain requirements
are satisfied, including, the originator must originate at least 20
percent of the securitized assets, as measured by the aggregate unpaid
principal balance of the asset pool.
In determining whether the allocation provisions of the proposal
would have a significant economic impact on a substantial number of
small banking organizations, the Federal banking agencies reviewed
December 31, 2012 Call Report data to evaluate the origination and
securitization activity of small banking organizations that potentially
could retain credit risk directly through their own securitization
activity or indirectly under allocation provisions of the
proposal.\211\
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\211\ Call Report Schedule RC-S provides information on the
servicing, securitization, and asset sale activities of banking
organizations. For purposes of the RFA analysis, the agencies
gathered and evaluated data regarding (1) net securitization income,
(2) the outstanding principal balance of assets sold and securitized
by the reporting entity with servicing retained or with recourse or
other seller-provided credit enhancements, and (3) assets sold with
recourse or other seller-provided credit enhancements and not
securitized by the reporting bank.
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As of December 31, 2012, there were approximately 1,291 small
national banks and Federal savings associations that would be subject
to this rule. The Call Report data indicates that approximately 140
small national banks and Federal savings associations, originate loans
to securitize themselves or sell to other entities for securitization,
predominately through ABS issuances collateralized by one-to-four
family residential mortgages. This number reflects conservative
assumptions, as few small entities sponsor securitizations, and few
originate a sufficient number of loans for securitization to meet the
minimum 20 percent share for the allocation to originator provisions
under the proposed rule. As the OCC regulates approximately 1,291 small
entities, and 140 of those entities could be subject to this proposed
rule, the proposed rule could impact a substantial number of small
national banks and Federal savings associations.
The vast majority of securitization activity by small entities is
in the residential mortgage sector. The majority of these originators
sell their loans either to Fannie Mae or Freddie Mac, which retain
credit risk through agency guarantees and would not be able to allocate
credit risk to originators under this proposed rule. For those loans
not sold to the Enterprises, most would likely meet the QRM exemption.
The QM rule, on which the QRM proposal is based, also includes
exceptions for small creditors, which may be utilized by many of these
small entities to meet the requirements and thus not need to hold risk
retention on those assets. For these reasons, the OCC believes the
proposed rule would not have a substantial economic effect on small
entities.
Therefore, the OCC concludes that the proposed rule would not have
a significant impact on a substantial number of small entities. The OCC
seeks comments on whether the proposed rule, if adopted in final form,
would impose undue burdens, or have unintended consequences for, small
national banks and Federal savings associations and whether there are
ways such potential burdens or consequences could be minimized in a
manner consistent with section 15G of the Exchange Act.
Board: The Regulatory Flexibility Act (5 U.S.C. 603(b)) generally
requires that, in connection with a notice of proposed rulemaking, an
agency prepare and make available for public comment an initial
regulatory flexibility analysis that describes the impact of a proposed
rule on small entities.\212\ Under regulations promulgated by the Small
Business Administration, a small entity includes a commercial bank or
bank holding company with assets of $500 million or less (each, a small
banking organization).\213\ The Board has considered the potential
impact of the proposed rules on small banking organizations supervised
by the Board in accordance with the Regulatory Flexibility Act.
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\212\ See 5 U.S.C. 601 et seq.
\213\ 13 CFR 121.201.
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For the reasons discussed in Part II of this Supplementary
Information, the proposed rules define a securitizer as a ``sponsor''
in a manner consistent with the definition of that term in the
Commission's Regulation AB and provide that the sponsor of a
[[Page 57998]]
securitization transaction is generally responsible for complying with
the risk retention requirements established under section 15G. The
Board is unaware of any small banking organization under the
supervision of the Board that has acted as a sponsor of a
securitization transaction \214\ (based on December 31, 2012
data).\215\ As of December 31, 2012, there were approximately 5,135
small banking organizations supervised by the Board, which includes
4,092 bank holding companies, 297 savings and loan holding companies,
632 state member banks, 22 Edge and agreement corporations and 92 U.S.
offices of foreign banking organizations.
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\214\ For purposes of the proposed rules, this would include a
small bank holding company; savings and loan holding company; state
member bank; Edge corporation; agreement corporation; foreign
banking organization; and any subsidiary of the foregoing.
\215\ Call Report Schedule RC-S; Data based on the Reporting
Form FR 2866b; Structure Data for the U.S. Offices of Foreign
Banking Organizations; and Aggregate Data on Assets and Liabilities
of U.S. Branches and agencies of Foreign Banks based on the
quarterly form FFIEC 002.
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The proposed rules permit, but do not require, a sponsor to
allocate a portion of its risk retention requirement to one or more
originators of the securitized assets, subject to certain conditions
being met. In particular, a sponsor may offset the risk retention
requirement by the amount of any eligible vertical risk retention
interest or eligible horizontal residual interest acquired by an
originator of one or more securitized assets if certain requirements
are satisfied, including, the originator must originate at least 20
percent of the securitized assets, as measured by the aggregate unpaid
principal balance of the asset pool.\216\ A sponsor using this risk
retention option remains responsible for ensuring that the originator
has satisfied the risk retention requirements. In light of this option,
the Board has considered the impact of the proposed rules on
originators that are small banking organizations.
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\216\ With respect to an open market CLO transaction, the risk
retention retained by the originator must be at least 20 percent of
the aggregate principal balance at origination of a CLO-eligible
loan tranche.
---------------------------------------------------------------------------
The December 31, 2012 regulatory report data \217\ indicates that
approximately 723 small banking organizations, 87 of which are small
banking organizations that are supervised by the Board, originate loans
for securitization, namely ABS issuances collateralized by one-to-four
family residential mortgages. The majority of these originators sell
their loans either to Fannie Mae or Freddie Mac, which retain credit
risk through agency guarantees and would not be able to allocate credit
risk to originators under this proposed rule. Additionally, based on
publicly-available market data, it appears that most residential
mortgage-backed securities offerings are collateralized by a pool of
mortgages with an unpaid aggregate principal balance of at least $500
million.\218\ Accordingly, under the proposed rule a sponsor could
potentially allocate a portion of the risk retention requirement to a
small banking organization only if such organization originated at
least 20 percent ($100 million) of the securitized mortgages. As of
December 31, 2012, only one small banking organization supervised by
the Board reported an outstanding principal balance of assets sold and
securitized of $100 million or more.\219\
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\217\ Call Report Schedule RC-S provides information on the
servicing, securitization, and asset sale activities of banking
organizations. For purposes of the RFA analysis, the agencies
gathered and evaluated data regarding (1) the outstanding principal
balance of assets sold and securitized by the reporting entity with
servicing retained or with recourse or other seller-provided credit
enhancements, and (2) assets sold with recourse or other seller-
provided credit enhancements and not securitized by the reporting
bank.
\218\ Based on the data provided in Table 1, page 29 of the
Board's ``Report to the Congress on Risk Retention,'' it appears
that the average MBS issuance is collateralized by a pool of
approximately $620 million in mortgage loans (for prime MBS
issuances) or approximately $690 million in mortgage loans (for
subprime MBS issuances). For purposes of the RFA analysis, the
agencies used an average asset pool size $500 million to account for
reductions in mortgage securitization activity following 2007, and
to add an element of conservatism to the analysis.
\219\ The FDIC notes that this finding assumes that no portion
of the assets originated by small banking organizations were sold to
securitizations that qualify for an exemption from the risk
retention requirements under the proposed rule.
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In light of the foregoing, the proposed rules would not appear to
have a significant economic impact on sponsors or originators
supervised by the Board. The Board seeks comment on whether the
proposed rules would impose undue burdens on, or have unintended
consequences for, small banking organizations, and whether there are
ways such potential burdens or consequences could be minimized in a
manner consistent with section 15G of the Exchange Act.
FDIC: The Regulatory Flexibility Act (RFA) generally requires that,
in connection with a notice of proposed rulemaking, an agency prepare
and make available for public comment an initial regulatory flexibility
analysis that describes the impact of a proposed rule on small
entities.\220\ However, a regulatory flexibility analysis is not
required if the agency certifies that the rule will not have a
significant economic impact on a substantial number of small entities
(defined in regulations promulgated by the Small Business
Administration to include banking organizations with total assets of
less than or equal to $500 million) and publishes its certification and
a short, explanatory statement in the Federal Register together with
the rule.
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\220\ See 5 U.S.C. 601 et seq.
---------------------------------------------------------------------------
As of March 31, 2013, there were approximately 3,711 small FDIC-
supervised institutions, which include 3,398 state nonmember banks and
313 state-chartered savings banks. For the reasons provided below, the
FDIC certifies that the proposed rule, if adopted in final form, would
not have a significant economic impact on a substantial number of small
entities. Accordingly, a regulatory flexibility analysis is not
required.
As discussed in the SUPPLEMENTARY INFORMATION above, section 941 of
the Dodd-Frank Act \221\ generally requires the Federal banking
agencies and the Commission, and, in the case of the securitization of
any residential mortgage asset, together with HUD and FHFA, to jointly
prescribe regulations, that (i) require a securitizer to retain not
less than 5 percent of the credit risk of any asset that the
securitizer, through the issuance of an asset-backed security (ABS),
transfers, sells, or conveys to a third party; and (ii) prohibit a
securitizer from directly or indirectly hedging or otherwise
transferring the credit risk that the securitizer is required to retain
under section 15G. Although the proposed rule would apply directly only
to securitizers, subject to a certain considerations, section 15G
authorizes the agencies to permit securitizers to allocate at least a
portion of the risk retention requirement to the originator(s) of the
securitized assets.
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\221\ Codified at section 15G of the Exchange Act, 17 U.S.C.
78o-11.
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Section 15G provides a total exemption from the risk retention
requirements for securitizers of certain securitization transactions,
such as an ABS issuance collateralized exclusively by QRMs, and further
authorizes the agencies to establish a lower risk retention requirement
for securitizers of ABS issuances collateralized by other asset types,
such as commercial, commercial real estate (CRE), and automobile loans,
which satisfy underwriting standards established by the Federal banking
agencies.
The risk retention requirements of section 15G apply generally to a
``securitizer'' of ABS, where securitizer is defined to mean (i) an
issuer of an ABS; or (ii) a person who organizes and
[[Page 57999]]
initiates an asset-backed transaction by selling or transferring
assets, either directly or indirectly, including through an affiliate,
to the issuer. Section 15G also defines an ``originator'' as a person
who (i) through the extension of credit or otherwise, creates a
financial asset that collateralizes an asset-backed security; and (ii)
sells an asset directly or indirectly to a securitizer.
The proposed rule implements the credit risk retention requirements
of section 15G. The proposal would, as a general matter, require that a
``sponsor'' of a securitization transaction retain the credit risk of
the securitized assets in the form and amount required by the proposed
rule. The agencies believe that imposing the risk retention requirement
on the sponsor of the ABS--as permitted by section 15G--is appropriate
in view of the active and direct role that a sponsor typically has in
arranging a securitization transaction and selecting the assets to be
securitized. The FDIC is aware of only 40 small banking organizations
that currently sponsor securitizations (two of which are national
banks, seven are state member banks, 23 are state nonmember banks, and
eight are savings associations, based on March 31, 2013 information)
and, therefore, the risk retention requirements of the proposed rule,
as generally applicable to sponsors, would not have a significant
economic impact on a substantial number of small state nonmember banks.
Under the proposed rule a sponsor may offset the risk retention
requirement by the amount of any eligible vertical risk retention or
eligible horizontal residual interest acquired by an originator of one
or more securitized assets if certain requirements are satisfied,
including, the originator must originate at least 20 percent of the
securitized assets, as measured by the aggregate unpaid principal
balance of the asset pool.\222\ In determining whether the allocation
provisions of the proposal would have a significant economic impact on
a substantial number of small banking organizations, the Federal
banking agencies reviewed March 31, 2013 Call Report data to evaluate
the securitization activity and approximate the number of small banking
organizations that potentially could retain credit risk under
allocation provisions of the proposal.\223\
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\222\ With respect to an open market CLO transaction, the risk
retention retained by the originator must be at least 20 percent of
the aggregate principal balance at origination of a CLO-eligible
loan tranche.
\223\ Call Report Schedule RC-S provides information on the
servicing, securitization, and asset sale activities of banking
organizations. For purposes of the RFA analysis, the agencies
gathered and evaluated data regarding (1) the outstanding principal
balance of assets sold and securitized by the reporting entity with
servicing retained or with recourse or other seller-provided credit
enhancements, and (2) assets sold with recourse or other seller-
provided credit enhancements and not securitized by the reporting
bank.
---------------------------------------------------------------------------
The Call Report data indicates that approximately 703 small banking
organizations, 456 of which are state nonmember banks, originate loans
for securitization, namely ABS issuances collateralized by one-to-four
family residential mortgages. The majority of these originators sell
their loans either to Fannie Mae or Freddie Mac, which retain credit
risk through agency guarantees, and therefore would not be allocated
credit risk under the proposed rule. Additionally, based on publicly-
available market data, it appears that most residential mortgage-backed
securities offerings are collateralized by a pool of mortgages with an
unpaid aggregate principal balance of at least $500 million.\224\
Accordingly, under the proposed rule a sponsor could potentially
allocate a portion of the risk retention requirement to a small banking
organization only if such organization originated at least 20 percent
($100 million) of the securitized mortgages. As of March 31, 2013, only
two small banking organizations reported an outstanding principal
balance of assets sold and securitized of $100 million or more.\225\
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\224\ Based on the data provided in Table 1, page 29 of the
Board's ``Report to the Congress on Risk Retention,'' it appears
that the average MBS issuance is collateralized by a pool of
approximately $620 million in mortgage loans (for prime MBS
issuances) or approximately $690 million in mortgage loans (for
subprime MBS issuances). For purposes of the RFA analysis, the
agencies used an average asset pool size $500 million to account for
reductions in mortgage securitization activity following 2007, and
to add an element of conservatism to the analysis.
\225\ The FDIC notes that this finding assumes that no portion
of the assets originated by small banking organizations were sold to
securitizations that qualify for an exemption from the risk
retention requirements under the proposed rule.
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The FDIC seeks comment on whether the proposed rule, if adopted in
final form, would impose undue burdens, or have unintended consequences
for, small state nonmember banks and whether there are ways such
potential burdens or consequences could be minimized in a manner
consistent with section 15G of the Exchange Act.
Commission: The Commission hereby certifies, pursuant to 5 U.S.C.
605(b), that the proposed rule, if adopted, would not have a
significant economic impact on a substantial number of small entities.
The proposed rule implements the risk retention requirements of section
15G of the Exchange Act, which, in general, requires the securitizer of
asset-backed securities (ABS) to retain not less than 5 percent of the
credit risk of the assets collateralizing the ABS.\226\ Under the
proposed rule, the risk retention requirements would apply to
``sponsors,'' as defined in the proposed rule. Based on our data, we
found only one sponsor that would meet the definition of a small
broker-dealer for purposes of the Regulatory Flexibility Act.\227\
Accordingly, the Commission does not believe that the proposed rule, if
adopted, would have a significant economic impact on a substantial
number of small entities.
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\226\ See 17 U.S.C. 78o-11.
\227\ 5 U.S.C. 601 et seq.
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A few commenters on the original proposal indicated that the
proposed risk retention requirements could indirectly affect the
availability of credit to small businesses and lead to contractions in
the secondary mortgage market, with a corresponding reduction in
mortgage originations. The Regulatory Flexibility Act only requires an
agency to consider regulatory alternatives for those small entities
subject to the proposed rules. The Commission has considered the
broader economic impact of the proposed rules, including their
potential effect on efficiency, competition and capital formation, in
the Commission's Economic Analysis below.
The Commission encourages written comments regarding this
certification. The Commission requests, in particular, that commenters
describe the nature of any direct impact on small entities and provide
empirical data to support the extent of the impact.
FHFA: Pursuant to section 605(b) of the Regulatory Flexibility Act,
FHFA hereby certifies that the proposed rule will not have a
significant economic impact on a substantial number of small entities.
B. Paperwork Reduction Act
1. Request for Comment on Proposed Information Collection
Certain provisions of the proposed rule contain ``collection of
information'' requirements within the meaning of the Paperwork
Reduction Act of 1995 (``PRA''), 44 U.S.C. 3501-3521. In accordance
with the requirements of the PRA, the agencies may not conduct or
sponsor, and the respondent is not required to respond to, an
information collection unless it displays a currently valid Office of
Management and Budget (OMB) control number. The information collection
requirements contained in this joint notice of proposed rulemaking
[[Page 58000]]
have been submitted by the FDIC, OCC, and the Commission to OMB for
approval under section 3507(d) of the PRA and section 1320.11 of OMB's
implementing regulations (5 CFR part 1320). The Board reviewed the
proposed rule under the authority delegated to the Board by OMB.
Comments are invited on:
(a) Whether the collections of information are necessary for the
proper performance of the agencies' functions, including whether the
information has practical utility;
(b) The accuracy of the estimates of the burden of the information
collections, including the validity of the methodology and assumptions
used;
(c) Ways to enhance the quality, utility, and clarity of the
information to be collected;
(d) Ways to minimize the burden of the information collections on
respondents, including through the use of automated collection
techniques or other forms of information technology; and
(e) Estimates of capital or start-up costs and costs of operation,
maintenance, and purchase of services to provide information.
All comments will become a matter of public record. Commenters may
submit comments on aspects of this notice that may affect disclosure
requirements and burden estimates at the addresses listed in the
ADDRESSES section of this Supplementary Information. A copy of the
comments may also be submitted to the OMB desk officer for the
agencies: By mail to U.S. Office of Management and Budget, 725 17th
Street NW., 10235, Washington, DC 20503, by facsimile to 202-
395-6974, or by email to: [email protected]. Attention,
Commission and Federal Banking Agency Desk Officer.
2. Proposed Information Collection
Title of Information Collection: Credit Risk Retention.
Frequency of response: Event generated; annual, monthly.
Affected Public: \228\
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\228\ The affected public of the FDIC, OCC, and Board is
assigned generally in accordance with the entities covered by the
scope and authority section of their respective proposed rule. The
affected public of the Commission is based on those entities not
already accounted for by the FDIC, OCC, and Board.
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FDIC: Insured state non-member banks, insured state branches of
foreign banks, state savings associations, and certain subsidiaries of
these entities.
OCC: National banks, Federal savings associations, Federal branches
or agencies of foreign banks, or any operating subsidiary thereof.
Board: Insured state member banks, bank holding companies, savings
and loan holding companies, Edge and agreement corporations, foreign
banking organizations, nonbank financial companies supervised by the
Board, and any subsidiary thereof.
Commission: All entities other than those assigned to the FDIC,
OCC, or Board.
Abstract: The notice sets forth permissible forms of risk retention
for securitizations that involve issuance of asset-backed securities.
The proposed rule contains requirements subject to the PRA. The
information requirements in the joint regulations proposed by the three
Federal banking agencies and the Commission are found in sections --.4,
-- .5, -- .6, --.7, --.8, --.9, --.10, --.11, --.13, --.15, --.16,
--.17, and --.18. The agencies believe that the disclosure and
recordkeeping requirements associated with the various forms of risk
retention will enhance market discipline, help ensure the quality of
the assets underlying a securitization transaction, and assist
investors in evaluating transactions. Compliance with the information
collections would be mandatory. Responses to the information
collections would not be kept confidential and, except for the
recordkeeping requirements set forth in sections -- .4(e) and --
.5(g)(2), there would be no mandatory retention period for the proposed
collections of information.
Section-by-Section Analysis
Section --.4 sets forth the conditions that must be met by sponsors
electing to use the standard risk retention option, which may consist
of an eligible vertical interest or an eligible horizontal residual
interest, or any combination thereof. Sections -- .4(d)(1) and
--.4(d)(2) specify the disclosures required with respect to eligible
horizontal residual interests and eligible vertical interests,
respectively.
A sponsor retaining any eligible horizontal residual interest (or
funding a horizontal cash reserve account) is required to calculate the
Closing Date Projected Cash Flow Rate and Closing Date Projected
Principal Repayment Rate for each payment date, and certify to
investors that it has performed such calculations and that the Closing
Date Projected Cash Flow Rate on any payment date does not exceed the
Closing Date Projected Principal Repayment Rate on such payment date
(Sec. --.4(b)(2)).
Additionally, the sponsor is required to disclose: the fair value
of the eligible horizontal residual interest retained by the sponsor
and the fair value of the eligible horizontal residual interest
required to be retained (Sec. --.4(d)(1)(i)); the material terms of
the eligible horizontal residual interest (Sec. --.4(d)(1)(ii)); the
methodology used to calculate the fair value of all classes of ABS
interests (Sec. --.4(d)(1)(iii)); the key inputs and assumptions used
in measuring the total fair value of all classes of ABS interests, and
the fair value of the eligible horizontal residual interest retained by
the sponsor (Sec. --.4(d)(1)(iv)); the reference data set or other
historical information used to develop the key inputs and assumptions
(Sec. --.4(d)(1)(v)); the number of securitization transactions
securitized by the sponsor during the previous five-year period in
which the sponsor retained an eligible horizontal residual interest
pursuant to this section, and the number (if any) of payment dates in
each such securitization on which actual payments to the sponsor with
respect to the eligible horizontal residual interest exceeded the cash
flow projected to be paid to the sponsor on such payment date in
determining the Closing Date Projected Cash Flow Rate (Sec.
--.4(d)(1)(vi)); and the amount placed by the sponsor in the horizontal
cash reserve account at closing, the fair value of the eligible
horizontal residual interest that the sponsor is required to fund
through such account, and a description of such account (Sec.
--.4(d)(1)(vii)).
For eligible vertical interests, the sponsor is required to
disclose: whether the sponsor retains the eligible vertical interest as
a single vertical security or as a separate proportional interest in
each class of ABS interests in the issuing entity issued as part of the
securitization transaction (Sec. --.4(d)(2)(i)); for eligible vertical
interests retained as a single vertical security, the fair value amount
of the single vertical security retained at the closing of the
securitization transaction and the fair value amount required to be
retained, and the percentage of each class of ABS interests in the
issuing entity underlying the single vertical security at the closing
of the securitization transaction and the percentage of each class of
ABS interests in the issuing entity that would have been required to be
retained if the eligible vertical interest was held as a separate
proportional interest (Sec. --.4(d)(2)(ii)); for eligible vertical
interests retained as a separate proportional interest in each class of
ABS interests in the issuing entity, the percentage of each class of
ABS interests in the issuing entity retained at the closing of the
securitization transaction and the percentage of each class of ABS
[[Page 58001]]
interests required to be retained (Sec. --.4(d)(2)(iii)); and
information with respect to the measurement of the fair value of the
ABS interests in the issuing entity (Sec. --.4(d)(2)(iv)).
Section --.4(e) requires a sponsor to retain the certifications and
disclosures required in paragraphs (b) and (d) of this section in
written form in its records and must provide the disclosure upon
request to the Commission and its appropriate Federal banking agency,
if any, until three years after all ABS interests are no longer
outstanding.
Section --.5 requires sponsors relying on the revolving master
trust risk retention option to disclose: The value of the seller's
interest retained by the sponsor, the fair value of any horizontal risk
retention retained by the sponsor under Sec. --.5(f), and the unpaid
principal balance value or fair value, as applicable, the sponsor is
required to retain (Sec. --.5(g)(1)(i)); the material terms of the
seller's interest and of any horizontal risk retention retained by the
sponsor under Sec. --.5(f) (Sec. --.5(g)(1)(ii)); and if the sponsor
retains any horizontal risk retention under Sec. --.5(f), the same
information as is required to be disclosed by sponsors retaining
horizontal interests (Sec. --.5(g)(1)(iii)). Additionally, a sponsor
must retain the disclosures required in Sec. --.5(g)(1) in written
form in its records and must provide the disclosure upon request to the
Commission and its appropriate Federal banking agency, if any, until
three years after all ABS interests are no longer outstanding (Sec.
--.5(g)(2)).
Section --.6 addresses the requirements for sponsors utilizing the
eligible ABCP conduit risk retention option. The requirements for the
eligible ABCP conduit risk retention option include disclosure to each
purchaser of ABCP and periodically to each holder of commercial paper
issued by the ABCP conduit of the name and form of organization of the
regulated liquidity provider that provides liquidity coverage to the
eligible ABCP conduit, including a description of the form, amount, and
nature of such liquidity coverage, and notice of any failure to fund;
and with respect to each ABS interest held by the ABCP conduit, the
asset class or brief description of the underlying receivables, the
standard industrial category code for the originator-seller or
majority-owned OS affiliate that retains an interest in the
securitization transaction, and a description of the form, fair value,
and nature of such interest (Sec. --.6(d)). An ABCP conduit sponsor
relying upon this section shall provide, upon request, to the
Commission and its appropriate Federal banking agency, if any, the
information required under Sec. --.6(d), in addition to the name and
form of organization of each originator-seller or majority-owned OS
affiliate that retains an interest in the securitization transaction
(Sec. --.6(e)).
A sponsor relying on the eligible ABCP conduit risk retention
option shall maintain and adhere to policies and procedures to monitor
compliance by each originator-seller or majority-owned OS affiliate
(Sec. --.6(f)(2)(i)). If the ABCP conduit sponsor determines that an
originator-seller or majority-owned OS affiliate is no longer in
compliance, the sponsor must promptly notify the holders of the ABCP,
the Commission and its appropriate Federal banking agency, in writing
of the name and form of organization of any originator-seller or
majority-owned OS affiliate that fails to retain and the amount of
asset-backed securities issued by an intermediate SPV of such
originator-seller and held by the ABCP conduit, the name and form of
organization of any originator-seller or majority-owned OS affiliate
that hedges, directly or indirectly through an intermediate SPV, their
risk retention in violation and the amount of asset-backed securities
issued by an intermediate SPV of such originator-seller or majority-
owned OS affiliate and held by the ABCP conduit, and any remedial
actions taken by the ABCP conduit sponsor or other party with respect
to such asset-backed securities (Sec. --.6(f)(2)(ii)).
Section --.7 sets forth the requirements for sponsors relying on
the commercial mortgage-backed securities risk retention option, and
includes disclosures of: The name and form of organization of each
third-party purchaser (Sec. --.7(a)(7)(i)); each initial third-party
purchaser's experience in investing in commercial mortgage-backed
securities (Sec. --.7(a)(7)(ii)); other material information (Sec.
--.7(a)(7)(iii)); the fair value of the eligible horizontal residual
interest retained by each third-party purchaser, the purchase price
paid, and the fair value of the eligible horizontal residual interest
that the sponsor would have retained if the sponsor had relied on
retaining an eligible horizontal residual interest under the standard
risk retention option (Sec. --.7(a)(7)(iv) and (v)); a description of
the material terms of the eligible horizontal residual interest
retained by each initial third-party purchaser, including the same
information as is required to be disclosed by sponsors retaining
horizontal interests pursuant to Sec. --.4 (Sec. --.7(a)(7)(vi)); the
material terms of the applicable transaction documents with respect to
the Operating Advisor (Sec. --.7(a)(7)(vii); and representations and
warranties concerning the securitized assets, a schedule of any
securitized assets that are determined not to comply with such
representations and warranties, and the factors used to determine such
securitized assets should be included in the pool notwithstanding that
they did not comply with the representations and warranties (Sec.
--.7(a)(7)(viii)). A sponsor relying on the commercial mortgage-backed
securities risk retention option shall provide in the underlying
securitization transaction documents certain provisions related to the
Operating Advisor (Sec. --.7(a)(6)), maintain and adhere to policies
and procedures to monitor compliance by third-party purchasers with
regulatory requirements (Sec. --.7(b)(2)(A)), and notify the holders
of the ABS interests in the event of noncompliance by a third-party
purchaser with such regulatory requirements (Sec. --.7(b)(2)(B)).
Section --.8 requires that a sponsor relying on the Federal
National Mortgage Association and Federal Home Loan Mortgage
Corporation ABS risk retention option must disclose a description of
the manner in which it has met the credit risk retention requirements
(Sec. --.8(c)).
Section --.9 sets forth the requirements for sponsors relying on
the open market CLO risk retention option, and includes disclosures of
a complete list of, and certain information related to, every asset
held by an open market CLO (Sec. --.9(d)(1)), and the full legal name
and form of organization of the CLO manager (Sec. --.9(d)(2).
Section --.10 sets forth the requirements for sponsors relying on
the qualified tender option bond risk retention option, and includes
disclosures of the name and form of organization of the Qualified
Tender Option Bond Entity, and a description of the form, fair value
(expressed as a percentage of the fair value of all of the ABS
interests issued in the securitization transaction and as a dollar
amount), and nature of such interest in accordance with the disclosure
obligations in section --.4(d) (Sec. --.10(e)).
Section --.11 sets forth the conditions that apply when the sponsor
of a securitization allocates to originators of securitized assets a
portion of the credit risk it is required to retain, including
disclosure of the name and form of organization of any originator that
acquires and retains an interest in the transaction, a description of
the form, amount and nature of such interest, and the method of payment
for such interest (Sec. --.11(a)(2)). A sponsor relying on this
section shall maintain and adhere to
[[Page 58002]]
policies and procedures that are reasonably designed to monitor
originator compliance with retention amount and hedging, transferring
and pledging requirements (Sec. --.11(b)(2)(A)) and shall promptly
notify the holders of the ABS interests in the transaction in the event
of originator noncompliance with such regulatory requirements (Sec.
--.11(b)(2)(B)).
Section --.13 provides an exemption from the risk retention
requirements for qualified residential mortgages that meet certain
specified criteria, including that the depositor of the asset-backed
security certify that it has evaluated the effectiveness of its
internal supervisory controls and concluded that the controls are
effective (Sec. --.13(b)(4)(i)), and that the sponsor provide a copy
of the certification to potential investors prior to sale of asset-
backed securities (Sec. --.13(b)(4)(iii)). In addition, Sec.
--.13(c)(3) provides that a sponsor that has relied upon the exemption
shall not lose the exemption if it complies with certain specified
requirements, including prompt notice to the holders of the asset-
backed securities of any loan repurchased by the sponsor.
Section --.15 provides exemptions from the risk retention
requirements for qualifying commercial loans that meet the criteria
specified in Section --.16, qualifying CRE loans that meet the criteria
specified in Section --.17, and qualifying automobile loans that meet
the criteria specified in Section --.18. Section --.15 also requires
the sponsor to disclose a description of the manner in which the
sponsor determined the aggregate risk retention requirement for the
securitization transaction after including qualifying commercial loans,
qualifying CRE loans, or qualifying automobile loans with 0 percent
risk retention, and descriptions of the qualifying commercial loans,
qualifying CRE loans, and qualifying automobile loans (``qualifying
assets'') and descriptions of the assets that are not qualifying
assets, and the material differences between the group of qualifying
assets and the group of assets that are not qualifying assets with
respect to the composition of each group's loan balances, loan terms,
interest rates, borrower credit information, and characteristics of any
loan collateral (Sec. --.15(a)(4)).
Sections --.16, --.17 and --.18 each require that: The depositor of
the asset-backed security certify that it has evaluated the
effectiveness of its internal supervisory controls and concluded that
its internal supervisory controls are effective (Sec. Sec.
--.16(b)(8)(i), --.17(b)(10)(i), and --.18(b)(8)(i)); the sponsor
provide a copy of the certification to potential investors prior to the
sale of asset-backed securities (Sec. Sec. --.16(b)(8)(iii),
--.17(b)(10)(iii), and --.18(b)(8)(iii)); and the sponsor promptly
notify the holders of the securities of any loan included in the
transaction that is required to be cured or repurchased by the sponsor,
including the principal amount of such loan(s) and the cause for such
cure or repurchase (Sec. Sec. --.16(c)(3), --.17(c)(3), and
--.18(c)(3)).
Estimated Paperwork Burden
Estimated Burden per Response:
Sec. --.4--Standard risk retention: Horizontal interests:
Recordkeeping--0.5 hours, disclosures--3.0 hours, payment date
disclosures--1.0 hour with a monthly frequency; vertical interests:
Recordkeeping--0.5 hours, disclosures--2.5 hours; combined horizontal
and vertical interests: Recordkeeping--0.5 hours, disclosures--4.0
hours, payment date disclosures--1.0 hour with a monthly frequency.
Sec. --.5--Revolving master trusts: Recordkeeping--0.5 hours;
disclosures--4.0 hours.
Sec. --.6--Eligible ABCP conduits: Recordkeeping--20.0 hours;
disclosures--3.0 hours.
Sec. --.7--Commercial mortgage-backed securities: Recordkeeping--30.0
hours; disclosures--20.75 hours.
Sec. --.8--Federal National Mortgage Association and Federal Home Loan
Mortgage Corporation ABS: Disclosures--1.5 hours.
Sec. --.9--Open market CLOs: Disclosures--20.25 hours.
Sec. --.10--Qualified tender option bonds: Disclosures--4.0 hours.
Sec. --.11--Allocation of risk retention to an originator:
Recordkeeping 20.0 hours; disclosures 2.5 hours.
Sec. --.13--Exemption for qualified residential mortgages:
Recordkeeping--40.0 hours; disclosures 1.25 hours.
Sec. --.15--Exemption for qualifying commercial loans, commercial real
estate loans, and automobile loans: Disclosure--20.0 hours.
Sec. --.16--Underwriting standards for qualifying commercial loans:
Recordkeeping--40.0 hours; disclosures--1.25 hours.
Sec. --.17- Underwriting standards for qualifying CRE loans:
Recordkeeping--40.0 hours; disclosures--1.25 hours.
Sec. --.18--Underwriting standards for qualifying automobile loans:
Recordkeeping--40.0 hours; disclosures--1.25 hours.
FDIC
Estimated Number of Respondents: 92 sponsors; 494 annual offerings
per year.
Total Estimated Annual Burden: 10,726 hours.
OCC
Estimated Number of Respondents: 30 sponsors; 160 annual offerings
per year.
Total Estimated Annual Burden: 3,549 hours.
Board
Estimated Number of Respondents: 20 sponsors; 107 annual offerings
per year.
Total Estimated Annual Burden: 2,361 hours.
Commission
Estimated Number of Respondents: 107 sponsors; 574 annual offerings
per year.
Total Estimated Annual Burden: 12,355 hours.
Commission's explanation of the calculation:
To determine the total paperwork burden for the requirements
contained in this proposed rule the agencies first estimated the
universe of sponsors that would be required to comply with the proposed
disclosure and recordkeeping requirements. The agencies estimate that
approximately 249 unique sponsors conduct ABS offerings per year. This
estimate was based on the average number of ABS offerings from 2004
through 2012 reported by the ABS database AB Alert for all non-CMBS
transactions and by Securities Data Corporation for all CMBS
transactions. Of the 249 sponsors, the agencies have assigned 8 percent
of these sponsors to the Board, 12 percent to the OCC, 37 percent to
the FDIC, and 43 percent to the Commission.
Next, the agencies estimated the burden per response that would be
associated with each disclosure and recordkeeping requirement, and then
estimated how frequently the entities would make the required
disclosure by estimating the proportionate amount of offerings per year
for each agency. In making this determination, the estimate was based
on the average number of ABS offerings from 2004 through 2012, and
therefore, we estimate the total number of annual offerings per year to
be 1,334.\229\ We also made the following additional estimates:
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\229\ We use the ABS issuance data from Asset-Backed Alert on
the initial terms of offerings, and we supplement that data with
information from Securities Data Corporation (SDC). This estimate
includes registered offerings, offerings made under Securities Act
Rule 144A, and traditional private placements. We also note that
this estimate is for offerings that are not exempted under
Sec. Sec. --.19 and --.20 of the proposed rule.
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[[Page 58003]]
12 offerings per year will be subject to disclosure and
recordkeeping requirements under section Sec. --.11, which are divided
equally among the four agencies (i.e., 3 offerings per year per
agency);
100 offerings per year will be subject to disclosure and
recordkeeping requirements under section Sec. ----.13, which are
divided proportionately among the agencies based on the entity
percentages described above (i.e., 8 offerings per year subject to
Sec. --.13 for the Board; 12 offerings per year subject to Sec. --.13
for the OCC; 37 offerings per year subject to Sec. --.13 for the FDIC;
and 43 offerings per year subject to Sec. --.13 for the Commission);
and
120 offerings per year will be subject to the disclosure
requirements under Sec. --.15, which are divided proportionately among
the agencies based on the entity percentages described above (i.e., 10
offerings per year subject to Sec. --.15 for the Board, 14 offerings
per year subject to Sec. --.15 for the OCC; 44 offerings per year
subject to Sec. --.15 for the FDIC, and 52 offerings per year subject
to Sec. --.15 for the Commission. Of these 120 offerings per year, 40
offerings per year will be subject to disclosure and recordkeeping
requirements under Sec. Sec. --.16, --.17, and --.18, respectively,
which are divided proportionately among the agencies based on the
entity percentages described above (i.e., 3 offerings per year subject
to each section for the Board, 5 offerings per year subject to each
section for the OCC; 15 offerings per year subject to each section for
the FDIC, and 17 offerings per year subject to each section for the
Commission).
To obtain the estimated number of responses (equal to the number of
offerings) for each option in subpart B of the proposed rule, the
agencies multiplied the number of offerings estimated to be subject to
the base risk retention requirements (i.e., 1,114) \230\ by the sponsor
percentages described above. The result was the number of base risk
retention offerings per year per agency. For the Commission, this was
calculated by multiplying 1,114 offerings per year by 43 percent, which
equals 479 offerings per year. This number was then divided by the
number of base risk retention options under subpart B of the proposed
rule (i.e., nine) \231\ to arrive at the estimate of the number of
offerings per year per agency per base risk retention option. For the
Commission, this was calculated by dividing 479 offerings per year by
nine options, resulting in 53 offerings per year per base risk
retention option.
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\230\ Estimate of 1,334 offerings per year minus the estimate of
the number of offerings qualifying for an exemption under Sec. Sec.
--.13 and --.15 (220 total).
\231\ For purposes of this calculation, the horizontal,
vertical, and combined horizontal and vertical risk retention
methods under the standard risk retention option are each counted as
a separate option under subpart B of the proposed rule.
---------------------------------------------------------------------------
The total estimated annual burden for each agency was then
calculated by multiplying the number of offerings per year per section
for such agency by the number of burden hours estimated for the
respective section, then adding these subtotals together. For example,
under Sec. --.10, the Commission multiplied the estimated number of
offerings per year for Sec. --.10 (i.e., 53 offerings per year) by the
estimated annual frequency of the response for Sec. --.10 of one
response, and then by the disclosure burden hour estimate for Sec.
--.10 of 4.0 hours. Thus, the estimated annual burden hours for
respondents to which the Commission accounts for the burden hours under
Sec. --.10 is 212 hours (53 * 1 * 4.0 hours = 212 hours). The reason
for this is that the agencies considered it possible that sponsors may
establish these policies and procedures during the year independent on
whether an offering was conducted, with a corresponding agreed upon
procedures report obtained from a public accounting firm each time such
policies and procedures are established.
For disclosures made at the time of the securitization
transaction,\232\ the Commission allocates 25 percent of these hours
(1,070 hours) to internal burden for all sponsors. For the remaining 75
percent of these hours, (3,211 hours), the Commission uses an estimate
of $400 per hour for external costs for retaining outside professionals
totaling $1,284,400. For disclosures made after the time of sale in a
securitization transaction,\233\ the Commission allocated 75 percent of
the total estimated burden hours (1,911 hours) to internal burden for
all sponsors. For the remaining 25 percent of these hours (637 hours),
the Commission uses an estimate of $400 per hour for external costs for
retaining outside professionals totaling $254,800.
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\232\ These are the disclosures required by Sec. --.4(d)(1) and
(2) (as applicable to horizontal interests, vertical interests, or
any combination of horizontal and vertical interests); Sec. Sec.
--.5(g)(1) through (3); --.6(d) and (e); --.7(a)(7)(i) through
(viii); --.8(c); --.9(d); --10(e); --.11(a)(2); --.13(b)(4)(iii);
--.15(a)(4); --.16(b)(8)(iii); --.17(b)(10)(iii); and
--.18(b)(8)(iii).
\233\ These are the disclosures required by Sec. Sec.
--.4(b)(2); --.6(f)(2)(ii); --.7(b)(2)(B); --.9(d); --.11(b)(2)(B);
--13(c)(3); --.16(c)(3); --17(c)(3); and --.18(c)(3).
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FHFA: The proposed regulation does not contain any FHFA information
collection requirement that requires the approval of OMB under the
Paperwork Reduction Act.
HUD: The proposed regulation does not contain any HUD information
collection requirement that requires the approval of OMB under the
Paperwork Reduction Act.
C. Commission Economic Analysis
1. Introduction
As discussed above, Section 15G of the Exchange Act, as added by
Section 941(b) of the Dodd-Frank Act, generally requires the agencies
to jointly prescribe regulations, that (i) require a sponsor to retain
not less than 5 percent of the credit risk of any asset that the
sponsor, through the issuance of an asset-backed security (ABS),
transfers, sells, or conveys to a third party, and (ii) prohibit a
sponsor from directly or indirectly hedging or otherwise transferring
the credit risk that the sponsor is required to retain under Section
15G and the agencies' implementing rules.\234\
---------------------------------------------------------------------------
\234\ See 15 U.S.C. 78o-11(b), (c)(1)(A) and (c)(1)(B)(ii).
---------------------------------------------------------------------------
Section 15G of the Exchange Act exempts certain types of
securitization transactions from these risk retention requirements and
authorizes the agencies to exempt or establish a lower risk retention
requirement for other types of securitization transactions. For
example, Section 15G specifically provides that a sponsor shall not be
required to retain any part of the credit risk for an asset that is
transferred, sold, or conveyed through the issuance of ABS by the
sponsor, if all of the assets that collateralize the ABS are qualified
residential mortgages (QRMs), as that term is jointly defined by the
agencies.\235\ In addition, Section 15G states that the agencies must
permit a sponsor to retain less than 5 percent of the credit risk of
commercial mortgages, commercial loans, and automobile loans that are
transferred, sold, or conveyed through the issuance of ABS by the
sponsor if the loans meet underwriting standards established by the
Federal banking agencies.\236\
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\235\ See id. at section 78o-11(c)(1)(C)(iii), (4)(A) and (B).
\236\ See id. at section 78o-11(c)(1)(B)(ii) and (2).
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Section 15G requires the agencies to prescribe risk retention
requirements for ``securitizers,'' which the agencies interpret as
depositors or sponsors of ABS. The proposal would require that a
``sponsor'' of a securitization transaction retain the credit risk of
the securitized assets in the form and amount required by the proposed
rule. The agencies believe that imposing the risk retention requirement
on the sponsor of the ABS is appropriate in light of the active and
direct role that a sponsor typically has
[[Page 58004]]
in arranging a securitization transaction and selecting the assets to
be securitized.
In developing the proposed rules, the agencies have taken into
account the diversity of assets that are securitized, the structures
historically used in securitizations, and the manner in which sponsors
may have retained exposure to the credit risk of the assets they
securitize. Moreover, the agencies have sought to ensure that the
amount of credit risk retained is meaningful--consistent with the
purposes of Section 15G--while reducing the potential for the proposed
rules to negatively affect the availability and costs of credit to
consumers and businesses.
As required by Section 15G, the proposed rules provide a complete
exemption from the risk retention requirements for ABS collateralized
solely by QRMs and establish the terms and conditions under which a
residential mortgage would qualify as a QRM. In developing the proposed
definition of a QRM, the agencies carefully considered the terms and
purposes of Section 15G, public input, and the potential impact of a
broad or narrow definition of QRM on the housing and housing finance
markets.
The Commission is sensitive to the economic impacts, including the
costs and benefits, of its rules. The discussion below addresses the
economic effects of the proposed rules, including the likely benefits
and costs of the rules as well as their effects on efficiency,
competition and capital formation. Some of the economic effects stem
from the statutory mandate of Section 15G, whereas others are affected
by the discretion the agencies have exercised in implementing this
mandate. These two types of costs and benefits may not be entirely
separable to the extent that the agencies' discretion is exercised to
realize the benefits that they believe were intended by Section 15G.
Section 23(a)(2) of the Exchange Act requires the Commission, when
making rules under the Exchange Act, to consider the impact on
competition that the rules would have, and prohibits the Commission
from adopting any rule that would impose a burden on competition not
necessary or appropriate in furtherance of the Exchange Act.\237\
Further, Section 3(f) of the Exchange Act requires the Commission,\238\
when engaging in rulemaking where it is required to consider or
determine whether an action is necessary or appropriate in the public
interest, to consider, in addition to the protection of investors,
whether the action will promote efficiency, competition and capital
formation.
---------------------------------------------------------------------------
\237\ 15 U.S.C. 78w(a).
\238\ 17 U.S.C. 78c(f).
---------------------------------------------------------------------------
2. Background
a. Historical Background
Asset-backed securitizations, or the pooling of consumer and
business loans into financial instruments that trade in the financial
markets, play an important role in the creation of credit for the U.S.
economy. Benefits of securitization may include reduced cost of credit
for borrowers, expanded availability of credit, and increased secondary
market liquidity for loans.\239\ The securitization process generally
involves the participation of multiple parties, each of whom has
varying amounts of information and differing economic incentives. For
example, the entity establishing and enforcing underwriting standards
and credit decisions (i.e., the originator) and the entity responsible
for structuring the securitization (i.e., the securitizer) are not
required to bear any credit risk. By contrast, the ultimate holders of
the securitized assets (i.e., the investors) bear considerable credit
risk and yet typically have minimal influence over underwriting
standards and decisions and limited information about the
characteristics of the borrower.
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\239\ See, e.g., Board of Governors of the Federal Reserve
System, ``Report to the Congress on Risk Retention'', (October 2010)
and Financial Stability Oversight Committee, ``Macroeconomic Effects
of Risk Retention Requirements'', (January 2011).
---------------------------------------------------------------------------
A considerable amount of literature has emerged that supports the
view that, during the early to mid-2000s, residential mortgage-backed
securitizations (RMBSs) contributed to a significant decline in
underwriting standards for residential mortgage loans.\240\ Much of the
initial securitization issuance focused primarily on mortgages, which
had guarantees from the Government National Mortgage Association
(Ginnie Mae) or the Government Sponsored Enterprises (Enterprises),
which included the Federal National Mortgage Association, also known as
Fannie Mae, and the Federal Home Loan Mortgage Corporation, also known
as Freddie Mac. Based on the initial success of these pass through
securitizations \241\ and investor demand and acceptance of these
instruments, asset-backed securitizations subsequently expanded to
include other asset classes (e.g., car loans, student loans, credit
card receivables, corporate loans and commercial mortgages). Over the
years, securitizers began creating increasingly complex structures,
including credit tranching and resecuritizations. As a result,
securitizations increased over time in a variety of asset classes,
providing investors with relatively attractive risk-return investment
choices.
---------------------------------------------------------------------------
\240\ Keys, Mukherjee, Seru and Vig, ``Did Securitization Lead
to Lax Screening? Evidence From Subprime Loans'' (February 2010) and
Nadauld and Sherlund, ``The Impact of Securitization on the
Expansion of Subprime Credit'', (2013).
\241\ Pass through securitization is considered the simplest and
least complex way to securitize an asset. In this structure,
investors receive a direct participation in the cash flows from a
pool of assets. Payments on the securities are made in essentially
the same manner as payments on the underlying loans. Principal and
interest are collected on the underlying assets and `passed through'
to investors without any tranching or structuring or
reprioritization of the cash flows.
---------------------------------------------------------------------------
In the early 2000s, as securitizers sought additional assets to
securitize, originators turned to a formerly lightly-tapped segment of
the residential home market, known as the sub-prime market.\242\ This
segment serves the mortgage needs of individuals that are less credit
worthy, generally for reasons related to income, assets and/or
employment. The securitization of subprime loans facilitated the
extension of credit to this segment of the market, which allowed
securitizers to generate more collateral for the securitization market
and led to a significant increase in the availability of low credit
quality mortgage loans for purposes of meeting the relatively high
demand for securitized investment products. This high volume of lending
contributed to higher residential property prices.\243\ A contributing
factor to the increase in housing prices was the unrealistically high
ratings provided by credit rating agencies on residential mortgage-
backed securities.\244\ Many investors may not have performed
independent credit assessments, either due to a lack of transparency
into the characteristics of the underlying assets or an undue reliance
on credit rating agencies that provided third-party credit evaluations.
This situation persisted until a high
[[Page 58005]]
number of defaults and an increase in interest rates led to subsequent
declines in housing prices. The ``originate-to-distribute'' model was
blamed by many for these events, as the originators and securitizers
were compensated on the basis of volume rather than quality of
underwriting. Because lenders often did not expect to bear the risk of
borrower default in connection with those loans that were securitized
and sold to third-party investors, the lenders had little ongoing
economic interest in the performance of the securitization.\245\
---------------------------------------------------------------------------
\242\ Dell'Ariccia, Deniz and Laeven, ``Credit Booms and Lending
Standards: Evidence From the Subprime Mortgage Market'', (2008);
Mian and Sufi, ``The Consequences of Mortgage Credit Expansion:
Evidence from the 2007 Mortgage Default Crisis'', (2008);
Puranandam, ``Originate-to-Distribute Model and the Sub-Prime
Mortgage Crisis'', (2008).
\243\ Board of Governors of the Federal Reserve, ``Report to the
Congress on Risk Retention'', (October 2010).
\244\ See, e.g., Benmelech and Dlugosz, 2010, The Credit Rating
Crisis, Chapter 3 of NBER Macroeconomics Annual 2009, Vol. 24, pp.
161-207, Acemoglu, Rogoff and Woodford, eds., University of Chicago
Press; Bolton, Freixas and Shapiro, ``The Credit Ratings Game''
Journal of Finance (February 2012); Griffin and Tang, ``Did
Subjectivity Play a Role in CDO Credit Ratings'', Working paper
(2010).
\245\ Dell'Ariccia, Deniz and Laeven, ``Credit Booms and Lending
Standards: Evidence From the Subprime Mortgage Market'', (2008),
Mian and Sufi, ``The Consequences of Mortgage Credit Expansion:
Evidence from the 2007 Mortgage Default Crisis'', (2008),
Puranandam, ``Originate-to-Distribute Model and the Sub-Prime
Mortgage Crisis'', (2008), Keys, Mukherjee, Seru and Vig, ``Did
Securitization Lead to Lax Screening? Evidence from Subprime Loans''
(February 2010) and Nadauld and Sherlund, ``The Impact of
Securitization on the Expansion of Subprime Credit'', (2013).
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b. Broad Economic Considerations
While securitization can redistribute financial risks in ways that
provide significant economic benefits, certain market practices related
to its implementation can potentially undermine the efficiency of the
market. In particular, securitization removes key features of the
classic borrower-lender relationship, which relies on borrower and
lender performance incentives generated from repeated interactions, as
well as the ongoing communication of proprietary information between
the borrower and the lender. The separation between the borrower and
the ultimate provider of credit in securitization markets can introduce
significant informational asymmetries and misaligned incentives between
the originators and the ultimate investors. In particular, the
originator has more information about the credit quality and other
relevant characteristics of the borrower than the ultimate investors,
which could introduce a moral hazard problem--the situation where one
party (e.g., the loan originator) may have a tendency to incur risks
because another party (e.g., investors) will bear the costs or burdens
of these risks. Hence, when there are inadequate processes in place to
encourage (or require) sufficient transparency to overcome concerns
about informational differences, the securitization process could lead
certain participants to maximize their own welfare and interests at the
expense of other participants.
For example, in the RMBS market, mortgage originators generally
have more information regarding a borrower's ability to repay a loan
obligation than the investors that ultimately own the economic
interest, as the originator collects and evaluates information to
initiate the mortgage. In a securitization, since ABS investors
typically do not participate in this process, they likely have less
information about expected loan performance than the originators.
Disclosures to investors may not be sufficiently detailed regarding the
quality of the underlying assets to adequately evaluate the assets
backing the security. In addition, in a securitization the underlying
pool is comprised of hundreds or thousands of loans, each requiring
time to evaluate. Thus, such information asymmetry may have an adverse
impact on investors, especially in the case when the originator and
securitizer receive full compensation before the time when investors
ultimately learn about loan quality. Consequently, the originator may
have incentive to approve and fund a loan that they would not
otherwise. In other words, the originator may be less diligent in
solving the adverse selection problem since the consequences are
transferred to the investors.
The securitization process removes (or lessens) the consequences of
poor loan performance from the loan originators, whose compensation
depends primarily on the fees generated during the origination process.
This provides economic incentive to produce as many loans as possible
because loan origination, structuring, and underwriting fees for
securitizations reward transaction volume. Without the requirement by
the market to bear any of the risk associated with subsequent defaults,
this can result in potentially misaligned incentives between the
originators and the ultimate investors.\246\ Through the securitization
process, risk is transferred from the originators to investors, who in
the absence of transparency into the composition of the underlying
assets, may rely too readily on credit rating agency assessments of the
underlying loans and credit enhancement supporting the securitization.
In the years preceding the financial crisis, these incentives may have
motivated originators to structure mortgage securitizations with little
or no credit enhancement and extend credit to less creditworthy
borrowers, whose subsequent defaults ultimately helped to trigger the
crisis.
---------------------------------------------------------------------------
\246\ As an example, Ashcraft and Schuermann (2008) identify at
least seven different frictions in the residential mortgage
securitization chain that can cause agency and adverse selection
problems in a securitization transaction. The main point of their
analysis is that there are many different parties in a
securitization transaction, each with differing economic interests
and incentives. Hence, there are multiple opportunities for
conflicts of interest to arise in such structures.
Table 1--Rating Performance of Prime RMBS (%)
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
All AAA Investment grade Speculative grade Likely to default
Year Issues -------------------------------------------------------------------------------------------------------------------
Up Down Share Up Down Share Up Down Share Up Down Share Up Down
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
2004.......................................................... 15,512 3.5 0.0 80.9 0.0 0.0 14.3 23.3 0.0 4.4 4.6 0.1 0.2 0.0 0.0
2005.......................................................... 14,474 4.6 0.1 72.1 0.0 0.0 18.6 20.9 0.1 8.9 7.4 0.7 0.2 0.0 0.0
2006.......................................................... 16,859 3.1 0.1 71.0 0.0 0.0 18.7 13.8 0.1 9.9 5.8 0.8 0.2 0.0 14.3
2007.......................................................... 18,452 1.8 0.2 72.1 0.0 0.0 17.9 8.5 0.3 9.7 2.6 1.1 0.2 0.0 21.4
2008.......................................................... 20,924 0.5 12.4 73.7 0.0 9.9 16.8 2.5 13.0 9.3 1.4 31.1 0.2 0.0 45.0
2009.......................................................... 20,475 0.0 46.4 65.6 0.0 32.0 21.2 0.0 69.0 9.5 0.0 81.7 3.7 0.0 91.2
2010.......................................................... 19,700 0.1 29.0 42.5 0.0 12.8 16.3 0.2 44.8 12.9 0.0 64.4 28.3 0.1 34.3
2011.......................................................... 18,338 0.3 36.7 36.9 0.0 14.4 14.2 0.6 62.3 10.8 0.9 81.3 38.1 0.5 49.4
2012.......................................................... 16,886 0.2 16.3 27.4 0.0 3.6 10.7 0.0 31.3 10.8 0.6 24.7 51.1 0.4 27.8
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Notes: The numbers in the table were calculated by Division of Economic and Risk Analysis (DERA) staff using the Standard & Poor's (S&P) RatingsXpress data. These statistics are for securities
issued by U.S. entities in U.S. dollars, carrying a local currency rating, and having a rating on the scale of AAA to D. Each security is assigned to an asset class based on the collateral
type information provided by S&P. Securities backed by collateral that mixes multiple types of assets are not included. ``Issues'' is the total number of RMBS issuances outstanding as of
January 1 for each year. ``Share'' is the share of each rating category among all rated RMBS. Upgrades and downgrades are expressed as a percentage of all rated securitizations in a
specified year and in a specified rating class. ``Investment Grade'' (IG) are ratings from AA+ to BBB-, ``Speculative'' are from BB+ to B-, and ``Likely to Default'' are CCC+ and below.
[[Page 58006]]
Evidence of the credit worthiness of borrowers during this period
is illustrated in Table 1, which shows that 9.9 percent of presumably
low-risk securities, such as AAA-rated non-agency RMBS, outstanding in
2008 were downgraded during 2008. More significantly 32.0 percent of
these securities outstanding in 2009 were downgraded during the year.
Thus, almost one third of the outstanding RMBS securities with the
highest possible credit rating were downgraded during 2009, suggesting
that the credit quality of the underlying collateral and underlying
credit enhancement for AAA notes was far poorer than originally rated
by the credit rating agencies.
The downgrades serve to illustrate the extent to which misaligned
incentives between originators/sponsors of ABS and the ultimate
investors may have manifested in the form of lax lending standards and
relaxed credit enhancement standards during the period before the
financial crisis. Risk retention is one possible response to this
problem. Requiring securitizers to share the same risks as the
investors that purchase these products seeks to mitigate the problems
caused by misaligned incentives. By retaining loss exposure to the
securitized assets, securitizers are considered to have ``skin in the
game'' and thus are economically motivated to be more judicious in
their selection of the underlying pool of assets, thereby helping to
produce higher quality (i.e., lower probability of default) securities.
Currently, sponsors who do not retain 5 percent of the
securitization likely deploy those funds to other uses, such as
repaying lines of credit used to fund securitized loans, holding other
assets or making new loans, which may earn a different interest rate
and have a different risk exposure. Therefore, a risk retention
requirement could impose costs to those sponsors who do not currently
hold risk, in the form of the opportunity costs of those newly tied-up
funds, or could limit the volume of securitizations that they can
perform. These costs will likely be passed onto borrowers, either in
terms of borrowing costs or access to capital. In particular, borrowers
whose loans do not meet the eligibility requirements or qualify for an
exemption (i.e., those that require risk retention when securitized by
the ABS originator/sponsor) will face increased borrowing costs, or be
priced out of the loan market, thus restricting their access to
capital. As a result, there could be a negative impact on capital
formation.
Hence, there are significant potential costs to the implementation
of risk retention requirements in the securitization market. The
Commission notes that the costs will also be impacted by any returns
and timing of the returns of any retained interest. If the costs are
deemed by sponsors to be onerous enough that they would no longer be
able to earn a sufficiently high expected return by sponsoring
securitizations, this form of supplying capital to the underlying asset
markets would decline. Fewer asset securitizations would require other
forms of funding to emerge in order to serve the needs of borrowers and
lenders. Given the historically large dollar volumes in the
securitization markets, this could reduce capital flows into the
underlying asset markets, thereby reducing the amount of capital
available for lending and possibly adversely impacting efficiency.
The net impact of this outcome depends on the availability of
alternative arrangements for transferring capital to the underlying
assets markets and the costs of transferring capital to sponsors. For
example, the impact of the potential decrease in the use of
securitizations in the residential home mortgage market would depend on
the cost and availability of alternative mortgage funding sources, and
the willingness of these originators to retain the full burden of the
associated risks. To the extent there are alternatives, and these
alternatives can provide funding on terms similar to those available in
the securitization markets, the impact of the substitution of these
alternatives for securitizations would likely be minimal. To the extent
that securitizers can find sources of capital at costs similar to the
returns paid on retained interests, the impact of risk retention
requirements would likely be minimal. Currently, however, there is
little available empirical evidence to reliably estimate the cost and
consequence of either such outcome.
To maintain a commensurate level of funding to underlying asset
markets with the risk retention requirement, the rates on the
underlying assets would have to increase so that sponsors could achieve
their higher target returns by serving the securitization market. Two
recent studies by the Federal Reserve Bank of New York attempt to
estimate the impact of the higher risk retention on the underlying
asset markets.\247\ Their analysis suggests that incremental sponsor
return requirements for serving markets with the higher levels of risk
retention are relatively modest, somewhere on the order of 0-30 basis
points.\248\ If so, the higher levels of risk retention would increase
residential mortgage rates by approximately 0.25 percent. While this
would increase the average borrower cost for loans that would not
otherwise be eligible for securitizations exempt from risk retention,
the increment may be sufficiently small such that securitizations would
be expected to remain a significant component of the capital formation
process.
---------------------------------------------------------------------------
\247\ See appendix A.
\248\ This assessment assumes that the underlying loan pool
characteristics are accurately disclosed, and with sufficient detail
for investors to properly assess the underlying risk. Such a
scenario would be reflective of the risk retention requirements
solving the moral hazard problem that might otherwise result in the
obfuscation of intrinsic risks to the ultimate investors.
---------------------------------------------------------------------------
3. Economic Baseline
The baseline the Commission uses to analyze the economic effects of
the risk retention requirements added by Section 15G of the Exchange
Act is the current set of rules, regulations, and market practices that
may determine the amount of credit exposure retained by securitizers.
To the extent not already followed by current market practices, the
proposed risk retention requirements will impose new costs. The risk
retention requirements will affect ABS market participants, including
loan originators, securitizers and investors in ABS, and consumers and
businesses that seek access to credit. The costs and benefits of the
risk retention requirements depend largely on the current market
practices specific to each securitization market--including current
risk retention practices--and corresponding asset characteristics. The
economic significance or the magnitude of the effects of the risk
retention requirements will also depend on the overall size of the
securitization market and the extent to which the requirements could
affect access to, and cost of, capital. Below the Commission describes
the Commission's current understanding of the securitization markets
that are affected by this proposed rule.
a. Size of Securitization Markets
The ABS market is important for the U.S. economy and comprises a
large fraction of the U.S. debt market. During the four year period
from 2009 to 2012, 31.1 percent of the $26.8 trillion in public and
private debt issued in the United States was in the form of mortgage-
backed securities (MBS) or other ABS, and 2.7 percent was in the form
of non-U.S. agency backed (private label) MBS or ABS. For comparison,
32.8 percent of all debt issued was U.S.
[[Page 58007]]
Treasury debt, and 5.7 percent was municipal debt at the end of
2012.\249\ Figure 1 shows the percentage breakdown of total non-Agency
issuances from 2009 to 2012 for various asset classes excluding asset-
backed commercial paper (ABCP) and collateralized loan obligations
(CLOs).\250\ Consumer credit categories including automobile and credit
card backed ABS comprise 39 percent and 15 percent of the total annual
issuance volume, respectively. Non-agency RMBS and commercial mortgage
backed securities (CMBS) comprise 4 percent and 18 percent of the
market, respectively, while student loan backed ABS account for 11
percent of the market. Below the Commission analyzes the variation in
issuance among these five largest asset classes. For several categories
the Commission provides detailed information about issuance volume and
the number of active securitizers (Table 2).
---------------------------------------------------------------------------
\249\ Source: SIFMA.
\250\ To estimate the size and composition of the private-label
securitization market the Commission uses the data from Securities
Industry and Financial Markets Association (SIFMA) and AB Alert. In
the following analysis, the Commission excludes all securities
guaranteed by U.S. government agencies. ABCP is a short-term
financing instrument and is frequently rolled over, thus, its
issuance volume is not directly comparable to the issuance volume of
long-term ABS of other sectors. The Commission does not have CLO
issuance data.
[GRAPHIC] [TIFF OMITTED] TP20SE13.000
Prior to the financial crisis of 2008, the number of non-agency
RMBS issuances was substantial. For example, new issuances totaled
$503.9 billion in 2004 and peaked at $724.1 billion in 2005. Non-agency
RMBS issuances fell dramatically in 2008, to $28.6 billion, as did the
total number of securitizers, from a high of 78 in 2007 to 31 in 2008.
In 2012, there was only $15.7 billion in new non-agency RMBS issuances
by 13 separate securitizers. Of this amount, however, only $3.6 billion
was issued by 3 separate securitizers backed by prime mortgages and
were not resecuritizations.
Table 2--Annual Issuance Volume and Number of Securitizers by Category
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Credit card ABS Automobile ABS Student loan ABS Non-agency RMBS
Year --------------------------------------------------------------------------------------------------------------------------------------
SEC 144A Private Total SEC 144A Private Total SEC 144A Private Total SEC 144A Private Total
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Panel A--Annual Issuance Volume by Category ($ bn)
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
2004..................................................... 46.3 4.9 0.0 51.2 63.4 6.5 0.0 70.0 38.3 7.5 0.2 45.9 490.3 13.6 0.0 503.9
2005..................................................... 61.2 1.8 0.0 62.9 85.1 8.7 0.0 93.9 54.1 8.1 0.4 62.6 707.9 16.2 0.0 724.1
2006..................................................... 60.0 12.5 0.0 72.5 68.0 12.2 0.0 80.2 54.9 10.9 0.5 66.2 702.8 20.4 0.0 723.3
2007..................................................... 88.1 6.4 0.0 94.5 55.8 6.8 0.0 62.6 41.7 16.0 0.6 58.3 598.1 42.2 0.0 640.3
2008..................................................... 56.7 5.0 0.0 61.6 31.9 5.6 0.0 37.6 25.8 2.4 0.0 28.2 12.2 16.4 0.0 28.6
2009..................................................... 34.1 12.5 0.0 46.6 33.9 15.4 0.0 49.2 8.3 12.5 0.0 20.8 0.3 47.8 0.0 48.1
2010..................................................... 5.3 2.1 0.0 7.5 38.0 15.3 0.0 53.3 2.8 16.2 1.2 20.2 0.2 46.1 12.8 59.2
2011..................................................... 10.0 4.8 1.5 16.3 41.9 14.4 0.0 56.3 2.5 13.9 1.1 17.5 0.7 11.1 10.5 22.2
2012..................................................... 28.7 10.5 0.0 39.2 65.6 13.9 0.0 79.5 6.6 23.2 0.0 29.9 1.9 12.6 1.2 15.7
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Panel B--Annual Number of Securitizers by Category
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
2004..................................................... 12 4 0 15 29 9 0 37 10 7 1 16 41 15 0 44
[[Page 58008]]
2005..................................................... 13 5 0 17 30 9 0 38 13 7 1 19 46 18 0 51
2006..................................................... 10 11 0 18 23 12 0 30 8 17 1 24 50 27 0 62
2007..................................................... 12 8 0 16 23 9 0 28 7 17 1 22 46 32 0 59
2008..................................................... 9 3 0 11 16 7 0 20 3 6 0 8 12 19 0 24
2009..................................................... 9 6 0 11 13 13 0 22 3 6 0 6 1 16 0 17
2010..................................................... 5 5 0 9 19 15 0 27 2 18 1 19 1 18 1 20
2011..................................................... 5 7 1 12 14 16 0 25 1 19 1 20 1 12 2 14
2012..................................................... 7 9 0 13 18 24 0 36 1 26 0 26 1 11 1 12
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Notes: The numbers in the table were calculated by DERA staff using the AB Alert database. The deals are categorized by offering year, underlying asset type, and offering type (SEC registered
offerings, Rule 144A offerings, or traditional private placement). Non-agency RMBS include residential, Alt-A, and subprime RMBS. Automobile loan ABS include ABS backed by automobile loans,
both prime and subprime, motorcycle loans, and truck loans). Panel A shows the total issuance amount in billions of dollars. Panel B shows the number of unique sponsors of ABS in each
category (the number in the column ``Total'' may not be the sum of numbers in the columns ``SEC'', ``144A'' and ``Private'' because some securitizers may sponsor deals in several
categories). Only ABS deals sold in the U.S. and sponsors of such deals are counted.
Similar to the market for non-agency RMBS, the market for CMBS also
experienced a decline following the financial crisis. There were $229.2
billion in new issuances at the market's peak in 2007.\251\ New
issuances fell to $4.4 billion in 2008 and to $8.9 billion in 2009. In
2012, there were $35.7 billion in new CMBS issuances.
---------------------------------------------------------------------------
\251\ See Table 3. The estimates relating to the CMBS market are
from SIFMA, and can be found at http://www.sifma.org/research/statistics.aspx. The SIFMA dataset does not include information
relating to the number of CMBS securitizers and does not distinguish
issuances by type.
Table 3--CMBS Issuance ($bn)
------------------------------------------------------------------------
Year Issuance
------------------------------------------------------------------------
2004.................................................... 93.5
2005.................................................... 156.7
2006.................................................... 183.8
2007.................................................... 229.2
2008.................................................... 4.4
2009.................................................... 8.9
2010.................................................... 22.5
2011.................................................... 34.3
2012.................................................... 35.7
------------------------------------------------------------------------
Notes: Source--SIFMA.
While the ABS markets based on credit cards, automobile loans, and
student loans experienced a similar decline in issuances following the
financial crisis, the issuance trends in Table 2 indicate that they
have rebounded substantially more than the non-agency RMBS and CMBS
markets. The automobile loans sector currently has the largest issuance
volume and the largest number of active sponsors of ABS among all asset
classes. There were $79.5 billion in new automobile ABS issuances in
2012 from 42 securitizers. This amount of new issuances is
approximately twice the amount of new issuances in 2008 ($37.6 billion)
and is similar to the amount of new issuances from 2004 to 2007.
Although the amount of new credit card ABS issuances has not fully
rebounded from pre-crisis levels, it is currently substantially larger
than in recent years. There were $39.2 billion in new credit card ABS
issuances in 2012, a five-fold increase over the amount of new
issuances in 2010 ($7.5 billion). The number of credit card ABS
securitizers has remained steady over time, totaling 16 in 2012. The
amount of new student loan issuances has also not fully rebounded from
pre-crisis levels. There were $29.9 billion in new student loan ABS
issuances in 2012, compared to a range from $45.9 billion to $58.3
billion between 2004 and 2007. However, the number of student loan
securitizers has returned to pre-crisis levels, totaling 27 in 2012.
While risk retention requirements will apply to the previous asset
classes there are other asset classes not listed here to which risk
retention will also apply.
Information describing the amount of issuances and the number of
securitizers in the ABCP and CLO markets is not readily available,
however, information on the total amount of issuances outstanding
indicates that the ABCP market has decreased since the end of 2006,
when the total amount outstanding was $1,081.4 billion, 55 percent of
the entire commercial paper market.\252\ As of the end of 2012, there
were $319.0 billion of ABCP outstanding, accounting for 30 percent of
the commercial paper market.
---------------------------------------------------------------------------
\252\ Based on information from the Federal Reserve Bank of St.
Louis FRED Economic Data database.
Table 4--Commercial Paper (CP) Outstanding ($bn)
------------------------------------------------------------------------
ABCP
Year ABCP All CP share
outstanding (percent)
------------------------------------------------------------------------
2004.............................. 688.9 1,401.5 49.2
2005.............................. 860.3 1,637.5 52.5
2006.............................. 1,081.4 1,974.7 54.8
2007.............................. 774.5 1,785.9 43.4
2008.............................. 734.0 1,681.5 43.7
2009.............................. 487.0 1,170.0 41.6
2010.............................. 348.1 971.5 35.8
2011.............................. 328.8 959.3 34.3
2012.............................. 319.0 1,065.6 29.9
------------------------------------------------------------------------
Notes: Source--Federal Reserve.
b. Current Risk Retention Market Practices
As noted earlier, the potential economic effects of the proposed
risk retention requirements will depend on current market practices.
Currently, risk retention is not mandated in any sector of the U.S. ABS
market, although some sponsors of different ABS classes do retain risk
voluntarily--at least at initial issuance. The aggregate levels of
current risk retention vary across sponsors and ABS asset classes.
Adopted practices are different for different sectors (to the extent
that they are applied at all) and there is no uniform reporting of the
types or amounts of retained ABS pieces. Because aggregated
quantitative information relating to the current risk retention
practices of ABS securitizers is currently unavailable, the Commission
does not have sufficient information to measure the extent to which
risk is currently retained. Below the Commission describes current risk
retention practices for various asset classes based upon its
understanding of these markets and public comment received to date. The
Commission would benefit from additional public comment and data about
historical and
[[Page 58009]]
current risk retention practices in all ABS sectors.
i. RMBS Risk Retention Practices
The Commission understands that securitizers of non-agency RMBS
historically did not generally retain a portion of credit risk.\253\
Consequently, except in the case where exemptions are applicable (e.g.,
the QRM exemption), the proposed risk retention requirements likely
will impose new constraints on these securitizers.
---------------------------------------------------------------------------
\253\ However, more recently, one of the largest sponsors of
SEC-registered RMBS has stated it currently retains some interest in
the RMBS transactions that it sponsors. For example, see Sequoia
Mortgage Trust 2013-1, 424b5, File No. 333-179292-06 filed January
16, 2013; http://www.sec.gov/Archives/edgar/data/1176320/000114420413002646/v332142_424b5.htm.
---------------------------------------------------------------------------
The Commission also understands that securitizers of other ABS
market sectors typically retain some portion of credit risk. For these
securitizers, depending on the amount and form of risk currently
retained, the proposed risk retention requirements may pose less of a
constraint. Markets where securitizers typically retain some portion of
risk include the markets for CMBS, automobile loan ABS, ABS with a
revolving master trust structure, and CLOs. The markets for CMBS and
ABCP include structures in which parties involved in the securitization
other than the securitizer retain risk.
ii. CMBS Risk Retention Practices
The current risk retention practice in the CMBS market is to retain
at issuance the ``first loss piece'' (riskiest tranche). This tranche
is typically sold to a specialized category of CMBS investors, known as
a ``B-piece buyer''. The B-piece investors in CMBS often hold dual
roles as bond investors, if the assets remain current on their
obligations, and as holders of controlling interests to appoint special
servicers, if the loans default and go into special servicing. As
holders of the controlling interest, they will typically appoint an
affiliate as the special servicer. The B-piece CMBS investors are
typically real estate specialists who use their extensive knowledge
about the underlying assets and mortgages in the pools to conduct
extensive due diligence on new deals.\254\ The B-pieces are often
``buy-and-hold'' investments, and secondary markets for B-pieces are
virtually non-existent at this time.\255\ Currently, the B-piece (as
defined by Standard & Poor's) typically makes up the lowest rated 3-4
percent of the outstanding amount of interests issued in CMBS
securitization at issuance. During the four year period from 2009 to
2012, the non-rated and all speculative grade tranches typically bought
by B-piece buyers made up the lowest 4.4 percent.\256\ Thus, the
prevailing market practice for risk retention in the CMBS sector is
less than the proposed 5 percent B-piece risk retention option for CMBS
sponsors.
---------------------------------------------------------------------------
\254\ CMBS have a much smaller number of underlying loans in a
pool (based on data from ABS prospectuses filed on EDGAR, a typical
CMBS has about 150 commercial properties in a pool, whereas RMBS
have about 3,000 assets in a pool and automobile loan/lease ABS
typically have 75,000 assets) and these loans are often not
standardized. Thus, direct management of individual underperforming
loans is often necessary and is much more viable for CMBS than for
other asset classes.
\255\ An industry publication places the number of active B-
piece buyers in 2007 at 12, and the number of active B-piece buyers
between 2010 and the first part of 2011 at 1. This information was
taken from S&P Credit Research. ``CMBS: The Big `B' Theory'' Apr 11,
2011, https://www.standardandpoors.com/ratings/articles/en/us/?articleType=HTML&assetID=1245302231520.
\256\ DERA staff calculated these numbers using data from
Standard & Poor's RatingsXpress.
---------------------------------------------------------------------------
iii. Master Trusts Risk Retention Practices
Securitizers of revolving master trusts often maintain risk
exposures through the use of a seller's interest which, as discussed
above, is intended to be equivalent to the securitizer's interest in
the receivables underlying the ABS. The Commission does not have
sufficient aggregated data about revolving master trusts that would
permit it to estimate the amount of risk currently retained. The
Commission requests comment for this below.
iv. Other ABS Risk Retention Practices
The current voluntary market practices for other categories of ABS
that serve to align the interests of the sponsor and investors vary
across asset classes. The Commission understands that securitizers of
automobile loan ABS typically maintain exposure to the quality of their
underwriting by retaining ABS interests from their securitization
transactions; however, there is insufficient data available to the
Commission to estimate the equivalent amount of risk retained through
this practice. The Commission understands that securitizers of student
loans do not typically retain credit risk. However, Sallie Mae, the
largest sponsor of student loan asset-backed securities, does retain a
residual interest in the securitizations that it sponsors.
vi. ABCP Risk Retention Practices
Commenting on the original proposal, ABCP conduit operators noted
that there are structural features in ABCP that align the interests of
the ABCP conduit sponsor and the ABCP investors. For instance, ABCP
conduits usually have some mix of credit support and liquidity support
equal to 100 percent of the ABCP outstanding. This liquidity and credit
support exposes the ABCP conduit sponsor to the quality of the assets
in an amount that far exceeds 5 percent.
vi. CLO Risk Retention Practices
Some commenters noted that securitizers of CLOs often retain a
small portion of the residual interest and asserted that securitizers
retain risk through subordinated management and performance fees that
have performance components that depend on the performance of the
overall pool or junior tranches. The proposed rule does not allow for
fees to satisfy risk retention requirements. The Commission is
requesting comment on any recent developments in the CLO market whereby
risk is retained as defined by the proposed rule.\257\
---------------------------------------------------------------------------
\257\ In the Board of Governors of the Federal Reserve System's
``Report to the Congress on Risk Retention'' (October 2010), pp. 41-
48, mechanisms intended to align incentives and mitigate risk are
described, including alternatives such as overcollateralization,
subordination, guarantees, representations and warranties, and
conditional cash flows as well as the retention of credit risk. The
Report also contains a description of the most common incentive
alignment and credit enhancement mechanisms used in the various
securitization asset classes. The Report does not establish the
extent to which these alternatives might be substitutes for the
retention of credit risk.
---------------------------------------------------------------------------
4. Analysis of Risk Retention Requirements
As discussed above, the agencies are proposing rules to implement
Section 15G of the Exchange Act requiring sponsors of asset backed
securitizations to retain risk. Each of the asset classes subject to
these proposed rules have their own particular structure and, as a
result, the implementation and impact of risk retention will vary
across asset classes, although certain attributes of risk retention are
common to all asset classes. In this section, the Commission discusses
those aspects of the proposed rules that apply across asset classes:
The requirement that securitizers hold 5 percent of the credit risk of
a securitization, the use of fair value (versus par value) of the
securitization as the method of measuring the amount of risk retained
by the securitizer, and the length of time that a securitizer would be
required to hold its risk exposure.
[[Page 58010]]
a. Level and Measurement of Risk Retention
i. Requirement To Hold Five Percent of Risk
Section 15G requires the agencies to jointly prescribe regulations
that require a securitizer to retain not less than 5 percent of the
credit risk of any asset that the securitizer, through the issuance of
ABS, transfers, sells, or conveys to a third party, unless an exemption
from the risk retention requirements for the securities or transaction
is otherwise available. The agencies are proposing to apply a minimum 5
percent base risk retention requirement to all ABS transactions that
are within the scope of Section 15G.
As a threshold matter, the requirement to retain risk is intended
to align the incentives of the ABS sponsors and their investors.
Sponsors of securitizations should be motivated to securitize assets
with probabilities of default that are accurately reflected in the
pricing of the corresponding tranches, because they will be required to
hold some of the risk of the assets being securitized. Risk retention
may increase investor participation rates because investors would have
assurance that the sponsor is exposed to the same credit risk and will
suffer similar losses if default rates are higher than anticipated.
This may increase borrower access to capital, particularly if loan
originators are otherwise constrained in their ability to underwrite
mortgages because more investors means more available capital. In
particular, the act of securitizing the loans allows the lenders to
replenish their capital and continue to make more loans, over and above
what could be made based solely on the initial capital of the lender.
When the underlying risks are disclosed properly, securitization should
facilitate capital formation as more money will flow to borrowers.
Higher investment may also lead to improved price efficiency, as the
increase in securitization transactions will provide additional
information to the market.
While risk retention is intended to result in better incentive
alignment, it is important to consider whether a 5 percent risk
retention requirement will appropriately align the incentives of the
sponsors and investors. Establishing an appropriate risk retention
threshold requires a tradeoff between ensuring that the level of risk
retained provides adequate incentive alignment, while avoiding costs
that are associated with restricting capital resources to projects that
may offer lower risk-adjusted returns. A risk retention requirement
that is set too high could lead to inefficient deployment of capital as
it would require the capital to be retained rather than further used in
the market to facilitate capital formation. On the other hand, a risk
retention requirement that is too low could provide insufficient
alignment of incentives.
In certain cases the agencies have proposed to exempt asset classes
from the risk retention requirements because there already exists
sufficient incentive alignment or other features to conclude that
further constraints are unnecessary. In particular, the securitizations
of these exempted asset classes have characteristics that ensure that
the quality of the assets is high. For example, if the pool of assets
sponsors can securitize is drawn from an asset class with a low
probability of default, opportunities to exploit potentially misaligned
incentives are fewer and investors may have a correspondingly lesser
need for the protection accorded by risk retention requirements.
Another possibility is that excessive required risk retention
levels may prevent capital from being used in more valuable
opportunities, leading to potentially higher borrowing rates as capital
is diverted to required risk retention. In this scenario the reduction
in capital formation would have a negative impact on competition due to
the extra cost of securitizing non-qualified assets, disadvantaging
them relative to qualified assets. However, the statute prescribes a 5
percent minimum amount of risk be retained.
ii. Measurement of Risk Retention Using Fair Value
The agencies have proposed to require sponsors to measure risk
retention using a fair value framework as described in U.S. GAAP (ASC
820). The Commission believes that this would align the measurement
more closely with the economics of a securitization transaction because
market valuations more precisely reflect the securitizer's underlying
economic exposure to borrower default. Defining a fair value framework
also may enhance comparability across different securitizations and
provide greater clarity and transparency.
Use of fair value accounting as a method of valuing risk retention
also will provide a benefit to the extent that investors and sponsors
can understand how much risk is being held and that the valuation
methodology accurately reflects intrinsic value. If investors cannot
understand the proposed measurement methodology, the value of holding
risk will be reduced as investors will be unable to determine the
extent to which risk retention aligns incentives. If investors cannot
determine whether incentives are properly aligned, they may invest less
in the securitization market because there will be uncertainty over the
quality of assets being securitized.
One benefit of fair value is investors and sponsors generally have
experience with fair value accounting. In addition, the use of fair
value is intended to prevent sponsors from structuring around risk
retention.
Fair value calculations are susceptible to a range of results
depending on the key variables selected by the sponsor in determining
fair value. This could result in costs to investors to the extent that
securitizers use assumptions resulting in fair value estimates at the
outer edge of the range of potential values, and thereby potentially
lowering their relative amount of risk retention. In order to help
mitigate this potential cost, the agencies have proposed to require the
sponsor to disclose specified information about how it calculates fair
value. While this requirement should discourage manipulation, sponsors
will incur additional costs to prepare the necessary disclosures. In
addition, because the proposed rule specifies that fair value must be
determined by fair value framework as described in US GAAP, sponsors
will incur costs to ensure that the reported valuations are compliant
with the appropriate valuation standards.
Alternatively, the agencies could have proposed to require risk
retention be measured using the par value of the securitization, as in
the original proposal. Par value is easy to measure, transparent, and
would not require any modeling or disclosure of methodology. However,
holding 5 percent of par value may cause sponsors to hold significantly
less than 5 percent of the risk because the risk is not spread evenly
throughout the securitization. In addition, not all securitizations
have a par value. Another alternative considered was premium capture
cash reserve account (PCCRA) plus par value. The agencies took into
consideration the potential negative unintended consequences the
premium capture cash reserve account might cause for securitizations
and lending markets. The elimination of the premium capture cash
reserve account should reduce the potential for the proposed rule to
negatively affect the availability and cost of credit to consumers and
businesses.
b. Duration of the Risk Retention Requirement
Another consideration is how long the sponsor is required to retain
risk. For example, most of the effects of poor
[[Page 58011]]
underwriting practices likely would be evident in the earlier stages of
a loan's life. If the risk is retained for longer than is optimal,
there may be a decrease in capital formation because capital cannot be
redeployed to more efficient uses, resulting in higher costs to
securitizers than necessary. On the other hand, if the risk is not
retained long enough, risk retention will not mitigate the incentive
misalignment problem. The optimal duration of the risk retention
requirement will in large part depend on the amount of time required
for investors to realize whether the risks of the underlying loan pools
were accurately captured, which may vary across asset classes. For
instance, short durations relative to maturity may be appropriate for
asset classes where a significant fraction of the defaults occur at the
beginning of the loan life cycle, such as in the case with RMBS, while
longer durations are more appropriate for asset classes where
performance takes longer to evaluate, such as with CMBS, where
performance may not be assessed until the end of the loan.
To the extent that there exists a window where risk retention is
needed but dissipates once the securitization is sufficiently mature,
requiring a sponsor to retain risk beyond this window could be
economically inefficient. Consequently, the proposal includes a sunset
provision whereby the sponsor is free to hedge or transfer the retained
risk after a specified period of time. Allowing the risk retention
requirement to sunset will eventually free up capital that can be
redeployed elsewhere in the business, thereby helping to promote
capital formation.
In certain instances where the sponsor is the servicer of the loan
pool, the sunset provision may motivate the sponsor to delay the
recognition of defaults and foreclosures until after the sunset
provision has lapsed. The sponsor's incentive to delay arises from its
credit exposure to the pool and its control over the foreclosure
process. Thus, the sponsor/servicer may extend the terms of the loans
until the expiration of the risk retention provision.\258\ To the
extent that sponsors delay revealing borrowers' non-performance, this
would decrease economic efficiency and impair pricing transparency.
---------------------------------------------------------------------------
\258\ Yingjin Hila Gan and Christopher Mayer. Agency Conflicts,
Asset Substitution, and Securitization. NBER Working Paper No.
12359, July 2006.
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For RMBS, the agencies have proposed to require securitizers to
retain risk for the later of five years or until the pool balance has
been reduced to 25 percent (but no longer than seven years). For all
other asset classes, the agencies have proposed to require securitizers
to retain risk for the later of two years or until the pool balance has
been reduced to 33 percent. These methods were chosen to balance the
tradeoff between retaining risk long enough to align the sponsors and
investors incentives and allowing the redeployment of retained capital
for other productive uses. A shorter duration was chosen for non-
mortgage asset classes, because these loans tend to have shorter
maturities than mortgages. Requiring a two year holding period
recognizes that it may not be necessary to retain risk for a longer
period. The alternative component further calibrates the required
duration of risk retention based on the remaining balances. By the time
the loan pool balance decreases to 33 percent, the information about
the loan performance will be largely revealed, at which point the moral
hazard problem between the sponsor and the investor is likely to be
significantly reduced. Although, in the case where the loan pool
balance drops below the prescribed threshold (25 percent for RMBS and
33 percent for other ABS) before the prescribed number of years (five
years for RMBS and two years for other ABS), the additional required
duration might be costly to the sponsor. In other words, requiring the
securitizer to continue to retain exposure to the securitization, once
impact of the information asymmetry has been significantly reduced,
would impose unnecessary costs, potentially impeding allocation
efficiency. Indeed, as currently proposed, as loan balances are paid
down the sponsor may hold more risk relative to other investors because
the size of the credit risk retention piece is based on the initial
size of the securitization, and does not change with the current market
value. This heightened level of risk retention may be unnecessary,
because at that point, there is nothing further the sponsor can do to
adversely impact investors, so that economic efficiency would be better
served by allowing securitizers to withdraw their risk retention
investment to utilize in new securitizations or other credit forming
activities.\259\
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\259\ See Hartman-Glaser, Piskorski and Tchistyi (2012). In
order to achieve the economic goals of the risk retention
requirement, it should be the case that the moral hazard and
information asymmetry between the securitizer and the investors
would be fully resolved by the time that loan balances are reduced
to 25 percent (in the case of RMBS) or 33 percent (in all other
asset classes). The Commission is unaware of any empirical studies
or evidence that supports such a conclusion.
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5. Blended Pools and Buyback Provision
a. Blended Pools
Blended pools are pools that consist of assets of the same class,
some of which qualify for an exemption from the risk retention
requirement, and some of which do not qualify for an exemption from the
risk retention requirement. The proposed rule permits proportional
reduction in required risk retention for blended pools that consist of
both exempted and non-exempted assets. The proposed rule does not allow
mixing asset classes in the same pool for the purpose of reduction of
the risk retention requirement and has several other restrictions to
reduce potential of structuring deals around the risk retention
requirement. Allowing blended pools with a reduced risk retention
requirement will improve efficiency, competition and capital formation
by allowing sponsors to securitize more loans when it is difficult to
obtain a large enough pool of qualifying assets to issue an ABS
consisting entirely of exempted assets.
b. Buyback Requirement
The proposal requires that, if after issuance of a qualifying asset
securitization, it was discovered that a loan did not meet the
qualifying underwriting criteria, the sponsor would have to repurchase
or cure the loan (the ``buyback requirement''). The buyback provision
increases investors' willingness to invest because it makes sponsors of
an ABS responsible for correcting discovered underwriting mistakes and
ensures that the actual characteristics of the underlying asset pool
conform to the promised characteristics.
6. Forms of Risk Retention Menu of Options
Rather than prescribe a single form of risk retention, the proposal
allows sponsors to choose from a range of permissible options to
satisfy their risk retention requirements. As a standard form of risk
retention available to all asset classes, sponsors may choose vertical
risk retention, horizontal risk retention, or any combination of those
two forms. All of these forms require the sponsor to share the risk of
the underlying asset pool. The proposal also includes options tailored
to specific asset classes and structures such as revolving master
trusts, CMBS, ABCP and CLOs. Given the special characteristics of
certain asset classes, some of these options permit the sponsor to
allocate a portion of the shared risk to originators or specified third
parties.
[[Page 58012]]
By proposing to allow sponsors flexibility to choose how they
retain risk, the agencies' proposal seeks to enable sponsors to select
the approach that is most effective. Various factors are likely to
impact the securitizers preferred method of retaining risk, including
size, funding costs, financial condition, riskiness of the underlying
assets, potential regulatory capital requirements, income requirements,
risk tolerances and accounting conventions. All else being equal,
sponsors may prefer the option that involves the least exposure to
credit risk. For example, the horizontal form of standard risk
retention essentially creates a fully subordinated equity tranche and
represents the option that is most exposed to credit risk. By contrast,
a vertical form of standard risk retention is comparable to a stand-
alone securitization that is held by the sponsor and, among the
available options, is the least exposed to credit risk. Some sponsors
may choose to utilize the horizontal method of risk retention or some
combination of the horizontal and vertical method in order to meet the
risk retention requirement, while at the same time signaling the market
that the sponsor is securitizing better quality assets.
If investors believe that the sponsor's choice of risk retention
method results in insufficient risk exposure to properly align
incentives, the proposed optionality may result in less effective risk
retention. However, because investors can observe this choice to help
inform their investment decision, sponsors have incentive to choose the
level of risk exposure that encourages optimal investor participation.
That is, investors may be more likely to participate if the sponsor has
more skin in the game, which may lead sponsors to prefer an option with
a higher level of risk retention. Alternatively if the sponsor retains
insufficient risk exposure investors may not perceive this as a
sufficient alignment of interest and may not invest (i.e., sponsors may
securitize bad assets if they do not have enough exposure).
As the Commission discusses below, a number of the options also
correspond to current market practices. By allowing sponsors to satisfy
their risk retention requirement while still maintaining current market
practices the proposed menu of options approach should help to reduce
costs of the required regime. Moreover, the flexibility sponsors have
to design how they prefer to be exposed to credit risk will allow them
to calibrate and adjust their selections according to changing market
conditions. It also will accommodate evolving market practices as
securitizers and investors update preferences and beliefs.
a. Standard Risk Retention
The standard form of risk retention would permit sponsors to choose
vertical risk retention, horizontal risk retention, or any combination
of these two forms.
i. Eligible Horizontal Residual Interest
One way that a sponsor may satisfy the standard risk retention
option is by retaining an ``eligible horizontal residual interest'' in
the issuing entity in ``an amount that is equal to at least 5 percent
of the fair value of all ABS interests in the issuing entity that are
issued as part of the securitization transaction.'' \260\ The proposed
rules include a number of terms and conditions governing the structure
of an eligible horizontal residual interest in order to ensure that the
interest would be a ``first-loss'' position, and could not be reduced
in principal amount (other than through the absorption of losses) more
quickly than more senior interests and, thus, would remain available to
absorb losses on the securitized assets.
---------------------------------------------------------------------------
\260\ Stated as an equation: The EHRI amount >= 5% of the fair
value of all ABS interests.
---------------------------------------------------------------------------
This option may provide sponsors with an incentive to securitize
safer assets relative to other risk retention options because they hold
the first loss piece. If sponsors are restricted to only holding risk
retention through the horizontal form, they may choose to reduce their
credit exposure by issuing relatively safe loans. This would possibly
restrict the amount of capital available for riskier but viable loans.
Alternatively, investors could require higher loan rates to compensate
for this risk.
A number of commenters on the original proposal generally believed
that the retention of a subordinated interest effectively aligns the
incentives of ABS sponsors with ABS investors. Another commenter stated
that in prime RMBS securitizations, where there is no
overcollateralization, a horizontal slice would be the best approach.
Horizontal risk retention may improve capital formation to the extent
it makes investors more willing to invest in the securitization
markets.
It is not clear that horizontal risk retention will fully align
sponsor incentives with investor incentives. Investors who are
investing in the most senior tranches will have different incentives
than the sponsor who is holding the equity tranche. This is similar to
debt/equity issues that exist in the corporate bond market. Several
commentators expressed concerns regarding the horizontal risk retention
option. These commentators noted that the retention of a subordinated
tranche by the sponsor has the potential to create substantial
conflicts of interest between sponsors and investors. Another
commentator recommended that the final rules remove horizontal as an
option in RMBS transactions noting that history has already shown that
retaining the equity tranche was not enough to align the securitizer's
incentives with those of investors in the securitization's other
tranches.
ii. Eligible Vertical Interest
Another way a sponsor may satisfy the standard risk retention
option is by retaining at least 5 percent piece of each class of
interests issued in the transaction or a single vertical security. The
proposed rules also would require a sponsor that elects to retain risk
through the vertical form of standard risk retention to disclose to
potential investors and regulators certain information about the
retained risks and the assumptions and methodologies used to determine
the aggregate dollar amount of ABS interests issued. The vertical form
of standard risk retention aligns incentives of the sponsor with every
tranche in the securitization by requiring the sponsor to hold a
percentage of each tranche. Several commentators on the original
proposal noted that the vertical form of standard risk retention was
easy to calculate, more transparent and less subject to manipulation.
Commenters also noted that the vertical form of standard risk retention
would receive better accounting treatment than the horizontal form of
standard risk retention. In addition, one of these commenters noted
that because managed structures, including CDOs, have compensation
structures that incentivize managers to select riskier, higher yielding
assets to maximize return and equity cash flows, the vertical form of
standard risk retention is the only option that incentivizes managers
to act for the benefit of all investors.
More generally, by allowing sponsors to choose a vertical form of
risk retention, there will be increased flexibility to choose higher
yielding assets and provide greater access to capital to viable but
higher risk borrowers than what would otherwise be possible through
only a horizontal form of risk retention. While the single vertical
security will have similar costs and benefits to holding 5 percent of
each tranche, there are slight
[[Page 58013]]
differences. The main difference is that the single vertical security
trading costs may be lower than the costs of buying 5 percent of each
tranche.
Alternatively, the agencies considered allowing for loan
participations as an option that commenters raised that would satisfy
the risk retention requirements. Ultimately, it was determined that
there would be little to no economic benefit for allowing this option
because the option is currently not used by the market and would
unlikely be used.
iii. L-Shaped Risk Retention
As discussed above, the horizontal and vertical risk retention
options each present certain costs to securitizers. It is possible that
potential sponsors of securitizations would find both of these risk
retention options costly. The original risk retention proposal included
an option of combining equal parts (2.5 percent) of vertical and
horizontal risk retention. While this combination of horizontal and
vertical risk retention may mitigate some of the costs related to the
horizontal only or vertical only risk retention options, it is possible
that combinations other than equal parts would also satisfy the
objectives of the risk retention requirements. Hence, in an effort to
provide greater flexibility to sponsors, the agencies are proposing to
permit sponsors to hold any combination of vertical and horizontal risk
retention. The benefit of this flexibility is that the approach allows
sponsors to minimize costs by selecting a customized risk retention
method that suits their individual situation and circumstance,
including relative market demand for the various types of interest that
may be retained under the rule. To the extent that the costs and
benefits of credit risk retention vary across time, across asset
classes, or across sponsors, this approach would implement risk
retention in the broadest possible manner such that sponsors may choose
the risk retention implementation that they view as optimal. This
approach may also permit sponsors some flexibility with regard to
structuring credit risk retention without having to consolidate assets.
The proposed set of risk retention alternatives would provide
sponsors with a much greater array of credit risk retention strategies
to choose from. Because sponsors are given the choice on how to retain
risk, their chosen shape may not be as effective in aligning interests
and mitigating risks for investors. That is, it may create fewer
benefits or more costs for investors than other alternatives might.
Thus, the standard risk retention option, to the extent that different
percentages of horizontal and vertical risk retention create disparate
benefits and costs for sponsors and investors, may perpetuate some of
the conflicts of interest that characterized prior securitizations.
This approach, may create flexibility, but may also increase the
complexity of implementation of risk retention and the measurement of
compliance due to the wide choices sponsors would enjoy.
Horizontal risk retention allows sponsors to communicate private
information about asset quality more efficiently, in some cases, than
vertical risk retention, but only if both forms of risk retention are
an option. A sponsor choosing to retain risk in a horizontal form over
a vertical form may be able to signal to the market that the sponsor's
incentives are better aligned with investors'. By choosing a costlier
way of retaining risk, such as the horizontal form, a sponsor can
signal to the market the high quality of their assets. This provides a
benefit to sponsors who are able to signal the high quality of their
assets less costly than retaining risk in the vertical form and using
another signaling mechanism.
Alternatively, the agencies considered allowing sponsors to retain
risk through holding a representative sample of the loans being
securitized as proposed in the original proposal. The option was not
included, among other reasons, because of, as noted by commenters, its
difficulty to implement.
b. Options for Specific Asset Classes and Structures
i. Master Trust
Securitizations of revolving lines of credit, such as credit card
accounts or dealer floor plan loans, are typically structured using a
revolving master trust, which issues more than one series of ABS backed
by a single pool of revolving assets. The proposed rule would allow a
sponsor of a revolving master trust that is collateralized by loans or
other extensions of credit to meet its risk retention requirement by
retaining a seller's interest in an amount not less than 5 percent of
the unpaid principal balance of the pool assets held by the sponsor.
The definitions of a seller's interest and a revolving master trust
are intended to be consistent with current market practices and, with
respect to seller's interest, designed to help ensure that any seller's
interest retained by a sponsor under the proposal would expose the
sponsor to the credit risk of the underlying assets. Commenters on the
original proposal supported permitting a sponsor to satisfy its risk
retention requirement through retention of the seller's interest. In
this regard, a trade association commented that the seller's interest,
in essence, represents a vertical slice of the risks and rewards of all
the receivables in the master trust, and therefore operates to align
the economic interests of securitizers with those of investors. In
contrast, many commenters raised structural (or technical) concerns
with the proposed master trust option.
The Commission preliminarily believes that aligning the
requirements with current market practice will balance implementation
costs for sponsors utilizing the master trust structure with the
benefits that investors receive through improved selection of
underlying assets by the sponsors. Maintaining current practice will be
transparent and easy for the market to understand and will preserve
current levels of efficiency and maintain investor's willingness to
invest in the market. Codification of current practice will also
provide clarity to market participants and may encourage additional
participation given the removal of previous uncertainty about potential
changes to current practices, thereby increasing capital formation.
Under this option, there would be a cost to sponsors of measuring
and disclosing the seller's interest amount on an ongoing basis, but
since this is a current market practice, the additional cost should be
minimal. The agencies propose requiring the 5 percent seller's interest
to be measured in relation to the fair value of the outstanding
investors' interests rather than the principal amount of assets of the
issuing entity. As discussed above this acts to make sure the sponsors'
incentives are aligned with the borrower and to make sure the holdings
of the sponsor are enough to economically incentivize them.
ii. CMBS
The Commission understands that the current market practice
regarding risk retention in the CMBS market is largely in line with the
agencies' proposed rules. The proposed rules allow for the continuation
of current risk retention market practice for CMBS in the form of the
B-piece retention with additional modifications to the current
practice. Under the agencies' proposal, a sponsor could satisfy the
risk retention requirements by having up to two third-party purchasers
(provided that each party's interest is pari passu with the other
party's interest) purchase an eligible horizontal residual interest (B-
piece) in the issuing entity if at least 95 percent of the total unpaid
principal balance is commercial real estate loans.
[[Page 58014]]
The third-party purchaser(s) would be required to acquire and retain an
eligible horizontal residual interest in the issuing entity in the same
form, amount, and manner as the sponsor (with the same hedging,
transfer and other restrictions) except that after five years the
third-party purchaser can sell the B-piece to another eligible third-
party purchaser. Giving the third-party purchaser the ability to sell
the B-piece to another qualified third-party purchaser should not
affect the costs or benefits as the transference of the B-piece keeps
the structure of the ABS intact and therefore the alignment of
incentives will not change. The original third-party purchaser benefits
by being given more liquidity and making the purchase of the B-piece
not as costly, encouraging eligible B-piece purchasers to purchase the
B-piece and increasing competition among B-piece purchasers. The
sponsor would be responsible for monitoring the B-piece buyer's
compliance with the preceding restrictions, and an independent
operating advisor with the authority to call a vote to remove the
special servicer would be appointed.
The proposed option would not allow for B-pieces to be further
packaged into other securitizations such as CDOs. Due to the current
limited state of the CDO market, to the extent the proposal is
codifying the current state of the market, there may be costs and
benefits to market perception that the Commission cannot quantify but
relative to the current state there are no costs and benefits. However,
to be consistent with the motivation behind the proposed rule,
prohibiting repackaging of B-pieces incentivizes sponsors to exercise
the oversight necessary to align interests.
Consistent with the current practice that the ``B-piece'' is the
lowest rated tranche(s) of CMBS (most junior tranche), it accepts the
first losses in the case of defaults, and, thus, it is equivalent to
the horizontal (``first-loss'') option of the general risk retention
rule applied to CMBS. Consequently, the costs and benefits of the ``B-
piece'' are similar to the ones for the horizontal form of standard
risk retention. To the extent that sponsors would continue the current
market practice that they voluntarily use, the costs and benefits will
be marginal (since the rule proposes mandating the size of a B-piece at
the level similar to, although slightly higher than, the currently
used) with the exception below.
Under current market practice, B-piece investors (who are often
also special servicers) have a conflict of interest with investment
grade tranche investors. This conflict could persist to the extent that
CMBS sponsors choose to structure their risk retention consistent with
current practice. In theory, a (special) servicer must try to maximize
recovery for all tranche holders; however, if the servicer is also the
subordinate tranche holder, it may not look after the borrowers' or
senior tranche investors' positions, but rather may undertake actions
(modification, foreclosure, etc.) that maximize the position of the
first-loss investors at the expense of borrowers or senior tranche
investors.\261\ While this potential conflict of interest may continue
to exist, depending on how the sponsor structures the risk retention,
the proposed rules include requirements that may lessen the impact of
the conflict.
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\261\ Yingjin Hila Gan and Christopher Mayer. ``Agency
Conflicts, Asset Substitution, and Securitization'', NBER Working
Paper No. 12359, July 2006, and Brent W. Ambrose, Anthony B.
Sanders, and Abdullah Yavas. ``CMBS Special Servicers and Adverse
Selection in Commercial Mortgage Markets: Theory and Evidence'',
2008, Working Paper.
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The proposed rule requires appointment of an independent operating
advisor who, among other obligations, has the authority to recommend
and call a vote for removal of the special servicer under certain
conditions. This proposed requirement may serve to limit the adverse
effects of the potential conflict of interest, thus helping to ensure
that the benefits of the risk retention requirements are preserved.
There would be costs, however, related to the appointment of the
independent operating advisor, including, but not limited to, the
payments to the advisor.
In comparison to the current lack of any statutorily mandated risk
retention, the primary benefit of allowing sponsors is to maintain
their current market practices, which effectively achieve the intended
objectives of risk retention. In a manner analogous to the discussion
of horizontal risk retention, the B-piece sale may incentivize the
sponsor (through the intended B-piece buyer) to securitize safer assets
relative to retaining an eligible vertical interest under the standard
risk retention option. To the extent that safer assets are securitized,
investors may be more willing to invest in CMBS, thus, increasing the
pool of available capital for lending on the commercial real estate
market. If only the safest commercial real estate loans are
securitized, however, capital formation could potentially be negatively
impacted due to sponsors not issuing loans they cannot securitize.
Thus, riskier loans may not be extended to potentially viable
borrowers. Since sponsors can sell the B-piece to specialized investors
who are willing to take risk (and able to evaluate and manage it),
sponsors can free up additional capital. Thus, allowing the B-piece
option may lead to increased capital formation and allocational
efficiency because the risk is transferred to those parties that are
willing and able to bear it. Both effects could lead to a decline in
costs of borrowing for commercial real estate buyers relative to a
situation where the B-piece is not permitted.
To the extent that the proposed rule allows the current market
practice to continue with minor change in the size of the horizontal
piece, and most market participants follow it, both costs and benefits
of the proposed rule are expected to be minimal with the exception of
the requirement of the appointment of the independent operating advisor
discussed above.
iii. ABCP
The original proposal included a risk retention option specifically
designed for ABCP structures. As explained in the original proposal,
ABCP is a type of liability that is typically issued by a special
purpose vehicle (commonly referred to as a ``conduit'') sponsored by a
financial institution or other sponsor. The commercial paper issued by
the conduit is collateralized by a pool of assets, which may change
over the life of the entity. Depending on the type of ABCP program
being conducted, the securitized assets collateralizing the ABS
interests that support the ABCP may consist of a wide range of assets
including automobile loans, commercial loans, trade receivables, credit
card receivables, student loans, and other loans. Some ABCP conduits
also purchase assets that are not ABS interests, including direct
purchases of loans and receivables and repurchase agreements. Like
other types of commercial paper, the term of ABCP typically is short,
and the liabilities are ``rolled,'' or refinanced, at regular
intervals. Thus, ABCP conduits generally fund longer-term assets with
shorter-term liabilities. In the current market the sponsors of the ABS
interests purchased by ABCP conduits often retain credit risk and
eventually all sponsors of ABS will be required to comply with the
credit risk retention rules.
Under the proposal, sponsors of ABCP conduits could either hold 5
percent of the risk as discussed above using the standard risk
retention option or could rely on the ABCP option outlined
[[Page 58015]]
below. To the extent that an ABCP conduit sponsor or its majority-owned
affiliate already holds over 5 percent of the outstanding ABCP and at
least 5 percent of the residual interest in the ABCP conduit, the costs
will be minimal. Under the current proposal, ABCP sponsors would be
provided an ABCP conduit risk retention option. As long as the assets
held in the ABCP conduit are not purchased in the secondary markets and
the sponsor of every ABS interest held by the ABCP conduit complies
with the credit risk retention requirements then the ABCP conduit
sponsor would not be required to retain risk. Because the sponsor of
the ABS interest held by the ABCP conduit would need to comply with the
credit risk retention requirements certain assets such as receivables
would not be eligible for purchase by an eligible ABCP conduit which
would incentivize ABCP conduits to hold other assets.
Another condition of the proposed conduit option is the requirement
that the ABCP conduit have 100 percent liquidity support and that all
ABS held in the conduit are not acquired in secondary market
transactions. Limiting an eligible ABCP conduit to holding ABS
interests acquired in initial issuances may allow the conduit to
negotiate the terms of the deal and have an effect on the riskiness of
the ABS interests. This may incentivize ABCP conduits to hold ABS
interests acquired in initial issuances over ABS interests acquired in
secondary markets, possibly resulting in increased costs in the
secondary markets for ABS interests due to lower liquidity and
potentially decreasing efficiency in the secondary markets for ABS
interests. At the same time, encouraging primary market transactions
may increase capital formation as new ABS interests will be necessary
for ABCP conduits to issue ABCP. The liquidity support may increase
costs for ABCP conduits that were previously unguaranteed or lacked
liquidity support that meets the requirements in the proposal.
iv. CLOs
Collateralized Loan Obligations (CLO) sponsors are required to
retain the same 5 percent of risk as other asset classes.
Collateralized loans have longer maturities, implying that loan
balances will not decrease much prior to the maturity of the CLO. Under
the proposed sunset provisions, this will require the manager to
effectively retain risk for the life of the CLO. Longer risk retention
periods could help to mitigate concerns that managers may alter the
composition of the loan portfolio relative to a short sunset provision.
The agencies consider CLO managers to be the sponsors of CLOs and thus
they would be required to meet the credit risk retention requirements.
The amount of capital available to managers to hold risk can vary with
the size and affiliations of the manager. To the extent that the CLO
market has different sized managers, the relative capital costs for
managers with a small balance sheet available to service the 5 percent
of risk retention will be greater than the capital costs for managers
with larger balance sheets. This may induce smaller managers to borrow
capital in order to cover holding 5 percent of the risk, which could
result in different funding costs between smaller and larger managers.
As a result, the CLO option may impact competition by creating an
advantage for managers with lower funding costs, and potentially
encourage banks to start sponsoring mangers. The Commission lacks
sufficient information on the distribution of CLO manager
characteristics, including their size, access to capital, and funding
costs, to be able to assess such an impact.
The agencies are proposing to allow certain types of CLO to satisfy
the risk retention requirement if the lead arranger for the underlying
loan tranche has taken an allocation of the syndicated credit facility
under the terms of the transaction that includes a tranche that is
designated as a CLO-eligible loan tranche and such allocation is at
least equal to the greater of (a) 20 percent of the aggregate principal
balance at origination and (b) the largest allocation taken by any
other member (or members affiliated with each other) of the syndication
group.
v. Enterprises
The proposed rules allow the guarantee of the Enterprises under
conservatorship or receivership to count as risk retention for purposes
of the risk retention requirements. Because of the capital support
provided by the U.S. government for the Enterprises, investors in
Enterprise ABS are not exposed to credit loss, and there is no
incremental benefit to be gained by requiring the Enterprises to retain
risk. This along with the Enterprises' capital support creates a
competitive advantage for the Enterprises over private-sector
securitizers when purchasing loans.
Reinforcing this competitive advantage will provide three
significant consequences. First, recognizing the guarantee of the
Enterprises as fulfilling their risk retention requirement will allow
them to facilitate the availability of capital to segments of the
population that might not otherwise have access through private sector
channels. In particular, without Enterprise programs, borrowers that
cannot qualify for loans that are exempt from the risk retention
requirements, but could otherwise support repayment of a loan, might
not be able to secure a loan if lenders are unwilling or unable to
underwrite and retain such loans on their own balance sheet. Second,
the recognition of the guarantee of the Enterprises as fulfilling their
risk retention requirement will smooth home financing in periods when
banks curb their lending due to limited access to capital and private-
sector securitizers are unable or unwilling to meet excess demand.
Finally, recognizing the guarantee of the Enterprises as fulfilling
their risk retention requirement will preserve liquidity in the market
for mortgages that are not QRMs.
The main cost of recognizing the Enterprises' guarantee as
fulfilling their risk retention requirement is the increased
probability that they will purchase riskier loans that do not meet the
QRM criteria. A riskier loan portfolio may increase the Enterprises'
likelihood of default, which has the potential of creating additional
taxpayer burden. Some commenters noted that by allowing the guarantee
of the Enterprises as fulfilling their risk-retention requirements and
preserving their competitive advantage vis-[agrave]-vis private
securitizers, our rules may result in costs to private securitizers,
including perhaps exiting the market because of their inability to
favorably compete with the Enterprises. This will have the effect of
reducing competition and may impede capital formation in segments of
the market not served by the Enterprises. However, analysis of loans
originated between 1997 and 2009, a period that spans the onset of the
financial crisis, shows that private label loans had a much higher
serious delinquency rate than Enterprise purchased loans, even after
accounting for different underlying loan characteristics.\262\ Hence,
this historical performance-based evidence suggest that Enterprise
underwriting standards offset any incentive to incur excess risk
because of their capital support relative, at least in relation the
incentives and behaviors among private label securitizers during the
same period. Furthermore, as discussed below, the proposed rule
includes a proposal to define QRM, which would lessen the
[[Page 58016]]
potential competitive harm to private securitizers.
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\262\ See Joshua White and Scott Bauguess, Qualified Residential
Mortgage: Background Data Analysis on Credit Risk Retention, (August
2013), available at http://www.sec.gov/divisions/riskfin/whitepapers/qrm-analysis-08-2013.pdf.
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vi. Alternatives
In developing the proposed rules on the retention of risk required
under Section 15G of the Exchange Act, as added by Section 941(b) of
the Dodd-Frank Act, the agencies considered a number of alternative
approaches. Some of the alternatives were suggested by commenters
following the previous rule proposals.
For instance, commenters suggested other forms of risk retention
such as: 5 percent participation interest in each securitized asset;
for CLOs, a performance fee-based option; loss-absorbing subordinate
financing in CMBS (such as ``rake bonds''); ``contractual'' risk
retention; private mortgage insurance as a permissible form;
overcollateralization; subordination; third-party credit enhancement;
and conditional cash flows. The agencies believed that the costs and
benefits of these options were not an improvement over the now proposed
standard risk retention option. The Commission invites public comment
regarding all aspects of the proposed approach and potential
alternative approaches.
Alternative amounts of risk retention include: Requiring sponsors
to retain a fixed amount of more than 5 percent; Establishing the risk
retention percentage depending on asset class; and establishing the
risk retention requirement on a sliding scale depending on the (risk)
characteristics of the underlying loans observable at origination
(e.g., instead of the two level structure of 0 percent for exempted
assets and 5 percent for the rest, to use 0 percent for exempted
assets, 1 percent for assets with low expected credit risk, 2 percent
with moderate risk, etc.). The Commission believes that these
alternatives are overly complicated and may create undue compliance and
compliance monitoring burden on market participants and regulators
without providing material benefits over the proposed approaches. The
Commission requests information about costs and benefits of these
alternative risk retention parameters, in particular, the costs and
benefits of requiring fixed risk retention amount of more than 5
percent. Because there is no current risk retention requirement or
voluntary compliance at levels above 5 percent, the Commission
currently lacks sufficient data to quantitatively determine the optimal
amount of risk retention across each asset class. The Commission seeks,
in particular, data or other comment on the economic effects of the 5
percent requirement or of other levels that the agencies have the
discretion to implement. The Commission also requests comment on
methodologies and data that could be used to quantitatively analyze the
appropriate level of risk retention, both generally and for each asset
class.
Alternative sunset provisions include: requiring sponsors to hold
retained pieces until maturity of issued ABS; making the sunset period
depend on average maturity of the underlying loans; and making sunset
gradual, i.e., to introduce gradual reduction in the retained
percentage. At this point, the Commission assumes that these
alternatives create additional costs, impose undue compliance and
compliance monitoring burden on market participants and regulators
without adding benefits. The sunset provision could also be implemented
with cut off horizons different from the proposed five years for RMBS
and two years for other asset classes and with pool balance cut offs
different from the proposed 25 percent and 33 percent respectively. The
agencies request information about costs and benefits of these
alternative risk retention structures, in particular, about the
currently proposed numerical parameters of the sunset provision. The
Commission also requests comment on methodologies and data that could
be used to quantitatively analyze the appropriate sunset horizons, both
generally and for each asset class.
7. Exemptions
As discussed above, there are overarching economic impacts of a
risk retention requirement. Below the Commission describes the
particular costs and benefits relevant to each of the asset classes
included within this rule that the agencies exempt from risk retention.
a. Federally Insured or Guaranteed Residential, Multifamily, and Health
Care Mortgage Loan Assets
The agencies are proposing, without changes from the original
proposal, the exemption from the risk retention requirements for any
securitization transaction that is collateralized solely by
residential, multifamily, or health care facility mortgage loan assets
if the assets are insured or guaranteed in whole or in part as to the
payment of principal and interest by the United States or an agency of
the United States. The agencies are also proposing, without changes
from the original proposal, the exemption from the risk retention
requirements for any securitization transaction that involves the
issuance of ABS if the ABS are insured or guaranteed as to the payment
of principal and interest by the United States or an agency of the
United States and that are collateralized solely by residential,
multifamily, or health care facility mortgage loan assets, or interests
in such assets.
Relative to the baseline there is no cost or benefit associated
with this exemption because risk retention is not currently mandated.
However, by providing this exemption it will incentivize sponsors to
use federally insured or guaranteed assets, which will have an impact
on competition with other assets that are not federally insured or
guaranteed. The agencies believe it is not necessary to require risk
retention for these type of assets because investors will be
sufficiently protected from loss because of the government guarantee
and adding the cost of risk retention would create costs to sponsors
where they are not necessary as the incentive alignment problem is
already being addressed.
b. Securitizations of Assets Issued, Insured or Guaranteed by the
United States or Any Agency of the United States
The rules the agencies are proposing today contain full exemptions
from risk retention for any securitization transaction if the ABS
issued in the transaction were (1) collateralized solely (excluding
servicing assets) by obligations issued by the United States or an
agency of the United States; (2) collateralized solely (excluding
servicing assets) by assets that are fully insured or guaranteed as to
the payment of principal and interest by the United States or an agency
of the United States (other than residential, multifamily, or health
care facility mortgage loan securitizations discussed above); or (3)
fully guaranteed as to the timely payment of principal and interest by
the United States or any agency of the United States.
Relative to the baseline there is no cost or benefit associated
with this exemption because risk retention is not currently mandated.
However, by providing this exemption it will incentivize sponsors to
use federally insured or guaranteed assets, which will have an impact
on competition with other assets that are not federally insured or
guaranteed. The agencies believe it is not necessary to require risk
retention for these type of assets because investors will be
sufficiently protected from loss because of the government guarantee
and adding the cost of risk retention would create costs to sponsors
where they are not necessary as the
[[Page 58017]]
incentive alignment problem is already being addressed.
c. QRM
As discussed above, the rules the agencies are re-proposing today
exempt from required risk retention any securitization comprised of
QRMs. Section 15G requires that ABS that are collateralized solely by
QRMs be completely exempted from risk retention requirements, and
allows the agencies to define the terms and conditions under which a
residential mortgage would qualify as a QRM. Section 15G mandates that
the definition of a QRM be ``no broader than'' the definition of a
``qualified mortgage'' (QM), as the term is defined under Section
129C(b)(2) of the Truth in Lending Act.
Pursuant to the statutory mandate, the agencies have proposed to
exempt ABS collateralized by QRMs, and pursuant to the discretion
permitted, have proposed defining QRMs broadly as QMs. The Commission
believes that this definition of QRM would achieve a number of
important benefits. First, since the criteria used to define QMs focus
on underwriting standards, safer product features, and affordability,
the Commission preliminarily believes that equating QRMs with QMs is
likely to promote more prudent lending, protect consumers, and
contribute to a sustainable, resilient and liquid mortgage
securitization market. Second, the Commission believes that a single
mortgage quality standard (as opposed to creating a second mortgage
quality standard) would benefit market participants by simplifying the
requirements applicable to this market. Third, a broader definition of
QRMs avoids the potential effect of squeezing out certain lenders, such
as community banks and credit unions, which may not have sufficient
resources to hold the capital associated with non-QRM mortgages, thus
enhancing competition within this segment of the lending market. The
Commission believes that this will increase borrower access to capital
and facilitate capital formation in securitization markets. Finally, a
broad definition of QRMs may help encourage the re-emergence of private
capital in securitization markets. Since Enterprises would have a
competitive securitizing advantage because of the proposed recognition
of the guarantee of the Enterprises as fulfilling their risk-retention
requirement and taxpayer backing, less restrictive QRM criteria would
enhance the competitiveness of private securitizations and reduce the
need to rely on low down-payment programs offered by Enterprises.
Aligning QRM to QM would build into the provision certain loan
product features that data indicates results in a lower risk of
default. The Commission acknowledges that QM does not fully address the
loan underwriting features that are most likely to result in a lower
risk of default. However, the agencies have considered the entire
regulatory environment, including regulatory consistency and the
possible effects on the housing finance market. In addition, the
agencies believe that other steps being considered may provide
investors with information that allows them to appropriately assess
this risk. The Commission has proposed rules that would require in
registered RMBS transactions disclosure of detailed loan-level
information at the time of issuance and on an ongoing basis. The
proposal also would require that securitizers provide investors with
this information in sufficient time prior to the first sale of
securities so that they can analyze this information when making their
investment decision.\263\
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\263\ See Asset-Backed Securities, SEC Release No. 33-9117, 75
FR 23328 at 23335, 23355 (May 3, 2010).
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The Commission is aware, however, that defining QRMs broadly to
equate with QMs may result in a number of economic costs. First, to the
extent that risk retention reduces the risk exposure of ABS investors,
a broader definition of QRMs will leave a larger number of ABS
investors bearing more risk. Second, securitizers will not be required
to retain an economic interest in the credit risk of QRM loans, and
thus, the incentives between securitizers and those bearing the credit
risk of a securitization will remain misaligned. An analysis of
historical performance among loans securitized into private-label RMBS
that originated between 1997 and 2009 shows that those meeting the QM
standard sustained exceedingly high serious delinquency rates, greater
than 30 percent during that period.\264\ Third, the QRM exemption is
based on the premise that well-underwritten mortgages were not the
cause of the financial crisis; however, the criteria for QM loans do
not account for all borrower characteristics that may provide
additional information about default rates. For instance, borrowers'
credit history, their down payment and their loan-to-value ratio have
been shown to be significantly associated with lower borrower default
rates.\265\ Fourth, allowing securitizers to bear less risk in their
securitizations avoids moderation of non-observable risk factors that
could substantially harm ABS investors during contractionary housing
periods. That is, investors would be better protected by a narrower QRM
standard. Fifth, commenters argued that not allowing blended pools of
QRMs and non-QRMs to qualify for a risk-retention exemption may limit
securitizations, if lenders cannot originate enough QRMs. Although
broadening the definition of QRMs reduces this concern, since blended
pools will still require risk retention, mortgage liquidity may still
be reduced.
---------------------------------------------------------------------------
\264\ See Joshua White and Scott Bauguess, Qualified Residential
Mortgage: Background Data Analysis on Credit Risk Retention, (August
2013), available at http://www.sec.gov/divisions/riskfin/whitepapers/qrm-analysis-08-2013.pdf
\265\ Id.
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d. Qualified Automobile Loans, Qualified Commercial Real Estate Loans
and Qualified Commercial Loans
Similar to RMBS discussed above, the agencies have proposed to
exempt securitizations containing certain qualified loans from the risk
retention requirement. Specifically, the agencies proposed an exemption
for qualified automobile loans, qualified commercial real estate loans
and commercial loans. The benefit to exempted qualified loans from risk
retention is that sponsors will have more capital available to deploy
more efficiently. The economic consequences of exempting qualified
loans are analogous to the discussion associated with requiring
stricter lending standards than QM in the residential lending market.
Also there will be fewer administrative, monitoring and compliance
costs to be met due to the lack of risk retention. Lower costs of
securitizing loans may enhance competition in the market for qualified
auto, commercial real estate and commercial loans by allowing more
firms to be profitable by exempting certain type of loans, sponsors
have an incentive to misrepresent qualifications of loans, similar to
what was observed in the financial crisis. One qualification
surrounding whether or not a loan is qualified is that the sponsor is
required to purchase any loan that fails to meet the underwriting
criteria. The benefit of the previous qualification is that it helps to
prevent and disincentivize sponsors from trying to include unqualified
loans in the securitization.
e. Resecuritizations
The agencies have identified certain resecuritizations where
duplicative risk retention requirements would not appear to provide any
added benefit. Resecuritizations collateralized only by existing 15G-
compliant ABS and financed through the issuance of a single class of
securities so that all principal and interest payments
[[Page 58018]]
received are evenly distributed to all security holders, are a unique
category of resecuritizations. For such transactions, the
resecuritization process would neither increase nor reallocate the
credit risk of the underlying ABS. Therefore, there would be no
potential cost to investors from possible incentive misalignment with
the securitizing sponsor. Furthermore, because this type of
resecuritization may be used to aggregate 15G-compliant ABS backed by
small asset pools, the exemption for this type of resecuritization
could improve access to credit at reasonable terms to consumers and
businesses by allowing for the creation of an additional investment
vehicle for these smaller asset pools. The exemption would allow the
creation of ABS that may be backed by more geographically diverse pools
than those that can be achieved by the pooling of individual assets as
part of the issuance of the underlying 15G-compliant ABS. Again, this
will likely improve access to credit on reasonable terms.
Under the proposed rule, sponsors of resecuritizations that do not
have the structure described above would not be exempted from risk
retention. Resecuritization transactions, which re-tranche the credit
risk of the underlying ABS, would be subject to risk retention
requirements in addition to the risk retention requirement imposed on
the underlying ABS. In such transactions, there is the possibility of
incentive misalignment between investors and sponsors just as when
structuring the underlying ABS. For such resecuritizations, the
proposed rule seeks to ensure that this misalignment is addressed by
not granting these resecuritizations with an exemption from risk
retention. The proposed rules may have an adverse impact on capital
formation and efficiency if they make certain resecuritization
transactions costlier or infeasible to conduct.
f. Other Exemptions
There are a few exemptions from risk retention included in the
current proposal that were not included in the original proposal. They
include exemptions for utility legislative securitizations, two options
for municipal bond ``repackaging'' securitizations, and seasoned loans.
With respect to utility legislative securitizations, the agencies
believe the implicit state guarantee in place for these securitizations
addresses the moral hazard problem discussed above and adding the cost
of risk retention would create costs to sponsors where they are not
necessary as the incentive alignment problem is already being
addressed.
For municipal bond repackaging securitizations, the agencies
believe that the risk retention mechanisms already in place for these
securitizations already serve to address the moral hazard problem
discussed above and thus have proposed two options that would reflect
current market practice.
Seasoned loans have had a sufficient period of time to prove their
performance and the agencies believe that providing an exemption for
these assets consistent with the sunset in place for risk retention
requirements addresses the moral hazard problem discussed above and
adding the cost of risk retention would create costs to sponsors where
they are not necessary as the incentive alignment problem is already
being addressed.
Relative to the baseline there is no cost or benefit associated
with these exemptions because risk retention is not currently mandated.
However, providing these exemptions would incentivize the creation of
utility legislative securitizations, municipal bond ``repackaging''
securitizations, and securitizations with seasoned loans, which will
have an impact on competition with other securitizations.
g. Alternatives
Commenters asked for exemptions for specific asset classes such as:
rental car securitization, tax lien-backed securities sponsored by a
municipal entity, ``non-conduit'' CMBS transactions, corporate debt
repackagings, and legacy loan securitizations. The agencies chose not
to provide exemptions for these asset classes because the cost
associated with retaining risk provided a benefit for these asset
classes by aligning the incentive of the sponsor and the investor.
These asset classes had either unfunded risk retention already in
practice or had loans created before the new underwriting
qualifications were in place. In either case there exists a
misalignment between the sponsor and investors. In order to resolve
this moral hazard risk retention is required.
8. Hedging, Transfer and Financing Restrictions
Under the proposal, a sponsor and its consolidated affiliates
generally would be prohibited from hedging or transferring the risk it
is required to retain, except for currency and interest rate hedges and
some index hedging. Additionally, the sponsor would be prohibited from
financing the retained interest on a non-recourse basis.
The main purpose of the hedging/transfer restrictions is to enforce
the economic intent of the risk retention rule. Without the hedging/
transfer restrictions, sponsors could hedge/transfer their (credit)
risk exposure to the retained ABS pieces, thereby eliminating the
``skin in the game'' intent of the rule. Thus, the restriction is
intended to prevent evasion of the rule's intent.
Costs related to the hedging/transfer restrictions include direct
administrative costs and compliance monitoring costs. Additionally,
according to a few commenters, there is uncertainty about the
interpretation of the proposed rules, namely, what constitutes
permissible and impermissible hedges. Such uncertainty may induce
strategic responses that are designed to evade the without violating
the letter of the rule. For example, derivative or cash instrument
positions can be used to hedge risk, but it may be difficult to
determine whether such a hedge is designed to evade the rule.
9. Foreign Safe Harbor
The proposal includes a safe harbor provision for certain,
predominantly foreign, transactions based on the limited nature of the
transactions' connections with the United States and U.S. investors.
The safe harbor is intended to exclude from the proposed risk retention
requirements transactions in which the effects on U.S. interests are
sufficiently remote so as not to significantly impact underwriting
standards and risk management practices in the United States or the
interests of U.S. investors. The exclusion would create compliance and
monitoring cost savings compared to universally applying the risk
retention rules to all ABS issues.
The costs of foreign safe harbor exemptions would be small. ABS
deals with a share of U.S. assets slightly above the threshold of 25
percent and sold primarily to foreign investors may be restructured by
sponsors to move the share below the threshold to avoid the need to
satisfy the risk retention requirements. The number of such deals will
likely be small \266\ and the resulting economic costs will be minimal.
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\266\ Since 2009, only 0.26 percent of all ABS in AB Alert
database had primary location of collateral in the U.S., but were
distributed outside of the U.S.
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There will be negligible effect of the exclusion on efficiency,
competition and capital formation (compared to the universal
application of the risk retention rule) because the affected ABS are
foreign and not related to U.S. markets. In some instances, allowed by
the foreign safe harbor provision, the effect on capital formation in
the United
[[Page 58019]]
States would be positive. For example, foreign sponsors which acquire
less than 25 percent of assets in the pool in the United States and
sell the ABS to foreign investors to avoid risk retention requirement
would create capital in the United States. The prevalence of such
situations would depend on relative strictness of the United States and
foreign risk retention rules, tax laws, and other relevant security
regulations. (see also footnote 36). The effect of the same scenario on
competition may be marginally negative for the United States sponsors
involved in similar transactions (securitizing U.S.-based assets for
sale to foreign investors) because the U.S. sponsors have to retain
risk pieces by the virtue of being organized under the laws of the U.S.
The proposal may have negative effect on foreign sponsors that seek
U.S. investors because they may need to satisfy risk retention
requirements of two countries (their home country and the United
States) and, thus, the rule may reduce competition and investment
opportunities for U.S. investors. The proposed rule is designed to
provide flexibility for sponsors with respect to forms of eligible risk
retention to permit foreign sponsors seeking a material U.S. investor
base to retain risk in a format that satisfies both home country and
U.S. regulatory requirements, without jeopardizing protection to the
U.S. investors in the form of risk retention.
10. Request for Comment
The Commission requests comments on the following questions:
1. Are the descriptions of the current risk retention practices and
structures or practices that align the interests of investors and
sponsors correct with respect to all ABS asset classes, but, in
particular, in the following: ABCP, CLO, RMBS, automobile loan backed
ABS, and master trusts with seller's interests?
2. With respect to current risk retention practices: what share of
ABS interest is currently retained (less/more than 5 percent)? What
type of ABS interest is currently retained (horizontal, vertical, L-
shaped, seller's interest)? When was this practice or structure
developed (before or after the crisis, before or after the promulgation
of Dodd-Frank Act)? Is information about risk retention (size or shape)
for specific transactions disclosed to investors? To what extent is
this practice or structure in response to regulatory restrictions
(e.g., EU risk retention regulations or the FDIC safe harbor)?
3. Is there a difference in historical delinquency rates/
performance of securitizations in which the sponsor retained ABS
interests and securitizations in which the sponsor did not retain ABS
interests? Is there a difference in the timing of defaults of
securitizations in which the sponsor retained ABS interests and
securitizations in which the sponsor did not retain ABS interests?
4. What are the estimates of the potential costs of appointing the
independent operating advisors for the proposed CMBS B-piece option?
5. To what extent do the sponsor and/or its affiliates receive
subordinated performance fees with respect to a securitization
transaction? Are the subordinated performance fees received by the
sponsor and its affiliates equal to or greater than the economic
exposure they would get from the 5 percent risk retention requirements?
Because subordinated performance fees only align incentives when the
assets are performing above a certain threshold, should there be any
additional restrictions on the use of performance fees to satisfy risk
retention requirements?
6. To the extent not already provided, what are the estimates of
the cost (including opportunity cost) of 5 percent risk retention and
how will 5 percent retention affect the interest rates paid by
borrowers under securitized loans?
7. What would be the costs of establishing the risk retention level
above the statutory 5 percent? What would be the benefits?
8. Are there any additional costs that the agencies should consider
with respect to the risk retention?
9. Are the sunset provision appropriate for RMBS (i.e., the latter
of (x) 5 years and (y) the reduction of the asset pool to 25% of its
original balance, but (z) no longer than 7 years) and all other asset
classes (i.e., the latter of (x) 2 years and (y) the reduction of the
asset pool balance to 33%)? What data can be used to support these or
alternative sunset bounds?
10. To what extent do the requirements and/or restrictions included
in each of the risk retention options limit the ability of sponsors to
use the option?
11. To what extent are the deals funded by ABCP conduits included
in the deal volumes for other asset classes?
12. To the extent that a warehouse line is funded by the issuance
of revolving ABS, is that ABS included in the deal volume?
13. It would be helpful to receive additional information about the
fees charged by sponsors for setting up securitizations, sponsors
interpretation of their opportunity cost of capital, the interaction of
regulatory capital with cost of capital, and historical returns of
tranches of different asset classes in particular the residual
interest.
14. The Commission requests data about master trusts that would
permit it to estimate the amount of risk currently retained.
15. The Commission currently lacks sufficient data to
quantitatively assess the potential impact of the proposed minimum 5
percent retention requirement. In connection with the re-proposal, the
Commission seeks data or other comment on the economic effects of the
proposed minimum 5 percent requirement.
The Commission also requests comment on methodologies and data that
could be used to quantitatively analyze the appropriate level of risk
retention, both generally and for each asset class.
Appendix: The Impact of Required Risk Retention on the Cost of Credit
In this section, we outline a framework for evaluating the impact
of required risk retention on the cost of credit, and apply it to a
hypothetical securitization of prime mortgages. While the ultimate
impact of required risk retention depends in part on the assumptions
about how risk retention is funded by the sponsor, we conclude that
incremental risk retention by the sponsor is unlikely to have a
significant impact on the cost of credit. Our range of reasonable
estimates of the cost of risk retention is between zero and 30 basis
points. The former estimate is relevant when incremental retention is
zero. The latter is relevant when the sponsor is currently retaining
nothing, and incremental retention is funded entirely with sponsor
equity.
I. Conceptual Framework
The analysis below focuses on the impact of risk retention on the
cost of credit through the cost of funding. If capital markets are
efficient, the cost of funding an ABS interest directly in capital
markets should be no different than funding the same ABS interest on
the balance sheet of the sponsor. However, when capital markets are not
efficient, risk retention can be costly, as the cost of funding credit
through securitization is lower than funding on the sponsor's balance
sheet. Here, we focus on measuring how much risk retention can increase
the cost of credit to borrowers by forcing a sponsor to increase the
amount of retention it is funding on its balance sheet.\267\
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\267\ As this cost is driven by financial market inefficiency,
it is worth noting that financial innovation which reduces or
eliminates this inefficiency over time will subsequently reduce or
eliminate these costs.
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[[Page 58020]]
The analysis starts by identifying the marginal amount and form of
retention. In a typical securitization transaction, the sponsor is
currently holding some risk retention without being prompted by
regulation, typically in a first-loss position. In some circumstances,
the proposed rule will increase the overall amount of retention by the
sponsor, and it is only this increase that will have an impact on the
cost of credit. If the sponsor's risk retention is already adequate to
meet the rule, the implication is that the impact of the rule on the
cost of credit is zero. In the analysis here, we focus first on the
marginal retention required by the sponsor to meet the rule.\268\
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\268\ It is possible that restrictions proposed above on the
timing of cash flow to an eligible horizontal residual interest
(EHRI) will also have an impact on the cost of credit. In
particular, an increase in the duration of first-loss cash flows may
prompt the sponsor to increase the required yield on the EHRI. As we
have found reasonable changes in the yield to have insignificant
impact on the analysis here, it is ignored it for simplicity.
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(1) Marginal Risk Retention = Required Risk Retention-Current Risk
Retention
For the purposes of this example, assume the sponsor currently
holds a first loss position equal to 3 percent of the fair value of all
ABS interests (Current Risk Retention), and consequently needs to hold
eligible interests with fair value of an additional 2 percent (Marginal
Risk Retention) in order to meet the 5 percent standard (Required Risk
Retention).
We assume that the sponsor has three options to fund this Marginal
Risk Retention of 2 percent. In the first option, the sponsor funds
entirely with new equity. In the second option, the sponsor funds part
of the marginal risk retention with maturity-matched debt secured by
the ABS interest and recourse to the sponsor, and the rest with new
equity. In the final option, the sponsor funds part of the marginal
risk retention with short-term bi-lateral repo secured by the ABS
interest and recourse to the sponsor, and the rest with new equity.
Regardless of the funding strategy, the framework outlined below is
focused on calculating the sponsor's return on marginal equity. This
calculation has three components: The Amount of Incremental Equity by
the sponsor, the Gross Yield on the Retained ABS Interest, and the Cost
of Debt Funding. We review each of these in turn. The amount of
incremental equity is simply the amount of incremental funding in the
form of sponsor equity, and it varies across sponsor funding strategy.
(2) Amount of Incremental Equity = Percent of Equity in Incremental
Funding x Marginal Risk Retention (1)
Assuming the marginal risk retention requirement of 2 percent from
the example above, when the sponsor funds marginal risk retention only
with equity, the Percent Equity in Incremental Funding is 100 percent,
and the Amount of Incremental Equity is 2 percent (= 1 x 0.02).
However, if the sponsor funds with 80 percent term debt, the Percent of
Equity in Incremental Funding is 20 percent, and the Amount of
Incremental Equity is 0.4 percent (= 0.20 x 0.02). Finally, when the
sponsor funds marginal risk retention with bi-lateral repo of 90
percent, the Percent of Equity in Incremental Funding would be 10
percent, and the Amount of Incremental Equity is 0.2 percent (= 0.10 x
0.02).
The Gross Yield at Issue on the Marginal Retained ABS interests by
the sponsor is an important input to the calculation below, as it
measures the sponsor's return from holding risk retention. As the gross
yield increases, all else equal, the cost of risk retention will
decrease, as the sponsor is being compensated more for its position.
(3) Gross Yield = Yield at Issue on Marginal Retained ABS Interest(s)
In the motivating example here, we assume the gross yield on
marginal ABS interests retained is 4 percent.
In order to calculate the return on marginal equity, it is
necessary to measure the difference between Gross Yield and the Cost of
Debt Funding, where the latter is simply the product of the cost of
incremental debt funding times the amount of debt in the capital
structure.
(4) Cost of Debt Funding = Percent of Debt in Incremental Funding x
Cost of Incremental Debt
When the sponsor only uses equity to fund incremental retention,
the amount of incremental debt is 0 percent and Cost of Debt Funding is
zero. When the sponsor uses term debt in 80 percent of the capital
structure at a cost of 5 percent, the Cost of Debt Funding is 4 percent
(= 0.8 x 0.05). Finally, when the sponsor uses bi-lateral repo in 90
percent of the capital structure at a cost of 4 percent, the Cost of
Debt Funding is 3.6 percent (= 0.9 x 0.04).
The next step in calculating the marginal return on equity is
measurement of the Net Yield on marginal retention, which is equal to
the difference between the gross yield and the cost of debt funding.
(5) Net Yield = Gross Yield (3)-Cost of Debt Funding (4)
In our examples from above, the Net Yield of the all equity funding
strategy is 4 percent (= 0.04-0), of the term debt funding strategy is
0 percent (= 0.04-0.04), and of the bi-lateral repo funding strategy is
0.4 percent (= 0.04-0.036) percent. Finally, the Return on Marginal
Equity is the ratio of the Net Yield to the Amount of Incremental
Equity. It is the actual return to marginal sponsor equity, taking the
current cost of credit as given.
(6) Return on Marginal Equity = Net Yield (5)/Percent of Equity in
Incremental Funding
In our examples from above, the Return on Marginal Equity of the
all equity funding strategy is 4 percent (= 0.04/1), of the term debt
funding strategy is 0 percent (= 0/0.2), and of the bi-lateral repo
funding strategy is 4 percent (= 0.004/0.1).
These Returns on Marginal Equity are likely to be too low to incent
the sponsor to go forward with the transaction. In order to remediate
this problem, we measure the ROE shortfall as the difference, if
positive, between the sponsor's target return on marginal equity and
the actual return on marginal equity. This number represents how much
the sponsor's ROE on marginal equity needs to increase to meet the
target return.
(7) ROE Shortfall = max (0,Target Return on Equity-Return on Marginal
Equity (6))
While we will let the target Return on Marginal Equity vary with
the funding strategy and risk of the ABS interest retained in the
detailed example below, for simplicity assume now that the Target
Return on Equity is 10 percent. Following our example, this leads to an
ROE shortfall of 6 percent (= 0.10-0.04) for the all equity strategy,
of 10 percent (= 0.10-0.0) for the term debt funding strategy, and of 6
percent (= 0.10-0.04) for the bi-lateral repo funding strategy.
In order to eliminate the shortfall, it is necessary to increase
the Return on Marginal Equity, which is done by generating more cash
flow for the sponsor. As all cash flow has been exhausted through
payments to ABS interests, this can only be done by increasing the
yield on the underlying assets, which is the measured increase in the
cost of credit. Note that the incremental cash flow from the higher
mortgage coupon only needs to flow to the sponsor.\269\
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\269\ In particular, since we have valued all of the other ABS
interests at market prices, and the rule does not affect investors
in those interests, it is safe to assume those tranches can continue
to be sold at the same price. It is possible that risk retention
could reduce the yield demanded by investors on those interests, but
for conservatism we ignore that impact here.
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[[Page 58021]]
While it is unclear how a sponsor might ultimately structure the
transaction to capture this incremental cash flow, we assume for
illustrative purposes here that the sponsor creates a senior IO strip
in the amount of the incremental yield on the assets, and holds that IO
strip along with incremental retention.\270\ As the sponsor receives
100 percent of the cash flow from the incremental cost of credit, small
changes in the cost of credit can have a large impact on the return on
marginal equity.\271\
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\270\ It is possible that the sponsor would structure this cash
flow to be an eligible form of retention, and reduce the amount of
incremental retention, but for conservatism we ignore that impact
here.
\271\ The impact of the higher coupon on the return on marginal
equity is driven by two factors. First, a one basis point increase
in the mortgage coupon only has to be distributed to the sponsor's
incremental ABS interest, which in this example is only 2 percent.
Second, when the sponsor uses leverage through debt, the amount of
marginal equity is a fraction of the incremental ABS interest. These
two levels of leverage permit small changes in the mortgage coupon
to have a relatively large impact on the return on marginal equity.
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In our example when the sponsor funds incremental risk retention
entirely with equity, an increase in the yield on assets by 12 basis
points, when divided by the amount of incremental equity of 2 percent,
results in an additional return to marginal equity of 6 percent (=0.12/
0.02). It follows that it would only take a 12 basis point increase in
the cost of credit to compensate the sponsor for the funding cost of
incremental risk retention entirely with equity when using a Target
Return on Incremental Equity of 10 percent.
More generally, the potential impact of risk retention on the cost
of credit is equal to the product of the ROE shortfall and the amount
of incremental equity.
(8) Impact on Cost of Credit = ROE shortfall (7) x Amount of
Incremental Equity (2) Substituting earlier equations into (8) results
in the simple following approximation to the impact of risk retention
on the cost of credit:
(9) Impact on the Cost of Credit = Max {0,Target Return on Marginal
Equity-[Yield on Marginal Retained Interest-(Cost of Incremental Debt x
(1-Amount of Incremental Equity))]/Amount of Incremental Equity{time}
x Amount of Incremental Risk Retention x Amount of Incremental Equity
The equation above demonstrates that the impact of the proposed
rule on the cost of credit is increasing in the following variables:
(i) Target return on marginal equity, (ii) cost of incremental debt,
(iii) amount of incremental risk retention, and (iv) yield on marginal
retained interest. The impact of the amount of incremental equity is
ambiguous, as it depends on the cost of incremental debt.
II. Application
In order to illustrate the framework, we will focus on the
hypothetical securitization of prime mortgage loans illustrated below.
The first column documents class name, the second column documents
tranche NRSRO rating, the third column documents tranche type, the
fourth column face amount, the fifth column documents tranche coupon,
and the sixth column is the ratio of tranche face amount (4) to total
face amount (the sum of face amounts for all non-IO tranches). Using
cash flow assumptions consistent with prime mortgage loans as well as
the yield assumption from (9), we compute the price in column (7).\272\
The value (8) is simply equal to the price (7) multiplied by the
balance (6) divided by 100.
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\272\ The analysis assumes 15 percent CPR (constant prepayment
rate), 0 percent CDR (constant default rate), 30 percent loss
severity, 24-month recovery lag, and employs the forward interest
rate curve as of 22 May 2013.
[GRAPHIC] [TIFF OMITTED] TP20SE13.001
The Amount and Form of Risk Retention
There are three ways for the sponsor of this mortgage transaction
to comply with the proposed rule which we will evaluate here: an
eligible horizontal retained interest, a vertical interest, or an L-
shaped interest. We review each of these in turn.
[[Page 58022]]
[GRAPHIC] [TIFF OMITTED] TP20SE13.002
Under the horizontal risk retention option, the sponsor must hold
ABS interests from the bottom of the capital structure up until the
value of those interests is no less than 5 percent of the fair value of
ABS interests. As the value of all ABS interests is $102.5 from Figure
A1, the value of the horizontal form must be 5.13 percent (=$102.5 x
5%). The table above illustrates that in order for the sponsor to
comply with the rule, the sponsor must hold 83.92 percent of the B1
tranche, as well as 100 percent of all junior tranches, in order to
meet required retention with horizontal. The value-weighted yield on
this interest is 5.24 percent.
Under the L-shaped risk retention option, the sponsor can hold any
combination of horizontal and vertical interests as long as the
aggregate fair value is 5.13 percent. We focus here on the sponsor
holding the non-investment grade part of the capital structure as
horizontal and the rest vertical. The middle columns illustrate that
the bottom two tranches (B4 and B5), together represent about 0.64
percent of fair value, implying that the sponsor needs to hold vertical
interests with fair value of 4.49 percent. The table illustrates that
holding 4.4 percent of each of the remaining ABS interests accomplishes
this requirement, resulting in a value-weighted yield of 4.01 percent.
Finally, under the vertical risk retention option, the sponsor must
hold 5 percent of each ABS interest, which mechanically ensures that
the fair value of those interests is equal to 5.13 percent, and has a
yield of 2.71 percent.
The Cost of All Equity Funding
In this section we take the conservative approach that eligible
risk retention is funded entirely with equity. As finance theory
suggests that the required return on sponsor equity should be
determined largely by the risk of asset funded by equity, we assume
that equity has a required risk-adjusted rate of return which is
increasing in the risk of the marginal retained ABS interest. In
particular, when equity is funding the safest form of risk retention--
the vertical form--we assume the required yield is only 7 percent.
However, when equity is funding the L-shaped form, which is more risky
than the vertical form but not as risky as horizontal form, we assume
the required yield increases to 9 percent. Finally, when equity is
funding the horizontal form, the most risky of all eligible forms, we
assume the required yield is 11 percent.
[GRAPHIC] [TIFF OMITTED] TP20SE13.003
In the ``ROE from Retained'' row, the table reports the actual
return on equity from the retained position, which in every
circumstance is below the target return on equity. This difference,
measured in the next row as ``ROE shortfall,'' measures the additional
yield which must be generated in order compensate equity for its
required return. For example, when horizontal is funded by full equity,
the ROE is 5.24
[[Page 58023]]
percent, which is 5.76 percent below the target return of 11 percent.
For conservatism, we assume that the sponsor was not retaining
anything without the rule, so the ``Marginal Equity'' is 5 percent. The
last row computes the coupon impact, which is simply equal to the
product of Marginal Equity and the ROE shortfall, as all additional
cash flow from a higher mortgage coupon can be directed to equity.
Overall, the table illustrates that in a conservative funding
structure, where the sponsor had no retention before the rule, the
impact of the proposed rule on the mortgage coupon varies between 21
and 29 basis points.
The Cost of Risk Retention With Term Debt Funding
In the example below, we focus on sponsor funding of incremental
risk retention using a capital structure which varies with the risk of
the underlying incremental ABS interest: 20 percent equity when
incremental retention is horizontal, 10 percent equity when incremental
retention is L-shaped interest, and 5 percent equity incremental
retention is vertical. The cost of term debt is assumed to be 30-day
LIBOR plus 6 percent, using the average for a BBB-rated sponsor at a
maturity of 7-10 years. Given the presence of leverage in the capital
structure, we assume the cost of equity is 2 percentage points higher
to fund each type of ABS interest than when funded entirely with
equity. Using the conceptual framework outlined above, the measured
impact of risk retention on the cost of credit, illustrated in the last
line, varies between 12 and 18 basis points.\273\
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\273\ For simplicity, we do not vary the cost of debt across the
risk of the asset portfolio, as this has a second-order impact on
the result.
[GRAPHIC] [TIFF OMITTED] TP20SE13.004
The Cost of Risk Retention With Bi-Lateral Repo Funding
In the final approach, we permit the sponsor to follow a more
aggressive strategy where funding eligible risk retention is funded in
part with bi-lateral repo. In particular, we assume that only the
investment-grade portion of the retained interest is funded by repo,
with a haircut of 10 percent and cost of 4.25 percent, and the rest is
funded with equity. The cost of repo funding includes a cost of 30-day
LIBOR plus 2 percent to the repo counterparty combined with a cost of 2
percent for a fixed-for-floating rate interest rate swap, using a
maturity of seven years. As repo involves maturity transformation and
creates unique risks to the sponsor beyond those created just by
leverage, we further increase the cost of equity funding by another 2
percentage points above and beyond the equity yield used in the term
leverage example above. Results suggest that the impact of the proposed
rule on the cost of credit, when a sponsor funds the marginal retained
interest with bi-lateral repo, is between 6 and 12 basis points.
[[Page 58024]]
[GRAPHIC] [TIFF OMITTED] TP20SE13.005
D. OCC Unfunded Mandates Reform Act of 1995 Determination
Section 202 of the Unfunded Mandates Reform Act of 1995, Public Law
104-4 (UMRA) requires that an agency prepare a budgetary impact
statement before promulgating a rule that includes a Federal mandate
that may result in an expenditure by State, local, and tribal
governments, in the aggregate, or by the private sector, of $100
million, adjusted for inflation, ($150 million in 2013) or more in any
one year. If a budgetary impact statement is required, section 205 of
the UMRA also requires an agency to identify and consider a reasonable
number of regulatory alternatives before promulgating a rule.
Based on current and historical supervisory data on national bank
and Federal savings association securitization activity, the OCC
estimates that as of December 31, 2012, there were 56 national banks
and Federal savings associations that engaged in any securitization
activity during that year. These entities may be affected by the
proposed rule. Pursuant to the proposed rule, national banks and
Federal savings associations would be required to retain approximately
$3.0 billion of credit risk, after taking into consideration the
proposed exemptions for QRMs and other qualified assets. This amount
reflects the marginal increase in risk retention required to be held
based on the proposed rule, that is, the total risk retention required
by the rule less the amount of ABS interests already held by
securitizers that would meet the definitions for eligible risk
retention.
The cost of retaining these interests has two components. The first
is the loss of origination and servicing fees on the reduced amount of
origination activity necessitated by the need to hold the $3.0 billion
retention amount on the bank's balance sheet. Typical origination fees
are 1 percent and typical servicing fees are another half of a
percentage point. To capture any additional lost fees, the OCC
conservatively estimated that the total cost of lost fees to be 2
percent of the retained amount, or approximately $60 million. The
second component of the retention cost is the opportunity cost of
earning the return on these retained assets versus the return that the
bank would earn if these funds were put to other use. Because of the
variety of assets and returns on the securitized assets, the OCC
assumes that this interest opportunity cost nets to zero.
In addition to the cost of retaining the assets under the proposed
rule, the overall cost of the proposed rule includes the administrative
costs associated with implementing the rule and providing the required
disclosures. The OCC estimates that the implementation and disclosure
will require approximately 480 hours per institution, or at $92 per
hour, approximately $44,000 per institution. The OCC estimates that the
rule will apply to as many as 56 national banks and Federal savings
associations. Thus, the estimated total administrative cost of the
proposed rule is approximately $2.5 million, and the estimated total
cost of the proposed rule applied to ABS is $62.5 million.
The OCC has determined that its portion of the final rules will not
result in expenditures by State, local, and tribal governments, or by
the private sector, of $150.0 million or more. Accordingly, the OCC has
not prepared a budgetary impact statement or specifically addressed the
regulatory alternatives considered.
E. Commission: Small Business Regulatory Enforcement Fairness Act
For purposes of the Small Business Regulatory Enforcement Fairness
Act of 1996, or ``SBREFA,'' \274\ the Commission solicits data to
determine whether the proposal constitutes a ``major'' rule. Under
SBREFA, a rule is considered ``major'' where, if adopted, it results or
is likely to result in:
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\274\ Public Law 104-121, Title II, 110 Stat. 857 (1996)
(codified in various sections of 5 U.S.C., 15 U.S.C. and as a note
to 5 U.S.C. 601).
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An annual effect on the economy of $100 million or more
(either in the form of an increase or a decrease);
A major increase in costs or prices for consumers or
individual industries; or
Significant adverse effects on competition, investment or
innovation.
We request comment on the potential impact of the proposal on the
U.S. economy on an annual basis, any potential increase in costs or
prices for consumers or individual industries, and any potential effect
on competition, investment or innovation. Commenters are requested to
provide empirical data and other factual support for their views if
possible.
F. FHFA: Considerations of Differences Between the Federal Home Loan
Banks and the Enterprises
Section 1313 of the Federal Housing Enterprises Financial Safety
and Soundness Act of 1992 requires the Director of FHFA, when
promulgating regulations relating to the Federal Home Loan Banks
(Banks), to consider the following differences between the Banks and
the Enterprises (Fannie Mae and Freddie Mac): cooperative ownership
structure; mission of providing liquidity to members; affordable
housing and community development mission; capital structure; and joint
and several
[[Page 58025]]
liability.\275\ The Director also may consider any other differences
that are deemed appropriate. In preparing the portions of this proposed
rule over which FHFA has joint rulemaking authority, the Director
considered the differences between the Banks and the Enterprises as
they relate to the above factors. FHFA requests comments from the
public about whether differences related to these factors should result
in any revisions to the proposal.
---------------------------------------------------------------------------
\275\ See 12 U.S.C. 4513.
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Text of the Proposed Common Rules
(All Agencies)
The text of the proposed common rules appears below:
PART ------CREDIT RISK RETENTION
Subpart A--Authority, Purpose, Scope and Definitions
Sec.
----.1 [Reserved]
----.2 Definitions.
Subpart B--Credit Risk Retention
----.3 Base risk retention requirement.
----.4 Standard risk retention.
----.5 Revolving master trusts.
----.6 Eligible ABCP conduits.
----.7 Commercial mortgage-backed securities.
----.8 Federal National Mortgage Association and Federal Home Loan
Mortgage Corporation ABS.
----.9 Open market CLOs.
----.10 Qualified tender option bonds.
Subpart C--Transfer of Risk Retention
----.11 Allocation of risk retention to an originator.
----.12 Hedging, transfer and financing prohibitions.
Subpart D--Exceptions and Exemptions
----.13 Exemption for qualified residential mortgages.
----.14 Definitions applicable to qualifying commercial loans,
commercial real estate loans, and automobile loans.
----.15 Exceptions for qualifying commercial loans, commercial real
estate loans, and automobile loans.
----.16 Underwriting standards for qualifying commercial loans.
----.17 Underwriting standards for qualifying CRE loans.
----.18 Underwriting standards for qualifying automobile loans.
----.19 General exemptions.
----.20 Safe harbor for certain foreign-related transactions.
----.21 Additional exemptions.
Subpart A--Authority, Purpose, Scope and Definitions
Sec. ----.1 [Reserved]
Sec. ----.2 Definitions.
For purposes of this part, the following definitions apply:
ABS interest means:
(1) Any type of interest or obligation issued by an issuing entity,
whether or not in certificated form, including a security, obligation,
beneficial interest or residual interest, payments on which are
primarily dependent on the cash flows of the collateral owned or held
by the issuing entity; and
(2) Does not include common or preferred stock, limited liability
interests, partnership interests, trust certificates, or similar
interests that:
(i) Are issued primarily to evidence ownership of the issuing
entity; and
(ii) The payments, if any, on which are not primarily dependent on
the cash flows of the collateral held by the issuing entity; and
(3) Does not include the right to receive payments for services
provided by the holder of such right, including servicing, trustee
services and custodial services.
An affiliate of, or a person affiliated with, a specified person
means a person that directly, or indirectly through one or more
intermediaries, controls, or is controlled by, or is under common
control with, the person specified.
Asset means a self-liquidating financial asset (including but not
limited to a loan, lease, mortgage, or receivable).
Asset-backed security has the same meaning as in section 3(a)(79)
of the Securities Exchange Act of 1934 (15 U.S.C. 78c(a)(79)).
Appropriate Federal banking agency has the same meaning as in
section 3 of the Federal Deposit Insurance Act (12 U.S.C. 1813).
Collateral with respect to any issuance of ABS interests means the
assets or other property that provide the cash flow (including cash
flow from the foreclosure or sale of the assets or property) for the
ABS interests irrespective of the legal structure of issuance,
including security interests in assets or other property of the issuing
entity, fractional undivided property interests in the assets or other
property of the issuing entity, or any other property interest in such
assets or other property.
Assets or other property collateralize an issuance of ABS interests
if the assets or property serve as collateral for such issuance.
Commercial real estate loan has the same meaning as in Sec. --
--.14.
Commission means the Securities and Exchange Commission.
Control including the terms ``controlling,'' ``controlled by'' and
``under common control with'':
(1) Means the possession, direct or indirect, of the power to
direct or cause the direction of the management and policies of a
person, whether through the ownership of voting securities, by
contract, or otherwise.
(2) Without limiting the foregoing, a person shall be considered to
control another person if the first person:
(i) Owns, controls or holds with power to vote 25 percent or more
of any class of voting securities of the other person; or
(ii) Controls in any manner the election of a majority of the
directors, trustees or persons performing similar functions of the
other person.
Credit risk means:
(1) The risk of loss that could result from the failure of the
borrower in the case of a securitized asset, or the issuing entity in
the case of an ABS interest in the issuing entity, to make required
payments of principal or interest on the asset or ABS interest on a
timely basis;
(2) The risk of loss that could result from bankruptcy, insolvency,
or a similar proceeding with respect to the borrower or issuing entity,
as appropriate; or
(3) The effect that significant changes in the underlying credit
quality of the asset or ABS interest may have on the market value of
the asset or ABS interest.
Creditor has the same meaning as in 15 U.S.C. 1602(g).
Depositor means:
(1) The person that receives or purchases and transfers or sells
the securitized assets to the issuing entity;
(2) The sponsor, in the case of a securitization transaction where
there is not an intermediate transfer of the assets from the sponsor to
the issuing entity; or
(3) The person that receives or purchases and transfers or sells
the securitized assets to the issuing entity in the case of a
securitization transaction where the person transferring or selling the
securitized assets directly to the issuing entity is itself a trust.
Eligible horizontal residual interest means, with respect to any
securitization transaction, an ABS interest in the issuing entity:
(1) That is an interest in a single class or multiple classes in
the issuing entity, provided that each interest meets, individually or
in the aggregate, all of the requirements of this definition;
(2) With respect to which, on any payment date on which the issuing
[[Page 58026]]
entity has insufficient funds to satisfy its obligation to pay all
contractual interest or principal due, any resulting shortfall will
reduce amounts paid to the eligible horizontal residual interest prior
to any reduction in the amounts paid to any other ABS interest, whether
through loss allocation, operation of the priority of payments, or any
other governing contractual provision (until the amount of such ABS
interest is reduced to zero); and
(3) That has the most subordinated claim to payments of both
principal and interest by the issuing entity.
Eligible vertical interest means, with respect to any
securitization transaction, a single vertical security or an interest
in each class of ABS interests in the issuing entity issued as part of
the securitization transaction that constitutes the same portion of the
fair value of each such class.
Federal banking agencies means the Office of the Comptroller of the
Currency, the Board of Governors of the Federal Reserve System, and the
Federal Deposit Insurance Corporation.
GAAP means generally accepted accounting principles as used in the
United States.
Issuing entity means, with respect to a securitization transaction,
the trust or other entity:
(1) That owns or holds the pool of assets to be securitized; and
(2) In whose name the asset-backed securities are issued.
Majority-owned affiliate of a sponsor means an entity that,
directly or indirectly, majority controls, is majority controlled by or
is under common majority control with, the sponsor. For purposes of
this definition, majority control means ownership of more than 50
percent of the equity of an entity, or ownership of any other
controlling financial interest in the entity, as determined under GAAP.
Originator means a person who:
(1) Through an extension of credit or otherwise, creates an asset
that collateralizes an asset-backed security; and
(2) Sells the asset directly or indirectly to a securitizer or
issuing entity.
Residential mortgage means a transaction that is a covered
transaction as defined in section 1026.43(b) of Regulation Z (12 CFR
1026.43(b)(1)) and any transaction that is exempt from the definition
of ``covered transaction'' under section 1026.43(a) of Regulation Z (12
CFR 1026.43(a)).
Retaining sponsor means, with respect to a securitization
transaction, the sponsor that has retained or caused to be retained an
economic interest in the credit risk of the securitized assets pursuant
to subpart B of this part.
Securitization transaction means a transaction involving the offer
and sale of asset-backed securities by an issuing entity.
Securitized asset means an asset that:
(1) Is transferred, sold, or conveyed to an issuing entity; and
(2) Collateralizes the ABS interests issued by the issuing entity.
Securitizer with respect to a securitization transaction shall mean
either:
(1) The depositor of the asset-backed securities (if the depositor
is not the sponsor); or
(2) The sponsor of the asset-backed securities.
Servicer means any person responsible for the management or
collection of the securitized assets or making allocations or
distributions to holders of the ABS interests, but does not include a
trustee for the issuing entity or the asset-backed securities that
makes allocations or distributions to holders of the ABS interests if
the trustee receives such allocations or distributions from a servicer
and the trustee does not otherwise perform the functions of a servicer.
Servicing assets means rights or other assets designed to assure
the timely distribution of proceeds to ABS interest holders and assets
that are related or incidental to purchasing or otherwise acquiring and
holding the issuing entity's securitized assets. Servicing assets
include amounts received by the issuing entity as proceeds of rights or
other assets, whether as remittances by obligors or as other
recoveries.
Single vertical security means, with respect to any securitization
transaction, an ABS interest entitling the sponsor to specified
percentages of the principal and interest paid on each class of ABS
interests in the issuing entity (other than such single vertical
security), which specified percentages result in the fair value of each
interest in each such class being identical.
Sponsor means a person who organizes and initiates a securitization
transaction by selling or transferring assets, either directly or
indirectly, including through an affiliate, to the issuing entity.
State has the same meaning as in Section 3(a)(16) of the Securities
Exchange Act of 1934 (15 U.S.C. 78c(a)(16)).
United States means the United States of America, its territories
and possessions, any State of the United States, and the District of
Columbia.
Wholly-owned affiliate means an entity (other than the issuing
entity) that, directly or indirectly, wholly controls, is wholly
controlled by, or is wholly under common control with, a sponsor. For
purposes of this definition, ``wholly controls'' means ownership of 100
percent of the equity of an entity.
Subpart B--Credit Risk Retention
Sec. ----.3 Base risk retention requirement.
(a) Base risk retention requirement. Except as otherwise provided
in this part, the sponsor of a securitization transaction (or majority-
owned affiliate of the sponsor) shall retain an economic interest in
the credit risk of the securitized assets in accordance with any one of
Sec. Sec. ----.4 through ----.10.
(b) Multiple sponsors. If there is more than one sponsor of a
securitization transaction, it shall be the responsibility of each
sponsor to ensure that at least one of the sponsors of the
securitization transaction (or at least one of their majority-owned
affiliates) retains an economic interest in the credit risk of the
securitized assets in accordance with any one of Sec. Sec. ----.4
through ----.10.
Sec. ----.4 Standard risk retention.
(a) Definitions. For the purposes of this section, the following
definitions apply:
Closing Date Projected Cash Flow Rate for any payment date shall
mean the percentage obtained by dividing:
(1) The fair value of all cash flow projected, as of the
securitization closing date, to be paid to the holder of the eligible
horizontal residual interest (or, if a horizontal cash reserve account
is established pursuant to this section, released to the sponsor or
other holder of such account), through such payment date (including
cash flow projected to be paid to such holder on such payment date) by
(2) The fair value of all cash flow projected, as of the
securitization closing date, to be paid to the holder the eligible
horizontal residual interest (or, with respect to any horizontal cash
reserve account, released to the sponsor or other holder of such
account), through the maturity of the eligible horizontal residual
interest (or the termination of the horizontal cash reserve account).
In calculating the fair value of cash flows and the amount of cash flow
so projected to be paid, the issuing entity shall use the same
assumptions and discount rates as were used in determining the fair
value of the eligible horizontal residual interest (or the amount that
must be placed in an eligible horizontal cash reserve account, equal to
the fair value of an eligible horizontal residual interest).
[[Page 58027]]
Closing Date Projected Principal Repayment Rate for any payment
date shall mean the percentage obtained by dividing:
(1) The amount of principal projected, as of the securitization
closing date, to be paid on all ABS interests through such payment date
(or released from the horizontal cash reserve account to the sponsor or
other holder of such account), including principal payments projected
to be paid on such payment date by
(2) The aggregate principal amount of all ABS interests issued in
the transaction. In calculating the projected principal repayments, the
issuing entity shall use the same assumptions as were used in
determining the fair value of the ABS interests in the transaction (or
the amount that must be placed in an eligible horizontal cash reserve
account, equal to the fair value of an eligible horizontal residual
interest).
(b) General requirement. (1) Except as provided in Sec. Sec. --
--.5 through ----.10, the sponsor of a securitization transaction must
retain an eligible vertical interest or eligible horizontal residual
interest, or any combination thereof, in accordance with the
requirements of this section. The fair value of the amount retained by
the sponsor under this section must equal at least 5 percent of the
fair value of all ABS interests in the issuing entity issued as part of
the securitization transaction, determined in accordance with GAAP. The
fair value of the ABS interests in the issuing entity (including any
interests required to be retained in accordance with this part) must be
determined as of the day on which the price of the ABS interests to be
sold to third parties is determined.
(2) A sponsor retaining any eligible horizontal residual interest
(or funding a horizontal cash reserve account) pursuant to this section
must prior to the issuance of the eligible horizontal residual interest
(or funding of a horizontal cash reserve account), or at the time of
any subsequent issuance of ABS interests, as applicable:
(i) Calculate the Closing Date Projected Cash Flow Rate and Closing
Date Projected Principal Repayment Rate for each payment date;
(ii) Certify to investors that it has performed the calculations
required by paragraph (b)(2)(i) of this section and that the Closing
Date Projected Cash Flow Rate for each payment date does not exceed the
Closing Date Projected Principal Repayment Rate for such payment date;
and
(iii) Maintain record of the calculations and certification
required under this paragraph (b)(2) in accordance with paragraph (e)
of this section.
(c) Option to hold base amount in horizontal cash reserve account.
In lieu of retaining all or any part of an eligible horizontal residual
interest under paragraph (b) of this section, the sponsor may, at
closing of the securitization transaction, cause to be established and
funded, in cash, a horizontal cash reserve account in the amount equal
to the fair value of such eligible horizontal residual interest or part
thereof, provided that the account meets all of the following
conditions:
(1) The account is held by the trustee (or person performing
similar functions) in the name and for the benefit of the issuing
entity;
(2) Amounts in the account are invested only in:
(i) (A) United States Treasury securities with maturities of one
year or less;
(B) Deposits in one or more insured depository institutions (as
defined in section 3 of the Federal Deposit Insurance Act (12 U.S.C.
1813)) that are fully insured by federal deposit insurance; or
(ii) With respect to securitization transactions in which the ABS
interests or the securitized assets are denominated in a currency other
than U.S. dollars:
(A) Sovereign bonds denominated in such other currency with
maturities of one year or less; or
(B) Fully insured deposit accounts denominated, in such other
foreign currency and held in a foreign bank whose home country
supervisor (as defined in Sec. 211.21 of the Federal Reserve Board's
Regulation K (12 CFR 211.21)) has adopted capital standards consistent
with the Capital Accord of the Basel Committee on Banking Supervision,
as amended; and
(3) Until all ABS interests in the issuing entity are paid in full,
or the issuing entity is dissolved:
(i) Amounts in the account shall be released to satisfy payments on
ABS interests in the issuing entity on any payment date on which the
issuing entity has insufficient funds from any source to satisfy an
amount due on any ABS interest;
(ii) No other amounts may be withdrawn or distributed from the
account unless the sponsor has complied with paragraphs (b)(2)(i) and
(ii) of this section and the amounts released to the sponsor or other
holder of the horizontal cash reserve account do not exceed, on any
release date, the Closing Date Principal Repayment Rate as of that
release date; and
(iii) Interest on investments made in accordance with paragraph
(c)(2) of this section may be released once received by the account.
(d) Disclosures. A sponsor relying on this section shall provide,
or cause to be provided, to potential investors a reasonable period of
time prior to the sale of the asset-backed securities in the
securitization transaction the disclosures in written form set forth in
this paragraph (d) under the caption ``Credit Risk Retention'':
(1) Horizontal interest. With respect to any eligible horizontal
residual interest held under paragraph (a) of this section, a sponsor
must disclose:
(i) The fair value (expressed as a percentage of the fair value of
all of the ABS interests issued in the securitization transaction and
dollar amount (or corresponding amount in the foreign currency in which
the ABS are issued, as applicable)) of the eligible horizontal residual
interest the sponsor will retain (or did retain) at the closing of the
securitization transaction, and the fair value (expressed as a
percentage of the fair value of all of the ABS interests issued in the
securitization transaction and dollar amount (or corresponding amount
in the foreign currency in which the ABS are issued, as applicable)) of
the eligible horizontal residual interest that the sponsor is required
to retain under this section;
(ii) A description of the material terms of the eligible horizontal
residual interest to be retained by the sponsor;
(iii) A description of the methodology used to calculate the fair
value of all classes of ABS interests, including any portion of the
eligible horizontal residual interest retained by the sponsor;
(iv) The key inputs and assumptions used in measuring the total
fair value of all classes of ABS interests, and the fair value of the
eligible horizontal residual interest retained by the sponsor,
including but not limited to quantitative information about each of the
following, as applicable:
(A) Discount rates;
(B) Loss given default (recovery);
(C) Prepayment rates;
(D) Defaults;
(E) Lag time between default and recovery; and
(F) The basis of forward interest rates used.
(v) The reference data set or other historical information used to
develop the key inputs and assumptions referenced in paragraph
(d)(1)(iv) of this section, including loss given default and actual
defaults.
(vi) As of a disclosed date which is no more than sixty days prior
to the closing
[[Page 58028]]
date of the securitization transaction, the number of securitization
transactions securitized by the sponsor during the previous five-year
period in which the sponsor retained an eligible horizontal residual
interest pursuant to this section, and the number (if any) of payment
dates in each such securitization on which actual payments to the
sponsor with respect to the eligible horizontal residual interest
exceeded the cash flow projected to be paid to the sponsor on such
payment date in determining the Closing Date Projected Cash Flow Rate.
(vii) If the sponsor retains risk through the funding of a
horizontal cash reserve account:
(A) The amount to be placed (or that is placed) by the sponsor in
the horizontal cash reserve account at closing, and the fair value
(expressed as a percentage of the fair value of all of the ABS
interests issued in the securitization transaction and dollar amount
(or corresponding amount in the foreign currency in which the ABS are
issued, as applicable)) of the eligible horizontal residual interest
that the sponsor is required to fund through the cash account under
this section; and
(B) A description of the material terms of the horizontal cash
reserve account; and
(C) The disclosures required in paragraphs (d)(1)(iii) through (vi)
of this section.
(2) Vertical interest. With respect to any eligible vertical
interest retained under paragraph (a) of this section:
(i) Whether the sponsor will retain (or did retain) the eligible
vertical interest as a single vertical security or as a separate
proportional interest in each class of ABS interests in the issuing
entity issued as part of the securitization transaction;
(ii) With respect to an eligible vertical interest retained as a
single vertical security:
(A) The fair value amount of the single vertical security that the
sponsor will retain (or did retain) at the closing of the
securitization transaction and the fair value amount of the single
vertical security that the sponsor is required to retain under this
section; and
(B) Each class of ABS interests in the issuing entity underlying
the single vertical security at the closing of the securitization
transaction and the percentage of each class of ABS interests in the
issuing entity that the sponsor would have been required to retain
under this section if the sponsor held the eligible vertical interest
as a separate proportional interest in each class of ABS interest in
the issuing entity; and
(iii) With respect to an eligible vertical interest retained as a
separate proportional interest in each class of ABS interests in the
issuing entity, the percentage of each class of ABS interests in the
issuing entity that the sponsor will retain (or did retain) at the
closing of the securitization transaction and the percentage of each
class of ABS interests in the issuing entity that the sponsor is
required to retain under this section; and
(iv) The information required under paragraphs (d)(1)(iii), (iv)
and (v) of this section with respect to the measurement of the fair
value of the ABS interests in the issuing entity, to the extent the
sponsor is not already required to disclose the information pursuant to
paragraph (d)(1) of this section.
(e) Record maintenance. A sponsor must retain the certifications
and disclosures required in paragraphs (b) and (d) of this section in
written form in its records and must provide the disclosure upon
request to the Commission and its appropriate Federal banking agency,
if any, until three years after all ABS interests are no longer
outstanding.
Sec. ----.5 Revolving master trusts.
(a) Definitions. For purposes of this section, the following
definitions apply:
Revolving master trust means an issuing entity that is:
(1) A master trust; and
(2) Established to issue on multiple issuance dates one or more
series, classes, subclasses, or tranches of asset-backed securities all
of which are collateralized by a common pool of securitized assets that
will change in composition over time.
Seller's interest means an ABS interest or ABS interests:
(1) Collateralized by all of the securitized assets and servicing
assets owned or held by the issuing entity other than assets that have
been allocated as collateral only for a specific series;
(2) That is pari passu to each series of investors' ABS interests
issued by the issuing entity with respect to the allocation of all
distributions and losses with respect to the securitized assets prior
to an early amortization event (as defined in the securitization
transaction documents); and
(3) That adjusts for fluctuations in the outstanding principal
balance of the securitized assets in the pool.
(b) General requirement. A sponsor satisfies the risk retention
requirements of Sec. ----.3 with respect to a securitization
transaction for which the issuing entity is a revolving master trust if
the sponsor retains a seller's interest of not less than 5 percent of
the unpaid principal balance of all outstanding investors' ABS
interests issued by the issuing entity.
(c) Measuring and retaining the seller's interest. The retention
interest required pursuant to paragraph (b) of this section:
(1) Must meet the 5 percent test at the closing of each issuance of
ABS interests by the issuing entity, and at every seller's interest
measurement date specified under the securitization transaction
documents, but no less than monthly, until no ABS interest in the
issuing entity is held by any person not affiliated with the sponsor;
(2) May be retained by one or more wholly-owned affiliates of the
sponsor, including one or more depositors of the revolving master
trust.
(d) Multi-level trusts. (1) If one revolving master trust issues
collateral certificates representing a beneficial interest in all or a
portion of the securitized assets held by that trust to another
revolving trust, which in turn issues ABS interests for which the
collateral certificates are all or a portion of the securitized assets,
a sponsor may satisfy the requirements of paragraphs (b) and (c) of
this section by retaining the seller's interest for the assets
represented by the collateral certificates through either revolving
master trust, so long as both revolving master trusts are maintained at
the direction of the same sponsor or its wholly-owned affiliates; and
(2) If the sponsor retains the seller's interest associated with
the collateral certificates at the level of the revolving trust that
issues those collateral certificates, the proportion of the seller's
interest required by paragraph (b) of this section that shall be
retained at that level shall equal no less than the proportion that the
securitized assets represented by the collateral certificates bears to
the total securitized assets in the revolving master trust that issues
the ABS interests, as of each measurement date required by paragraph
(c) of this section.
(e) Offset for pool-level excess funding account. The 5 percent
seller's interest required on each measurement date by paragraph (c) of
this section may be reduced on a dollar-for-dollar basis by the
balance, as of such date, of an excess funding account in the form of a
segregated account that:
(1) Is funded in the event of a failure to meet the minimum
seller's interest requirements under the securitization transaction
documents by distributions otherwise payable to the holder of the
seller's interest;
[[Page 58029]]
(2) Is pari passu to each series of investors' ABS interests issued
by the issuing entity with respect to the allocation of losses with
respect to the securitized assets prior to an early amortization event;
and
(3) In the event of an early amortization, makes payments of
amounts held in the account to holders of investors' ABS interests in
the same manner as distributions on securitized assets.
(f) Combined retention at trust and series level. The 5 percent
seller's interest required on each measurement date by paragraph (c) of
this section may be reduced to a percentage lower than 5 percent to the
extent that, for all series of ABS interests issued by the revolving
master trust, the sponsor or wholly-owned affiliate of the sponsor
retains, at a minimum, a corresponding percentage of the fair value of
all ABS interests issued in each series, in the form of an eligible
horizontal residual interest that meets the requirements of Sec. --
--.4, or, for so long as the revolving master trust continues to
operate by issuing, on multiple issuance dates, one or more series,
classes, subclasses, or tranches of asset-backed securities, all of
which are collateralized by pooled securitized assets that change in
composition over time, a horizontal interest meeting the following
requirements:
(1) Whether certificated or uncertificated, in a single or multiple
classes, subclasses, or tranches, the horizontal interest meets,
individually or in the aggregate, the requirements of this paragraph
(f);
(2) Each series of the revolving master trust distinguishes between
the series' share of the interest and fee cash flows and the series'
share of the principal repayment cash flows from the securitized assets
collateralizing the revolving master trust, which may according to the
terms of the securitization transaction documents, include not only the
series' ratable share of such cash flows but also excess cash flows
available from other series;
(3) The horizontal interest's claim to any part of the series'
share of the interest and fee cash flows for any interest payment
period is subordinated to all accrued and payable interest and
principal due on the payment date to more senior ABS interests in the
series for that period, and further reduced by the series' share of
losses, including defaults on principal of the securitized assets
collateralizing the revolving master trust for that period, to the
extent that such payments would have been included in amounts payable
to more senior interests in the series;
(4) The horizontal interest has the most subordinated claim to any
part of the series' share of the principal repayment cash flows.
(g) Disclosure and record maintenance--(1) Disclosure. A sponsor
relying on this section shall provide, or cause to be provided, to
potential investors a reasonable period of time prior to the sale of
the asset-backed securities in the securitization transaction and, upon
request, to the Commission and its appropriate Federal banking agency,
if any, the following disclosure in written form under the caption
``Credit Risk Retention'':
(i) The value (expressed as a percentage of the unpaid principal
balance of all of the investors' ABS interests issued in the
securitization transaction and dollar amount (or corresponding amount
in the foreign currency in which the ABS are issued, as applicable)) of
the seller's interest that the sponsor will retain (or did retain) at
the closing of the securitization transaction, the fair value
(expressed as a percentage of the fair value of all of the investors'
ABS interests issued in the securitization transaction and dollar
amount (or corresponding amount in the foreign currency in which the
ABS are issued, as applicable)) of any horizontal risk retention
described in paragraph (f) of this section that the sponsor will retain
(or did retain) at the closing of the securitization transaction, and
the unpaid principal balance or fair value, as applicable (expressed as
percentages of the values of all of the ABS interests issued in the
securitization transaction and dollar amounts (or corresponding amounts
in the foreign currency in which the ABS are issued, as applicable))
that the sponsor is required to retain pursuant to this section;
(ii) A description of the material terms of the seller's interest
and of any horizontal risk retention described in paragraph (f) of this
section; and
(iii) If the sponsor will retain (or did retain) any horizontal
risk retention described in paragraph (f) of this section, the same
information as is required to be disclosed by sponsors retaining
horizontal interests pursuant to Sec. --.4(d)(i).
(2) Record maintenance. A sponsor must retain the disclosures
required in paragraph (g)(1) of this section in written form in its
records and must provide the disclosure upon request to the Commission
and its appropriate Federal banking agency, if any, until three years
after all ABS interests are no longer outstanding.
(h) Early amortization of all outstanding series. A sponsor that
organizes a revolving master trust for which all securitized assets
collateralizing the trust are revolving assets, and that relies on this
Sec. --.5 to satisfy the risk retention requirements of Sec. --.3,
does not violate the requirements of this part if its seller's interest
falls below the level required by Sec. ----.5 after an event of
default triggers early amortization, as specified in the securitization
transaction documents, of all series of ABS interests issued by the
trust to persons not affiliated with the sponsor, if:
(1) The sponsor was in full compliance with the requirements of
this section on all measurement dates specified in paragraph (c) of
this section prior to the event of default that triggered early
amortization;
(2) The terms of the seller's interest continue to make it pari
passu or subordinate to each series of investors' ABS interests issued
by the issuing entity with respect to the allocation of all losses with
respect to the securitized assets;
(3) The terms of any horizontal interest relied upon by the sponsor
pursuant to paragraph (f) to offset the minimum seller's interest
amount continue to require the interests to absorb losses in accordance
with the terms of paragraph (f) of this section; and
(4) The revolving master trust issues no additional ABS interests
after early amortization is initiated to any person not affiliated with
the sponsor, either during the amortization period or at any time
thereafter.
Sec. ----.6 Eligible ABCP conduits.
(a) Definitions. For purposes of this section, the following
additional definitions apply:
100 percent liquidity coverage means an amount equal to the
outstanding balance of all ABCP issued by the conduit plus any accrued
and unpaid interest without regard to the performance of the ABS
interests held by the ABCP conduit and without regard to any credit
enhancement.
ABCP means asset-backed commercial paper that has a maturity at the
time of issuance not exceeding nine months, exclusive of days of grace,
or any renewal thereof the maturity of which is likewise limited.
ABCP conduit means an issuing entity with respect to ABCP.
Eligible ABCP conduit means an ABCP conduit, provided that:
(1) The ABCP conduit is bankruptcy remote or otherwise isolated for
insolvency purposes from the sponsor of the ABCP conduit and from any
intermediate SPV;
[[Page 58030]]
(2) The asset-backed securities acquired by the ABCP conduit are:
(i) Collateralized solely by the following:
(A) Asset-backed securities collateralized solely by assets
originated by an originator-seller or one or more majority-owned OS
affiliates of the originator seller, and by servicing assets;
(B) Special units of beneficial interest or similar interests in a
trust or special purpose vehicle that retains legal title to leased
property underlying leases that were transferred to an intermediate SPV
in connection with a securitization collateralized solely by such
leases originated by an originator-seller or majority-owned OS
affiliate, and by servicing assets; or
(C) Interests in a revolving master trust collateralized solely by
assets originated by an originator-seller or majority-owned OS
affiliate and by servicing assets; and
(ii) Not collateralized by asset-backed securities (other than
those described in paragraphs (2)(i)(A) through (C) of this
definition), otherwise purchased or acquired by the intermediate SPV,
the intermediate SPV's originator-seller, or a majority-owned OS
affiliate of the originator seller; and
(iii) Acquired by the ABCP conduit in an initial issuance by or on
behalf of an intermediate SPV (A) directly from the intermediate SPV,
(B) from an underwriter of the securities issued by the intermediate
SPV, or (C) from another person who acquired the securities directly
from the intermediate SPV;
(3) The ABCP conduit is collateralized solely by asset-backed
securities acquired from intermediate SPVs as described in paragraph
(2) of this definition and servicing assets; and
(4) A regulated liquidity provider has entered into a legally
binding commitment to provide 100 percent liquidity coverage (in the
form of a lending facility, an asset purchase agreement, a repurchase
agreement, or other similar arrangement) to all the ABCP issued by the
ABCP conduit by lending to, purchasing ABCP issued by, or purchasing
assets from, the ABCP conduit in the event that funds are required to
repay maturing ABCP issued by the ABCP conduit. With respect to the 100
percent liquidity coverage, in the event that the ABCP conduit is
unable for any reason to repay maturing ABCP issued by the issuing
entity, the liquidity provider shall be obligated to pay an amount
equal to any shortfall, and the total amount that may be due pursuant
to the 100 percent liquidity coverage shall be equal to 100 percent of
the amount of the ABCP outstanding at any time plus accrued and unpaid
interest (amounts due pursuant to the required liquidity coverage may
not be subject to credit performance of the ABS held by the ABCP
conduit or reduced by the amount of credit support provided to the ABCP
conduit and liquidity support that only funds performing receivables or
performing ABS interests does not meet the requirements of this
section).
Intermediate SPV means a special purpose vehicle that:
(1) Is a direct or indirect wholly-owned affiliate of the
originator-seller;
(2) Is bankruptcy remote or otherwise isolated for insolvency
purposes from the eligible ABCP conduit, the originator-seller, and any
majority-owned OS affiliate that, directly or indirectly, sells or
transfers assets to such intermediate SPV;
(3) Acquires assets that are originated by the originator-seller or
its majority-owned OS affiliate from the originator-seller or majority-
owned OS affiliate, or acquires asset-backed securities issued by
another intermediate SPV or the original seller that are collateralized
solely by such assets; and
(4) Issues asset-backed securities collateralized solely by such
assets, as applicable.
Majority-owned OS affiliate means an entity that, directly or
indirectly, majority controls, is majority controlled by or is under
common majority control with, an originator-seller participating in an
eligible ABCP conduit. For purposes of this definition, majority
control means ownership of more than 50 percent of the equity of an
entity, or ownership of any other controlling financial interest in the
entity, as determined under GAAP.
Originator-seller means an entity that originates assets and sells
or transfers those assets directly, or through a majority-owned OS
affiliate, to an intermediate SPV.
Regulated liquidity provider means:
(1) A depository institution (as defined in section 3 of the
Federal Deposit Insurance Act (12 U.S.C. 1813));
(2) A bank holding company (as defined in 12 U.S.C. 1841), or a
subsidiary thereof;
(3) A savings and loan holding company (as defined in 12 U.S.C.
1467a), provided all or substantially all of the holding company's
activities are permissible for a financial holding company under 12
U.S.C. 1843(k), or a subsidiary thereof; or
(4) A foreign bank whose home country supervisor (as defined in
Sec. 211.21 of the Federal Reserve Board's Regulation K (12 CFR
211.21)) has adopted capital standards consistent with the Capital
Accord of the Basel Committee on Banking Supervision, as amended, and
that is subject to such standards, or a subsidiary thereof.
(b) In general. An ABCP conduit sponsor satisfies the risk
retention requirement of Sec. ----.3 with respect to the issuance of
ABCP by an eligible ABCP conduit in a securitization transaction if,
for each ABS interest the ABCP conduit acquires from an intermediate
SPV:
(1) The intermediate SPV's originator-seller retains an economic
interest in the credit risk of the assets collateralizing the ABS
interest acquired by the eligible ABCP conduit in accordance with
paragraph (b)(2) of this section, in the same form, amount, and manner
as would be required under Sec. Sec. ----.4 or ----.5; and
(2) The ABCP conduit sponsor:
(i) Approves each originator-seller and any majority-owned OS
affiliate permitted to sell or transfer assets, directly or indirectly,
to an intermediate SPV from which an eligible ABCP conduit acquires ABS
interests;
(ii) Approves each intermediate SPV from which an eligible ABCP
conduit is permitted to acquire ABS interests;
(iii) Establishes criteria governing the ABS interests, and the
assets underlying the ABS interests, acquired by the ABCP conduit;
(iv) Administers the ABCP conduit by monitoring the ABS interests
acquired by the ABCP conduit and the assets supporting those ABS
interests, arranging for debt placement, compiling monthly reports, and
ensuring compliance with the ABCP conduit documents and with the ABCP
conduit's credit and investment policy; and
(v) Maintains and adheres to policies and procedures for ensuring
that the conditions in this paragraph (b) have been met.
(c) Originator-seller compliance with risk retention. The use of
the risk retention option provided in this section by an ABCP conduit
sponsor does not relieve the originator-seller that sponsors ABS
interests acquired by an eligible ABCP conduit from such originator-
seller's obligation, if any, to comply with its own risk retention
obligations under this part.
(d) Periodic disclosures to investors. An ABCP conduit sponsor
relying upon this section shall provide, or cause to be provided, to
each purchaser of ABCP, before or contemporaneously with the first sale
of ABCP to such purchaser and at least monthly thereafter, to each
holder of commercial paper issued by the ABCP Conduit, in writing, each
of the following items of information:
[[Page 58031]]
(1) The name and form of organization of the regulated liquidity
provider that provides liquidity coverage to the eligible ABCP conduit,
including a description of the form, amount, and nature of such
liquidity coverage, and notice of any failure to fund.
(2) With respect to each ABS interest held by the ABCP conduit:
(A) The asset class or brief description of the underlying
receivables;
(B) The standard industrial category code (SIC Code) for the
originator-seller or majority-owned OS affiliate that will retain (or
has retained) pursuant to this section an interest in the
securitization transaction; and
(C) A description of the form, fair value (expressed as a
percentage of the fair value of all of the ABS interests issued in the
securitization transaction and as a dollar amount (or corresponding
amount in the foreign currency in which the ABS are issued, as
applicable)), as applicable, and nature of such interest in accordance
with the disclosure obligations in Sec. ----.4(d).
(e) Disclosures to regulators regarding originator-sellers and
majority-owned OS affiliates. An ABCP conduit sponsor relying upon this
section shall provide, or cause to be provided, upon request, to the
Commission and its appropriate Federal banking agency, if any, in
writing, all of the information required to be provided to investors in
paragraph (d) of this section, and the name and form of organization of
each originator-seller or majority-owned OS affiliate that will retain
(or has retained) pursuant to this section an interest in the
securitization transaction.
(f) Duty to comply. (1) The ABCP conduit retaining sponsor shall be
responsible for compliance with this section.
(2) An ABCP conduit retaining sponsor relying on this section:
(i) Shall maintain and adhere to policies and procedures that are
reasonably designed to monitor compliance by each originator-seller and
any majority-owned OS affiliate which sells assets to the eligible ABCP
conduit with the requirements of paragraph (b)(1) of this section; and
(ii) In the event that the ABCP conduit sponsor determines that an
originator-seller or majority-owned OS affiliate no longer complies
with the requirements of paragraph (b)(1) of this section, shall:
(A) Promptly notify the holders of the ABCP, the Commission and its
appropriate Federal banking agency, if any, in writing of:
(1) The name and form of organization of any originator-seller that
fails to retain risk in accordance with paragraph (b)(2)(i) of this
section and the amount of asset-backed securities issued by an
intermediate SPV of such originator-seller and held by the ABCP
conduit;
(2) The name and form of organization of any originator-seller or
majority-owned OS affiliate that hedges, directly or indirectly through
an intermediate SPV, its risk retention in violation of paragraph
(b)(1) of this section and the amount of asset-backed securities issued
by an intermediate SPV of such originator-seller or majority-owned OS
affiliate and held by the ABCP conduit; and
(3) Any remedial actions taken by the ABCP conduit sponsor or other
party with respect to such asset-backed securities; and
(B) Take other appropriate steps pursuant to the requirements of
paragraphs (b)(2)(iv) and (b)(2)(v) of this section which may include,
as appropriate, curing any breach of the requirements in this section,
or removing from the eligible ABCP conduit any asset-backed security
that does not comply with the requirements in this section.
Sec. ----.7 Commercial mortgage-backed securities.
(a) Definitions. For purposes of this section, the following
definition shall apply:
Special servicer means, with respect to any securitization of
commercial real estate loans, any servicer that, upon the occurrence of
one or more specified conditions in the servicing agreement, has the
right to service one or more assets in the transaction.
(b) Third-Party Purchaser. A sponsor may satisfy some or all of its
risk retention requirements under Sec. ----.3 with respect to a
securitization transaction if a third party purchases and holds for its
own account an eligible horizontal residual interest in the issuing
entity in the same form, amount, and manner as would be held by the
sponsor under Sec. ----.4 and all of the following conditions are met:
(1) Number of third-party purchasers. At any time, there are no
more than two third-party purchasers of an eligible horizontal residual
interest. If there are two third-party purchasers, each third-party
purchaser's interest must be pari passu with the other third-party
purchaser's interest.
(2) Composition of collateral. The securitization transaction is
collateralized solely by commercial real estate loans and servicing
assets.
(3) Source of funds. (i) Each third-party purchaser pays for the
eligible horizontal residual interest in cash at the closing of the
securitization transaction.
(ii) No third-party purchaser obtains financing, directly or
indirectly, for the purchase of such interest from any other person
that is a party to, or an affiliate of a party to, the securitization
transaction (including, but not limited to, the sponsor, depositor, or
servicer other than a special servicer affiliated with the third-party
purchaser), other than a person that is a party to the transaction
solely by reason of being an investor.
(4) Third-party review. Each third-party purchaser conducts an
independent review of the credit risk of each securitized asset prior
to the sale of the asset-backed securities in the securitization
transaction that includes, at a minimum, a review of the underwriting
standards, collateral, and expected cash flows of each commercial real
estate loan that is collateral for the asset-backed securities.
(5) Affiliation and control rights. (i) Except as provided in
paragraph (b)(5)(ii) of this section, no third-party purchaser is
affiliated with any party to the securitization transaction (including,
but not limited to, the sponsor, depositor, or servicer) other than
investors in the securitization transaction.
(ii) Notwithstanding paragraph (b)(5)(i) of this section, a third-
party purchaser may be affiliated with:
(A) The special servicer for the securitization transaction; or
(B) One or more originators of the securitized assets, as long as
the assets originated by the affiliated originator or originators
collectively comprise less than 10 percent of the unpaid principal
balance of the securitized assets included in the securitization
transaction at closing of the securitization transaction.
(6) Operating Advisor. The underlying securitization transaction
documents shall provide for the following:
(i) The appointment of an operating advisor (the Operating Advisor)
that:
(A) Is not affiliated with other parties to the securitization
transaction;
(B) Does not directly or indirectly have any financial interest in
the securitization transaction other than in fees from its role as
Operating Advisor; and
(C) Is required to act in the best interest of, and for the benefit
of, investors as a collective whole;
(ii) Standards with respect to the Operating Advisor's experience,
expertise and financial strength to fulfill its duties and
responsibilities under the applicable transaction documents over the
life of the securitization transaction;
[[Page 58032]]
(iii) The terms of the Operating Advisor's compensation with
respect to the securitization transaction;
(iv) When the eligible horizontal residual interest has a principal
balance of 25 percent or less of its initial principal balance, the
special servicer for the securitized assets must consult with the
Operating Advisor in connection with, and prior to, any material
decision in connection with its servicing of the securitized assets,
including, without limitation:
(A) Any material modification of, or waiver with respect to, any
provision of a loan agreement (including a mortgage, deed of trust, or
other security agreement);
(B) Foreclosure upon or comparable conversion of the ownership of a
property; or
(C) Any acquisition of a property.
(v) The Operating Advisor shall have adequate and timely access to
information and reports necessary to fulfill its duties under the
transaction documents and shall be responsible for:
(A) Reviewing the actions of the special servicer;
(B) Reviewing all reports made by the special servicer to the
issuing entity;
(C) Reviewing for accuracy and consistency calculations made by the
special servicer with the transaction documents; and
(D) Issuing a report to investors and the issuing entity on a
periodic basis concerning:
(1) Whether the Operating Advisor believes, in its sole discretion
exercised in good faith, that the special servicer is operating in
compliance with any standard required of the special servicer as
provided in the applicable transaction documents; and
(2) With which, if any, standards the Operating Advisor believes,
in its sole discretion exercised in good faith, the special servicer
has failed to comply.
(vi) (A) The Operating Advisor shall have the authority to
recommend that the special servicer be replaced by a successor special
servicer if the Operating Advisor determines, in its sole discretion
exercised in good faith, that:
(1) The special servicer has failed to comply with a standard
required of the special servicer as provided in the applicable
transaction documents; and
(2) Such replacement would be in the best interest of the investors
as a collective whole; and
(B) If a recommendation described in paragraph (b)(6)(vi)(A) of
this section is made, the special servicer shall be replaced upon the
affirmative vote of a majority of the outstanding principal balance of
all ABS interests voting on the matter, with a minimum of a quorum of
ABS interests voting on the matter. For purposes of such vote, the
holders of 5 percent of the outstanding principal balance of all ABS
interests in the issuing entity shall constitute a quorum.
(7) Disclosures. The sponsor provides, or causes to be provided, to
potential investors a reasonable period of time prior to the sale of
the asset-backed securities as part of the securitization transaction
and, upon request, to the Commission and its appropriate Federal
banking agency, if any, the following disclosure in written form under
the caption ``Credit Risk Retention'':
(i) The name and form of organization of each initial third-party
purchaser that acquired an eligible horizontal residual interest at the
closing of a securitization transaction;
(ii) A description of each initial third-party purchaser's
experience in investing in commercial mortgage-backed securities;
(iii) Any other information regarding each initial third-party
purchaser or each initial third-party purchaser's retention of the
eligible horizontal residual interest that is material to investors in
light of the circumstances of the particular securitization
transaction;
(iv) A description of the fair value (expressed as a percentage of
the fair value of all of the ABS interests issued in the securitization
transaction and dollar amount (or corresponding amount in the foreign
currency in which the ABS are issued, as applicable)) of the eligible
horizontal residual interest that will be retained (or was retained) by
each initial third-party purchaser, as well as the amount of the
purchase price paid by each initial third-party purchaser for such
interest;
(v) The fair value (expressed as a percentage of the fair value of
all of the ABS interests issued in the securitization transaction and
dollar amount (or corresponding amount in the foreign currency in which
the ABS are issued, as applicable)) of the eligible horizontal residual
interest in the securitization transaction that the sponsor would have
retained pursuant to Sec. ----.4 if the sponsor had relied on
retaining an eligible horizontal residual interest in that section to
meet the requirements of Sec. ----.3 with respect to the transaction;
(vi) A description of the material terms of the eligible horizontal
residual interest retained by each initial third-party purchaser,
including the same information as is required to be disclosed by
sponsors retaining horizontal interests pursuant to Sec. ----.4;
(vii) The material terms of the applicable transaction documents
with respect to the Operating Advisor, including without limitation:
(A) The name and form of organization of the Operating Advisor;
(B) The standards required by paragraph (b)(6)(ii) of this section
and a description of how the Operating Advisor satisfies each of the
standards; and
(C) The terms of the Operating Advisor's compensation under
paragraph (b)(6)(iii) of this section; and
(viii) The representations and warranties concerning the
securitized assets, a schedule of any securitized assets that are
determined do not comply with such representations and warranties, and
what factors were used to make the determination that such securitized
assets should be included in the pool notwithstanding that the
securitized assets did not comply with such representations and
warranties, such as compensating factors or a determination that the
exceptions were not material.
(8) Hedging, transfer and pledging--(i) General rule. Except as set
forth in paragraph (b)(8)(ii) of this section, each third-party
purchaser must comply with the hedging and other restrictions in Sec.
----.12 as if it were the retaining sponsor with respect to the
securitization transaction and had acquired the eligible horizontal
residual interest pursuant to Sec. ----.4.
(ii) Exceptions--(A) Transfer by initial third-party purchaser or
sponsor. An initial third-party purchaser that acquired an eligible
horizontal residual interest at the closing of a securitization
transaction in accordance with this section, or a sponsor that acquired
an eligible horizontal residual interest at the closing of a
securitization transaction in accordance with this section, may, on or
after the date that is five years after the date of the closing of a
securitization transaction, transfer that interest to a subsequent
third-party purchaser that complies with paragraph (b)(8)(ii)(C) of
this section. The initial third-party purchaser shall provide the
sponsor with complete identifying information for the subsequent third-
party purchaser.
(B) Transfer by subsequent third-party purchaser. At any time, a
subsequent third-party purchaser that acquired an eligible horizontal
residual interest pursuant to this paragraph (b)(8)(ii)(B) may transfer
its interest to a different third-party purchaser that complies with
paragraph (b)(8)(ii)(C) of this section. The transferring third-party
purchaser shall provide the sponsor
[[Page 58033]]
with complete identifying information for the acquiring third-party
purchaser.
(C) Requirements applicable to subsequent third-party purchasers. A
subsequent third-party purchaser is subject to all of the requirements
of paragraphs (b)(1), (b)(3) through (b)(5), and (b)(8) of this section
applicable to third-party purchasers, provided that obligations under
paragraphs (b)(1), (b)(3) through (b)(5), and (b)(8) of this section
that apply to initial third-party purchasers at or before the time of
closing of the securitization transaction shall apply to successor
third-party purchasers at or before the time of the transfer of the
eligible horizontal residual interest to the successor third-party
purchaser.
(c) Duty to comply. (1) The retaining sponsor shall be responsible
for compliance with this section by itself and by each initial or
subsequent third-party purchaser that acquired an eligible horizontal
residual interest in the securitization transaction.
(2) A sponsor relying on this section:
(A) Shall maintain and adhere to policies and procedures to monitor
each third-party purchaser's compliance with the requirements of
paragraphs (b)(1), (b)(3) through (b)(5), and (b)(8) of this section;
and
(B) In the event that the sponsor determines that a third-party
purchaser no longer complies with any of the requirements of paragraphs
(b)(1), (b)(3) through (b)(5), or (b)(8) of this section, shall
promptly notify, or cause to be notified, the holders of the ABS
interests issued in the securitization transaction of such
noncompliance by such third-party purchaser.
Sec. ----.8 Federal National Mortgage Association and Federal Home
Loan Mortgage Corporation ABS.
(a) In general. A sponsor satisfies its risk retention requirement
under this part if the sponsor fully guarantees the timely payment of
principal and interest on all ABS interests issued by the issuing
entity in the securitization transaction and is:
(1) The Federal National Mortgage Association or the Federal Home
Loan Mortgage Corporation operating under the conservatorship or
receivership of the Federal Housing Finance Agency pursuant to section
1367 of the Federal Housing Enterprises Financial Safety and Soundness
Act of 1992 (12 U.S.C. 4617) with capital support from the United
States; or
(2) Any limited-life regulated entity succeeding to the charter of
either the Federal National Mortgage Association or the Federal Home
Loan Mortgage Corporation pursuant to section 1367(i) of the Federal
Housing Enterprises Financial Safety and Soundness Act of 1992 (12
U.S.C. 4617(i)), provided that the entity is operating with capital
support from the United States.
(b) Certain provisions not applicable. The provisions of Sec. --
--.12(b), (c), and (d) shall not apply to a sponsor described in
paragraph (a)(1) or (2) of this section, its affiliates, or the issuing
entity with respect to a securitization transaction for which the
sponsor has retained credit risk in accordance with the requirements of
this section.
(c) Disclosure. A sponsor relying on this section shall provide to
investors, in written form under the caption ``Credit Risk Retention''
and, upon request, to the Federal Housing Finance Agency and the
Commission, a description of the manner in which it has met the credit
risk retention requirements of this part.
Sec. ----.9 Open market CLOs.
(a) Definitions. For purposes of this section, the following
definitions shall apply:
CLO means a special purpose entity that:
(1) Issues debt and equity interests, and
(2) Whose assets consist primarily of loans that are securitized
assets and servicing assets.
CLO-eligible loan tranche means a term loan of a syndicated
facility that meets the criteria set forth in paragraph (c) of this
section.
CLO Manager means an entity that manages a CLO, which entity is
registered as an investment adviser under the Investment Advisers Act
of 1940, as amended (15 U.S.C. 80b-1 et seq.), or is an affiliate of
such a registered investment adviser and itself is managed by such
registered investment adviser.
Commercial borrower means an obligor under a corporate credit
obligation (including a loan).
Initial loan syndication transaction means a transaction in which a
loan is syndicated to a group of lenders.
Lead arranger means, with respect to a CLO-eligible loan tranche,
an institution that:
(1) Is active in the origination, structuring and syndication of
commercial loan transactions (as defined in Sec. ----.14) and has
played a primary role in the structuring, underwriting and distribution
on the primary market of the CLO-eligible loan tranche.
(2) Has taken an allocation of the syndicated credit facility under
the terms of the transaction that includes the CLO-eligible loan
tranche of at least 20 percent of the aggregate principal balance at
origination, and no other member (or members affiliated with each
other) of the syndication group at origination has taken a greater
allocation; and
(3) Is identified at the time of origination in the credit
agreement and any intercreditor or other applicable agreements
governing the CLO-eligible loan tranche; represents therein to the
holders of the CLO-eligible loan tranche and to any holders of
participation interests in such CLO-eligible loan tranche that such
lead arranger and the CLO-eligible loan tranche satisfy the
requirements of this section; and covenants therein to such holders
that such lead arranger will fulfill the requirements of clause (i) of
the definition of CLO-eligible loan tranche.
Open market CLO means a CLO:
(1) Whose assets consist of senior, secured syndicated loans
acquired by such CLO directly from the sellers thereof in open market
transactions and of servicing assets,
(2) That is managed by a CLO manager, and
(3) That holds less than 50 percent of its assets, by aggregate
outstanding principal amount, in loans syndicated by lead arrangers
that are affiliates of the CLO or originated by originators that are
affiliates of the CLO.
Open market transaction means:
(1) Either an initial loan syndication transaction or a secondary
market transaction in which a seller offers senior, secured syndicated
loans to prospective purchasers in the loan market on market terms on
an arm's length basis, which prospective purchasers include, but are
not limited to, entities that are not affiliated with the seller, or
(2) A reverse inquiry from a prospective purchaser of a senior,
secured syndicated loan through a dealer in the loan market to purchase
a senior, secured syndicated loan to be sourced by the dealer in the
loan market.
Secondary market transaction means a purchase of a senior, secured
syndicated loan not in connection with an initial loan syndication
transaction but in the secondary market.
Senior, secured syndicated loan means a loan made to a commercial
borrower that:
(1) Is not subordinate in right of payment to any other obligation
for borrowed money of the commercial borrower,
(2) Is secured by a valid first priority security interest or lien
in or on specified collateral securing the
[[Page 58034]]
commercial borrower's obligations under the loan, and
(3) The value of the collateral subject to such first priority
security interest or lien, together with other attributes of the
obligor (including, without limitation, its general financial
condition, ability to generate cash flow available for debt service and
other demands for that cash flow), is adequate (in the commercially
reasonable judgment of the CLO manager exercised at the time of
investment) to repay the loan in accordance with its terms and to repay
all other indebtedness of equal seniority secured by such first
priority security interest or lien in or on the same collateral, and
the CLO manager certifies as to the adequacy of the collateral and
attributes of the borrower under this paragraph in regular periodic
disclosures to investors.
(b) In general. A sponsor satisfies the risk retention requirements
of Sec. ----.3 with respect to an open market CLO transaction if:
(1) The open market CLO does not acquire or hold any assets other
than CLO-eligible loan tranches that meet the requirements of paragraph
(c) of this section and servicing assets;
(2) The governing documents of such open market CLO require that,
at all times, the assets of the open market CLO consist of senior,
secured syndicated loans that are CLO-eligible loan tranches and
servicing assets;
(3) The open market CLO does not invest in ABS interests or in
credit derivatives other than hedging transactions that are servicing
assets to hedge risks of the open market CLO;
(4) All purchases of CLO-eligible loan tranches and other assets by
the open market CLO issuing entity or through a warehouse facility used
to accumulate the loans prior to the issuance of the CLO's ABS
interests are made in open market transactions on an arms-length basis;
(5) The CLO Manager of the open market CLO is not entitled to
receive any management fee or gain on sale at the time the open market
CLO issues its ABS interests.
(c) CLO-eligible loan tranche. To qualify as a CLO-eligible loan
tranche, a term loan of a syndicated credit facility to a commercial
borrower must have the following features:
(1) A minimum of 5 percent of the face amount of the CLO-eligible
loan tranche is retained by the lead arranger thereof until the
earliest of the repayment, maturity, involuntary and unscheduled
acceleration, payment default, or bankruptcy default of such CLO-
eligible loan tranche, provided that such lead arranger complies with
limitations on hedging, transferring and pledging in Sec. ----.12 with
respect to the interest retained by the lead arranger.
(2) Lender voting rights within the credit agreement and any
intercreditor or other applicable agreements governing such CLO-
eligible loan tranche are defined so as to give holders of the CLO-
eligible loan tranche consent rights with respect to, at minimum, any
material waivers and amendments of such applicable documents, including
but not limited to, adverse changes to money terms, alterations to pro
rata provisions, changes to voting provisions, and waivers of
conditions precedent; and
(3) The pro rata provisions, voting provisions, and similar
provisions applicable to the security associated with such CLO-eligible
loan tranches under the CLO credit agreement and any intercreditor or
other applicable agreements governing documents such CLO-eligible loan
tranches are not materially less advantageous to the obligor than the
terms of other tranches of comparable seniority in the broader
syndicated credit facility.
(d) Disclosures. A sponsor relying on this section shall provide,
or cause to be provided, to potential investors a reasonable period of
time prior to the sale of the asset-backed securities in the
securitization transaction and at least annually with respect to the
information required by paragraph (d)(1) of this section and, upon
request, to the Commission and its appropriate Federal banking agency,
if any, the following disclosure in written form under the caption
``Credit Risk Retention'':
(1) Open market CLOs. A complete list of every asset held by an
open market CLO (or before the CLO's closing, in a warehouse facility
in anticipation of transfer into the CLO at closing), including the
following information:
(i) The full legal name and Standard Industrial Classification
(SIC) category code of the obligor of the loan or asset;
(ii) The full name of the specific loan tranche held by the CLO;
(iii) The face amount of the loan tranche held by the CLO;
(iv) The price at which the loan tranche was acquired by the CLO;
and
(v) For each loan tranche, the full legal name of the lead arranger
subject to the sales and hedging restrictions of Sec. ----.12 and the;
and
(2) CLO manager. The full legal name and form of organization of
the CLO manager.
Sec. ----.10 Qualified tender option bonds.
(a) Definitions. For purposes of this section, the following
definitions shall apply:
Municipal security or municipal securities shall have the same
meaning as municipal securities in Section 3(a)(29) of the Securities
Exchange Act of 1934 (15 U.S.C. 78c(a)(29)) and any rules promulgated
pursuant to such section.
Qualified tender option bond entity means an issuing entity with
respect to tender option bonds for which each of the following applies:
(1) Such entity is collateralized solely by servicing assets and
municipal securities that have the same municipal issuer and the same
underlying obligor or source of payment (determined without regard to
any third-party credit enhancement), and such municipal securities are
not subject to substitution.
(2) Such entity issues no securities other than:
(i) a single class of tender option bonds with a preferred variable
return payable out of capital that meets the requirements of paragraph
(b) of this section and
(ii) a single residual equity interest that is entitled to all
remaining income of the TOB issuing entity. Both of these types of
securities must constitute ``asset-backed securities'' as defined in
Section 3(a)(79) of the Exchange Act (15 U.S.C. 78c(a)(79)).
(3) The municipal securities held as assets by such entity are
issued in compliance with Section 103 of the Internal Revenue Code of
1986, as amended (the ``IRS Code'', 26 U.S.C. 103), such that the
interest payments made on those securities are excludable from the
gross income of the owners under Section 103 of the IRS Code.
(4) The holders of all of the securities issued by such entity are
eligible to receive interest that is excludable from gross income
pursuant to Section 103 of the IRS Code or ``exempt-interest
dividends'' pursuant to Section 852(b)(5) of the IRS Code (26 U.S.C.
852(b)(5)) in the case of regulated investment companies under the
Investment Company Act of 1940, as amended.
(5) Such entity has a legally binding commitment from a regulated
liquidity provider as defined in Sec. ----.6(a), to provide a 100
percent guarantee or liquidity coverage with respect to all of the
issuing entity's outstanding tender option bonds.
(6) Such entity qualifies for monthly closing elections pursuant to
IRS Revenue Procedure 2003-84, as amended or supplemented from time to
time.
[[Page 58035]]
Tender option bond means a security which:
(1) Has features which entitle the holders to tender such bonds to
the TOB issuing entity for purchase at any time upon no more than 30
days' notice, for a purchase price equal to the approximate amortized
cost of the security, plus accrued interest, if any, at the time of
tender; and
(2) Has all necessary features so such security qualifies for
purchase by money market funds under Rule 2a-7 under the Investment
Company Act of 1940, as amended.
(b) Standard risk retention. Notwithstanding anything in this
section, the sponsor with respect to an issuance of tender option bonds
by a qualified tender option bond entity may retain an eligible
vertical interest or eligible horizontal residual interest, or any
combination thereof, in accordance with the requirements of Sec. --
--.4.
(c) Tender option termination event. The sponsor with respect to an
issuance of tender option bonds by a qualified tender option bond
entity may retain an interest that upon issuance meets the requirements
of an eligible horizontal residual interest but that upon the
occurrence of a ``tender option termination event'' as defined in
Section 4.01(5) of IRS Revenue Procedure 2003-84, as amended or
supplemented from time to time will meet requirements of an eligible
vertical interest.
(d) Retention of a municipal security outside of the qualified
tender option bond entity. The sponsor with respect to an issuance of
tender option bonds by a qualified tender option bond entity may
satisfy their risk retention requirements under this Section by holding
municipal securities from the same issuance of municipal securities
deposited in the qualified tender option bond entity, the face value of
which retained municipal securities is equal to 5 percent of the face
value of the municipal securities deposited in the qualified tender
option bond entity.
(e) Disclosures. The sponsor provides, or causes to be provided, to
potential investors a reasonable period of time prior to the sale of
the asset-backed securities as part of the securitization transaction
and, upon request, to the Commission and its appropriate Federal
banking agency, if any, the following disclosure in written form under
the caption ``Credit Risk Retention'' the name and form of organization
of the qualified tender option bond entity, and a description of the
form, fair value (expressed as a percentage of the fair value of all of
the ABS interests issued in the securitization transaction and as a
dollar amount), and nature of such interest in accordance with the
disclosure obligations in Sec. ----.4(d).
(f) Prohibitions on Hedging and Transfer. The prohibitions on
transfer and hedging set forth in Sec. ----.12, apply to any municipal
securities retained by the sponsor with respect to an issuance of
tender option bonds by a qualified tender option bond entity pursuant
to paragraph (d) of this section.
Subpart C--Transfer of Risk Retention
Sec. ----.11 Allocation of risk retention to an originator.
(a) In general. A sponsor choosing to retain an eligible vertical
interest or an eligible horizontal residual interest (including an
eligible horizontal cash reserve account), or combination thereof under
Sec. ----.4, with respect to a securitization transaction may offset
the amount of its risk retention requirements under Sec. ----.4 by the
amount of the eligible interests, respectively, acquired by an
originator of one or more of the securitized assets if:
(1) At the closing of the securitization transaction:
(i) The originator acquires the eligible interest from the sponsor
and retains such interest in the same manner as the sponsor under Sec.
----.4, as such interest was held prior to the acquisition by the
originator;
(ii) The ratio of the fair value of eligible interests acquired and
retained by the originator to the total fair value of eligible
interests otherwise required to be retained by the sponsor pursuant to
Sec. ----.4, does not exceed the ratio of:
(A) The unpaid principal balance of all the securitized assets
originated by the originator; to
(B) The unpaid principal balance of all the securitized assets in
the securitization transaction;
(iii) The originator acquires and retains at least 20 percent of
the aggregate risk retention amount otherwise required to be retained
by the sponsor pursuant to Sec. ----.4; and
(iv) The originator purchases the eligible interests from the
sponsor at a price that is equal, on a dollar-for-dollar basis, to the
amount by which the sponsor's required risk retention is reduced in
accordance with this section, by payment to the sponsor in the form of:
(A) Cash; or
(B) A reduction in the price received by the originator from the
sponsor or depositor for the assets sold by the originator to the
sponsor or depositor for inclusion in the pool of securitized assets.
(2) Disclosures. In addition to the disclosures required pursuant
to Sec. ----.4(d), the sponsor provides, or causes to be provided, to
potential investors a reasonable period of time prior to the sale of
the asset-backed securities as part of the securitization transaction
and, upon request, to the Commission and its appropriate Federal
banking agency, if any, in written form under the caption ``Credit Risk
Retention'', the name and form of organization of any originator that
will acquire and retain (or has acquired and retained) an interest in
the transaction pursuant to this section, including a description of
the form, amount (expressed as a percentage and dollar amount (or
corresponding amount in the foreign currency in which the ABS are
issued, as applicable)), and nature of the interest, as well as the
method of payment for such interest under paragraph (a)(1)(iv) of this
section.
(3) Hedging, transferring and pledging. The originator complies
with the hedging and other restrictions in Sec. ----.12 with respect
to the interests retained by the originator pursuant to this section as
if it were the retaining sponsor and was required to retain the
interest under subpart B of this part.
(b) Duty to comply. (1) The retaining sponsor shall be responsible
for compliance with this section.
(2) A retaining sponsor relying on this section:
(A) Shall maintain and adhere to policies and procedures that are
reasonably designed to monitor the compliance by each originator that
is allocated a portion of the sponsor's risk retention obligations with
the requirements in paragraphs (a)(1) and (a)(3) of this section; and
(B) In the event the sponsor determines that any such originator no
longer complies with any of the requirements in paragraphs (a)(1) and
(a)(3) of this section, shall promptly notify, or cause to be notified,
the holders of the ABS interests issued in the securitization
transaction of such noncompliance by such originator.
Sec. ----.12 Hedging, transfer and financing prohibitions.
(a) Transfer. A retaining sponsor may not sell or otherwise
transfer any interest or assets that the sponsor is required to retain
pursuant to subpart B of this part to any person other than an entity
that is and remains a majority-owned affiliate of the sponsor.
(b) Prohibited hedging by sponsor and affiliates. A retaining
sponsor and its affiliates may not purchase or sell a security, or
other financial instrument, or enter into an agreement, derivative or
other position, with any other person if:
[[Page 58036]]
(1) Payments on the security or other financial instrument or under
the agreement, derivative, or position are materially related to the
credit risk of one or more particular ABS interests that the retaining
sponsor is required to retain with respect to a securitization
transaction pursuant to subpart B of this part or one or more of the
particular securitized assets that collateralize the asset-backed
securities issued in the securitization transaction; and
(2) The security, instrument, agreement, derivative, or position in
any way reduces or limits the financial exposure of the sponsor to the
credit risk of one or more of the particular ABS interests that the
retaining sponsor is required to retain with respect to a
securitization transaction pursuant to subpart B of this part or one or
more of the particular securitized assets that collateralize the asset-
backed securities issued in the securitization transaction.
(c) Prohibited hedging by issuing entity. The issuing entity in a
securitization transaction may not purchase or sell a security or other
financial instrument, or enter into an agreement, derivative or
position, with any other person if:
(1) Payments on the security or other financial instrument or under
the agreement, derivative or position are materially related to the
credit risk of one or more particular ABS interests that the retaining
sponsor for the transaction is required to retain with respect to the
securitization transaction pursuant to subpart B of this part; and
(2) The security, instrument, agreement, derivative, or position in
any way reduces or limits the financial exposure of the retaining
sponsor to the credit risk of one or more of the particular ABS
interests that the sponsor is required to retain pursuant to subpart B
of this part.
(d) Permitted hedging activities. The following activities shall
not be considered prohibited hedging activities under paragraph (b) or
(c) of this section:
(1) Hedging the interest rate risk (which does not include the
specific interest rate risk, known as spread risk, associated with the
ABS interest that is otherwise considered part of the credit risk) or
foreign exchange risk arising from one or more of the particular ABS
interests required to be retained by the sponsor under subpart B of
this part or one or more of the particular securitized assets that
underlie the asset-backed securities issued in the securitization
transaction; or
(2) Purchasing or selling a security or other financial instrument
or entering into an agreement, derivative, or other position with any
third party where payments on the security or other financial
instrument or under the agreement, derivative, or position are based,
directly or indirectly, on an index of instruments that includes asset-
backed securities if:
(i) Any class of ABS interests in the issuing entity that were
issued in connection with the securitization transaction and that are
included in the index represents no more than 10 percent of the dollar-
weighted average (or corresponding weighted average in the currency in
which the ABS is issued, as applicable) of all instruments included in
the index; and
(ii) All classes of ABS interests in all issuing entities that were
issued in connection with any securitization transaction in which the
sponsor was required to retain an interest pursuant to subpart B of
this part and that are included in the index represent, in the
aggregate, no more than 20 percent of the dollar-weighted average (or
corresponding weighted average in the currency in which the ABS is
issued, as applicable) of all instruments included in the index.
(e) Prohibited non-recourse financing. Neither a retaining sponsor
nor any of its affiliates may pledge as collateral for any obligation
(including a loan, repurchase agreement, or other financing
transaction) any ABS interest that the sponsor is required to retain
with respect to a securitization transaction pursuant to subpart B of
this part unless such obligation is with full recourse to the sponsor
or affiliate, respectively.
(f) Duration of the hedging and transfer restrictions--(1) General
rule. Except as provided in paragraph (f)(2) of this section, the
prohibitions on sale and hedging pursuant to paragraphs (a) and (b) of
this section shall expire on or after the date that is the latest of:
(i) The date on which the total unpaid principal balance of the
securitized assets that collateralize the securitization transaction
has been reduced to 33 percent of the total unpaid principal balance of
the securitized assets as of the closing of the securitization
transaction;
(ii) The date on which the total unpaid principal obligations under
the ABS interests issued in the securitization transaction has been
reduced to 33 percent of the total unpaid principal obligations of the
ABS interests at closing of the securitization transaction; or
(iii) Two years after the date of the closing of the securitization
transaction.
(2) Securitizations of residential mortgages. (i) If all of the
assets that collateralize a securitization transaction subject to risk
retention under this part are residential mortgages, the prohibitions
on sale and hedging pursuant to paragraphs (a) and (b) of this section
shall expire on or after the date that is the later of:
(A) Five years after the date of the closing of the securitization
transaction; or
(B) The date on which the total unpaid principal balance of the
residential mortgages that collateralize the securitization transaction
has been reduced to 25 percent of the total unpaid principal balance of
such residential mortgages at the closing of the securitization
transaction.
(ii) Notwithstanding paragraph (f)(2)(i) of this section, the
prohibitions on sale and hedging pursuant to paragraphs (a) and (b) of
this section shall expire with respect to the sponsor of a
securitization transaction described in paragraph (f)(2)(i) of this
section on or after the date that is seven years after the date of the
closing of the securitization transaction.
(3) Conservatorship or receivership of sponsor. A conservator or
receiver of the sponsor (or any other person holding risk retention
pursuant to this part) of a securitization transaction is permitted to
sell or hedge any economic interest in the securitization transaction
if the conservator or receiver has been appointed pursuant to any
provision of federal or State law (or regulation promulgated
thereunder) that provides for the appointment of the Federal Deposit
Insurance Corporation, or an agency or instrumentality of the United
States or of a State as conservator or receiver, including without
limitation any of the following authorities:
(i) 12 U.S.C. 1811;
(ii) 12 U.S.C. 1787;
(iii) 12 U.S.C. 4617; or
(iv) 12 U.S.C. 5382.
Subpart D--Exceptions and Exemptions
Sec. ----.13 Exemption for qualified residential mortgages.
(a) Definitions. For purposes of this section, the following
definitions shall apply:
Currently performing means the borrower in the mortgage transaction
is not currently thirty (30) days past due, in whole or in part, on the
mortgage transaction.
Qualified residential mortgage means a ``qualified mortgage'' as
defined in section 129 C of the Truth in Lending Act (15 U.S.C. 1639c)
and regulations issued thereunder.
(b) Exemption. A sponsor shall be exempt from the risk retention
[[Page 58037]]
requirements in subpart B of this part with respect to any
securitization transaction, if:
(1) All of the assets that collateralize the asset-backed
securities are qualified residential mortgages or servicing assets;
(2) None of the assets that collateralize the asset-backed
securities are other asset-backed securities;
(3) At the closing of the securitization transaction, each
qualified residential mortgage collateralizing the asset-backed
securities is currently performing; and
(4)(i) The depositor of the asset-backed security certifies that it
has evaluated the effectiveness of its internal supervisory controls
with respect to the process for ensuring that all assets that
collateralize the asset-backed security are qualified residential
mortgages or servicing assets and has concluded that its internal
supervisory controls are effective; and
(ii) The evaluation of the effectiveness of the depositor's
internal supervisory controls must be performed, for each issuance of
an asset-backed security in reliance on this section, as of a date
within 60 days of the cut-off date or similar date for establishing the
composition of the asset pool collateralizing such asset-backed
security; and
(iii) The sponsor provides, or causes to be provided, a copy of the
certification described in paragraph (b)(4)(i) of this section to
potential investors a reasonable period of time prior to the sale of
asset-backed securities in the issuing entity, and, upon request, to
the Commission and its appropriate Federal banking agency, if any.
(c) Repurchase of loans subsequently determined to be non-qualified
after closing. A sponsor that has relied on the exemption provided in
paragraph (b) of this section with respect to a securitization
transaction shall not lose such exemption with respect to such
transaction if, after closing of the securitization transaction, it is
determined that one or more of the residential mortgage loans
collateralizing the asset-backed securities does not meet all of the
criteria to be a qualified residential mortgage provided that:
(1) The depositor complied with the certification requirement set
forth in paragraph (b)(4) of this section;
(2) The sponsor repurchases the loan(s) from the issuing entity at
a price at least equal to the remaining aggregate unpaid principal
balance and accrued interest on the loan(s) no later than 90 days after
the determination that the loans do not satisfy the requirements to be
a qualified residential mortgage; and
(3) The sponsor promptly notifies, or causes to be notified, the
holders of the asset-backed securities issued in the securitization
transaction of any loan(s) included in such securitization transaction
that is (or are) required to be repurchased by the sponsor pursuant to
paragraph (c)(2) of this section, including the amount of such
repurchased loan(s) and the cause for such repurchase.
Sec. ----.14 Definitions applicable to qualifying commercial loans,
qualifying commercial real estate loans, and qualifying automobile
loans.
The following definitions apply for purposes of Sec. Sec. ----.15
through ----.18:
Appraisal Standards Board means the board of the Appraisal
Foundation that establishes generally accepted standards for the
appraisal profession.
Automobile loan: (1) Means any loan to an individual to finance the
purchase of, and that is secured by a first lien on, a passenger car or
other passenger vehicle, such as a minivan, van, sport-utility vehicle,
pickup truck, or similar light truck for personal, family, or household
use; and
(2) Does not include any:
(i) Loan to finance fleet sales;
(ii) Personal cash loan secured by a previously purchased
automobile;
(iii) Loan to finance the purchase of a commercial vehicle or farm
equipment that is not used for personal, family, or household purposes;
(iv) Lease financing
(v) Loan to finance the purchase of a vehicle with a salvage title;
or
(vi) Loan to finance the purchase of a vehicle intended to be used
for scrap or parts.
Combined loan-to-value (CLTV) ratio means, at the time of
origination, the sum of the principal balance of a first-lien mortgage
loan on the property, plus the principal balance of any junior-lien
mortgage loan that, to the creditor's knowledge, would exist at the
closing of the transaction and that is secured by the same property,
divided by:
(1) For acquisition funding, the lesser of the purchase price or
the estimated market value of the real property based on an appraisal
that meets the requirements set forth in Sec. ----.17(a)(2)(ii); or
(2) For refinancing, the estimated market value of the real
property based on an appraisal that meets the requirements set forth in
Sec. ----.17(a)(2)(ii).
Commercial loan means a secured or unsecured loan to a company or
an individual for business purposes, other than any:
(1) Loan to purchase or refinance a one-to-four family residential
property;
(2) Commercial real estate loan.
Commercial real estate (CRE) loan: (1) Means a loan secured by a
property with five or more single family units, or by nonfarm
nonresidential real property, the primary source (50 percent or more)
of repayment for which is expected to be:
(i) The proceeds of the sale, refinancing, or permanent financing
of the property; or
(ii) Rental income associated with the property; and
(2) Does not include:
(i) A land development and construction loan (including 1- to 4-
family residential or commercial construction loans);
(ii) Any other land loan; or
(iii) An unsecured loan to a developer.
Debt service coverage (DSC) ratio means:
(1) For qualifying leased CRE loans, qualifying multi-family loans,
and other CRE loans:
(i) The annual NOI less the annual replacement reserve of the CRE
property at the time of origination of the CRE loans divided by
(ii) The sum of the borrower's annual payments for principal and
interest on any debt obligation.
(2) For commercial loans:
(i) The borrower's EBITDA as of the most recently completed fiscal
year divided by
(ii) The sum of the borrower's annual payments for principal and
interest on all debt obligations.
Debt to income (DTI) ratio means the borrower's total debt,
including the monthly amount due on the automobile loan, divided by the
borrower's monthly income.
Earnings before interest, taxes, depreciation, and amortization
(EBITDA) means the annual income of a business before expenses for
interest, taxes, depreciation and amortization are deducted, as
determined in accordance with GAAP.
Environmental risk assessment means a process for determining
whether a property is contaminated or exposed to any condition or
substance that could result in contamination that has an adverse effect
on the market value of the property or the realization of the
collateral value.
First lien means a lien or encumbrance on property that has
priority over all other liens or encumbrances on the property.
Junior lien means a lien or encumbrance on property that is lower
in priority relative to other liens or encumbrances on the property.
[[Page 58038]]
Leverage ratio means the borrower's total debt divided by the
borrower's EBITDA.
Loan-to-value (LTV) ratio means, at the time of origination, the
principal balance of a first-lien mortgage loan on the property divided
by:
(1) For acquisition funding, the lesser of the purchase price or
the estimated market value of the real property based on an appraisal
that meets the requirements set forth in Sec. ----.17(a)(2)(ii); or
(2) For refinancing, the estimated market value of the real
property based on an appraisal that meets the requirements set forth in
Sec. ----.17(a)(2)(ii).
Model year means the year determined by the manufacturer and
reflected on the vehicle's Motor Vehicle Title as part of the vehicle
description.
Net operating income (NOI) refers to the income a CRE property
generates for the borrower after all expenses have been deducted for
federal income tax purposes, except for depreciation, debt service
expenses, and federal and State income taxes, and excluding any unusual
and nonrecurring items of income.
Operating affiliate means an affiliate of a borrower that is a
lessor or similar party with respect to the commercial real estate
securing the loan.
Payments-in-kind means payments of principal or accrued interest
that are not paid in cash when due, and instead are paid by increasing
the principal balance of the loan or by providing equity in the
borrowing company.
Purchase money security interest means a security interest in
property that secures the obligation of the obligor incurred as all or
part of the price of the property.
Purchase price means the amount paid by the borrower for the
vehicle net of any incentive payments or manufacturer cash rebates.
Qualified tenant means:
(1) A tenant with a lease who has satisfied all obligations with
respect to the property in a timely manner; or
(2) A tenant who originally had a lease that subsequently expired
and currently is leasing the property on a month-to-month basis, has
occupied the property for at least three years prior to the date of
origination, and has satisfied all obligations with respect to the
property in a timely manner.
Qualifying leased CRE loan means a CRE loan secured by commercial
nonfarm real property, other than a multi-family property or a hotel,
inn, or similar property:
(1) That is occupied by one or more qualified tenants pursuant to a
lease agreement with a term of no less than one (1) month; and
(2) Where no more than 20 percent of the aggregate gross revenue of
the property is payable from one or more tenants who:
(i) Are subject to a lease that will terminate within six months
following the date of origination; or
(ii) Are not qualified tenants.
Qualifying multi-family loan means a CRE loan secured by any
residential property (other than a hotel, motel, inn, hospital, nursing
home, or other similar facility where dwellings are not leased to
residents):
(1) That consists of five or more dwelling units (including
apartment buildings, condominiums, cooperatives and other similar
structures) primarily for residential use; and
(2) Where at least 75 percent of the NOI is derived from
residential rents and tenant amenities (including income from parking
garages, health or swim clubs, and dry cleaning), and not from other
commercial uses.
Rental income means:
(1) Income derived from a lease or other occupancy agreement
between the borrower or an operating affiliate of the borrower and a
party which is not an affiliate of the borrower for the use of real
property or improvements serving as collateral for the applicable loan,
and
(2) Other income derived from hotel, motel, dormitory, nursing
home, assisted living, mini-storage warehouse or similar properties
that are used primarily by parties that are not affiliates or employees
of the borrower or its affiliates.
Replacement reserve means the monthly capital replacement or
maintenance amount based on the property type, age, construction and
condition of the property that is adequate to maintain the physical
condition and NOI of the property.
Salvage title means a form of vehicle title branding, which notes
that the vehicle has been severely damaged and/or deemed a total loss
and uneconomical to repair by an insurance company that paid a claim on
the vehicle.
Total debt, with respect to a borrower, means:
(1) In the case of an automobile loan, the sum of:
(i) All monthly housing payments (rent- or mortgage-related,
including property taxes, insurance and home owners association fees);
and
(ii) Any of the following that are dependent upon the borrower's
income for payment:
(A) Monthly payments on other debt and lease obligations, such as
credit card loans or installment loans, including the monthly amount
due on the automobile loan;
(B) Estimated monthly amortizing payments for any term debt, debts
with other than monthly payments and debts not in repayment (such as
deferred student loans, interest-only loans); and
(C) Any required monthly alimony, child support or court-ordered
payments; and
(2) In the case of a commercial loan, the outstanding balance of
all long-term debt (obligations that have a remaining maturity of more
than one year) and the current portion of all debt that matures in one
year or less.
Total liabilities ratio means the borrower's total liabilities,
determined in accordance with GAAP divided by the sum of the borrower's
total liabilities and equity, less the borrower's intangible assets,
with each component determined in accordance with GAAP.
Trade-in allowance means the amount a vehicle purchaser is given as
a credit at the purchase of a vehicle for the fair exchange of the
borrower's existing vehicle to compensate the dealer for some portion
of the vehicle purchase price, not to exceed the highest trade-in value
of the existing vehicle, as determined by a nationally recognized
automobile pricing agency and based on the manufacturer, year, model,
features, mileage, and condition of the vehicle, less the payoff
balance of any outstanding debt collateralized by the existing vehicle.
Uniform Standards of Professional Appraisal Practice means the
standards issued by the Appraisal Standards Board for the performance
of an appraisal, an appraisal review, or an appraisal consulting
assignment.
Sec. ----.15 Qualifying commercial loans, commercial real estate
loans, and automobile loans.
(a) General exception for qualifying assets. Commercial loans,
commercial real estate loans, and automobile loans that are securitized
through a securitization transaction shall be subject to a 0 percent
risk retention requirement under subpart B, provided that the following
conditions are met:
(1) The assets meet the underwriting standards set forth in
Sec. Sec. ----.16 (qualifying commercial loans), ----.17 (qualifying
CRE loans), or ----.18 (qualifying automobile loans) of this part, as
applicable;
(2) The securitization transaction is collateralized solely by
loans of the same asset class and by servicing assets;
(3) The securitization transaction does not permit reinvestment
periods; and
(4) The sponsor provides, or causes to be provided, to potential
investors a
[[Page 58039]]
reasonable period of time prior to the sale of asset-backed securities
of the issuing entity, and, upon request, to the Commission, and to its
appropriate Federal banking agency, if any, in written form under the
caption ``Credit Risk Retention'':
(i) A description of the manner in which the sponsor determined the
aggregate risk retention requirement for the securitization transaction
after including qualifying commercial loans, qualifying CRE loans, or
qualifying automobile loans with 0 percent risk retention; and
(ii) Descriptions of the qualifying commercial loans, qualifying
CRE loans, and qualifying automobile loans (qualifying assets) and
descriptions of the assets that are not qualifying assets, and the
material differences between the group of qualifying assets and the
group of assets that are not qualifying assets with respect to the
composition of each group's loan balances, loan terms, interest rates,
borrower credit information, and characteristics of any loan
collateral.
(b) Risk retention requirement. For any securitization transaction
described in paragraph (a) of this section, the amount of risk
retention required under Sec. ----.3(b)(1) is reduced by the same
amount as the ratio of the unpaid principal balance of the qualifying
commercial loans, qualifying CRE loans, or qualifying automobile loans
(as applicable) to the total unpaid principal balance of commercial
loans, CRE loans, or automobile loans (as applicable) that are included
in the pool of assets collateralizing the asset-backed securities
issued pursuant to the securitization transaction (the qualifying asset
ratio); provided that:
(1) The qualifying asset ratio is measured as of the cut-off date
or similar date for establishing the composition of the pool assets
collateralizing the asset-backed securities issued pursuant to the
securitization transaction; and
(2) The qualifying asset ratio does not exceed 50 percent.
(c) Exception for securitizations of qualifying assets only.
Notwithstanding other provisions of this section, the risk retention
requirements of subpart B of this part shall not apply to
securitization transactions where the transaction is collateralized
solely by servicing assets and either qualifying commercial loans,
qualifying CRE loans, or qualifying automobile loans.
Sec. ----.16 Underwriting standards for qualifying commercial loans.
(a) Underwriting, product and other standards. (1) Prior to
origination of the commercial loan, the originator:
(i) Verified and documented the financial condition of the
borrower:
(A) As of the end of the borrower's two most recently completed
fiscal years; and
(B) During the period, if any, since the end of its most recently
completed fiscal year;
(ii) Conducted an analysis of the borrower's ability to service its
overall debt obligations during the next two years, based on reasonable
projections;
(iii) Determined that, based on the previous two years' actual
performance, the borrower had:
(A) A total liabilities ratio of 50 percent or less;
(B) A leverage ratio of 3.0 or less; and
(C) A DSC ratio of 1.5 or greater;
(iv) Determined that, based on the two years of projections, which
include the new debt obligation, following the closing date of the
loan, the borrower will have:
(A) A total liabilities ratio of 50 percent or less;
(B) A leverage ratio of 3.0 or less; and
(C) A DSC ratio of 1.5 or greater.
(2) Prior to, upon or promptly following the inception of the loan,
the originator:
(i) If the loan is originated on a secured basis, obtains a
perfected security interest (by filing, title notation or otherwise)
or, in the case of real property, a recorded lien, on all of the
property pledged to collateralize the loan; and
(ii) If the loan documents indicate the purpose of the loan is to
finance the purchase of tangible or intangible property, or to
refinance such a loan, obtains a first lien on the property.
(3) The loan documentation for the commercial loan includes
covenants that:
(i) Require the borrower to provide to the servicer of the
commercial loan the borrower's financial statements and supporting
schedules on an ongoing basis, but not less frequently than quarterly;
(ii) Prohibit the borrower from retaining or entering into a debt
arrangement that permits payments-in-kind;
(iii) Impose limits on:
(A) The creation or existence of any other security interest or
lien with respect to any of the borrower's property that serves as
collateral for the loan;
(B) The transfer of any of the borrower's assets that serve as
collateral for the loan; and
(C) Any change to the name, location or organizational structure of
the borrower, or any other party that pledges collateral for the loan;
(iv) Require the borrower and any other party that pledges
collateral for the loan to:
(A) Maintain insurance that protects against loss on the collateral
for the commercial loan at least up to the amount of the loan, and that
names the originator or any subsequent holder of the loan as an
additional insured or loss payee;
(B) Pay taxes, charges, fees, and claims, where non-payment might
give rise to a lien on any collateral;
(C) Take any action required to perfect or protect the security
interest and first lien (as applicable) of the originator or any
subsequent holder of the loan in any collateral for the commercial loan
or the priority thereof, and to defend any collateral against claims
adverse to the lender's interest;
(D) Permit the originator or any subsequent holder of the loan, and
the servicer of the loan, to inspect any collateral for the commercial
loan and the books and records of the borrower; and
(E) Maintain the physical condition of any collateral for the
commercial loan.
(4) Loan payments required under the loan agreement are:
(i) Based on straight-line amortization of principal and interest
that fully amortize the debt over a term that does not exceed five
years from the date of origination; and
(ii) To be made no less frequently than quarterly over a term that
does not exceed five years.
(5) The primary source of repayment for the loan is revenue from
the business operations of the borrower.
(6) The loan was funded within the six (6) months prior to the
closing of the securitization transaction.
(7) At the closing of the securitization transaction, all payments
due on the loan are contractually current.
(8)(i) The depositor of the asset-backed security certifies that it
has evaluated the effectiveness of its internal supervisory controls
with respect to the process for ensuring that all qualifying commercial
loans that collateralize the asset-backed security and that reduce the
sponsor's risk retention requirement under Sec. ----.15 meet all of
the requirements set forth in paragraphs (a)(1) through (a)(7) of this
section and has concluded that its internal supervisory controls are
effective;
(ii) The evaluation of the effectiveness of the depositor's
internal supervisory controls referenced in paragraph (a)(8)(i)
[[Page 58040]]
of this section shall be performed, for each issuance of an asset-
backed security, as of a date within 60 days of the cut-off date or
similar date for establishing the composition of the asset pool
collateralizing such asset-backed security; and
(iii) The sponsor provides, or causes to be provided, a copy of the
certification described in paragraph (a)(8)(i) of this section to
potential investors a reasonable period of time prior to the sale of
asset-backed securities in the issuing entity, and, upon request, to
its appropriate Federal banking agency, if any.
(b) Cure or buy-back requirement. If a sponsor has relied on the
exception provided in Sec. ----.15 with respect to a qualifying
commercial loan and it is subsequently determined that the loan did not
meet all of the requirements set forth in paragraphs (a)(1) through
(a)(7) of this section, the sponsor shall not lose the benefit of the
exception with respect to the commercial loan if the depositor complied
with the certification requirement set forth in paragraph (a)(8) of
this section and:
(1) The failure of the loan to meet any of the requirements set
forth in paragraphs (a)(1) through (a)(7) of this section is not
material; or
(2) No later than 90 days after the determination that the loan
does not meet one or more of the requirements of paragraphs (a)(1)
through (a)(7) of this section, the sponsor:
(i) Effectuates cure, establishing conformity of the loan to the
unmet requirements as of the date of cure; or
(ii) Repurchases the loan(s) from the issuing entity at a price at
least equal to the remaining principal balance and accrued interest on
the loan(s) as of the date of repurchase.
(3) If the sponsor cures or repurchases pursuant to paragraph
(b)(2) of this section, the sponsor must promptly notify, or cause to
be notified, the holders of the asset-backed securities issued in the
securitization transaction of any loan(s) included in such
securitization transaction that is required to be cured or repurchased
by the sponsor pursuant to paragraph (b)(2) of this section, including
the principal amount of such loan(s) and the cause for such cure or
repurchase.
Sec. ----.17 Underwriting standards for qualifying CRE loans.
(a) Underwriting, product and other standards. (1) The CRE loan
must be secured by the following:
(i) An enforceable first lien, documented and recorded
appropriately pursuant to applicable law, on the commercial real estate
and improvements;
(ii)(A) An assignment of:
(1) Leases and rents and other occupancy agreements related to the
commercial real estate or improvements or the operation thereof for
which the borrower or an operating affiliate is a lessor or similar
party and all payments under such leases and occupancy agreements; and
(2) All franchise, license and concession agreements related to the
commercial real estate or improvements or the operation thereof for
which the borrower or an operating affiliate is a lessor, licensor,
concession granter or similar party and all payments under such other
agreements, whether the assignments described in this paragraph
(a)(1)(ii)(A)(2) are absolute or are stated to be made to the extent
permitted by the agreements governing the applicable franchise, license
or concession agreements;
(B) An assignment of all other payments due to the borrower or due
to any operating affiliate in connection with the operation of the
property described in paragraph (a)(1)(i) of this section; and
(C) The right to enforce the agreements described in paragraph
(a)(1)(ii)(A) of this section and the agreements under which payments
under paragraph (a)(1)(ii)(B) of this section are due against, and
collect amounts due from, each lessee, occupant or other obligor whose
payments were assigned pursuant to paragraphs (a)(1)(ii)(A) or
(a)(1)(ii)(B) of this section upon a breach by the borrower of any of
the terms of, or the occurrence of any other event of default (however
denominated) under, the loan documents relating to such CRE loan; and
(iii) A security interest:
(A) In all interests of the borrower and any applicable operating
affiliate in all tangible and intangible personal property of any kind,
in or used in the operation of or in connection with, pertaining to,
arising from, or constituting, any of the collateral described in
paragraphs (a)(1)(i) or (a)(1)(ii) of this section; and
(B) In the form of a perfected security interest if the security
interest in such property can be perfected by the filing of a financing
statement, fixture filing, or similar document pursuant to the law
governing the perfection of such security interest;
(2) Prior to origination of the CRE loan, the originator:
(i) Verified and documented the current financial condition of the
borrower and each operating affiliate;
(ii) Obtained a written appraisal of the real property securing the
loan that:
(A) Was performed not more than six months from the origination
date of the loan by an appropriately State-certified or State-licensed
appraiser;
(B) Conforms to generally accepted appraisal standards as evidenced
by the Uniform Standards of Professional Appraisal Practice promulgated
by the Appraisal Standards Board and the appraisal requirements \1\ of
the Federal banking agencies; and
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\1\ 12 CFR part 34, subpart C (OCC); 12 CFR part 208, subpart E,
and 12 CFR part 225, subpart G (Board); and 12 CFR part 323 (FDIC).
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(C) Provides an ``as is'' opinion of the market value of the real
property, which includes an income valuation approach that uses a
discounted cash flow analysis;
(iii) Qualified the borrower for the CRE loan based on a monthly
payment amount derived from a straight-line amortization of principal
and interest over the term of the loan, not exceeding 25 years, or 30
years for a qualifying multi-family property;
(iv) Conducted an environmental risk assessment to gain
environmental information about the property securing the loan and took
appropriate steps to mitigate any environmental liability determined to
exist based on this assessment;
(v) Conducted an analysis of the borrower's ability to service its
overall debt obligations during the next two years, based on reasonable
projections;
(vi) Determined that, based on the previous two years' actual
performance, the borrower had:
(A) A DSC ratio of 1.5 or greater, if the loan is a qualifying
leased CRE loan, net of any income derived from a tenant(s) who is not
a qualified tenant(s);
(B) A DSC ratio of 1.25 or greater, if the loan is a qualifying
multi-family property loan; or
(C) A DSC ratio of 1.7 or greater, if the loan is any other type of
CRE loan;
(vii) Determined that, based on two years of projections, which
include the new debt obligation, following the origination date of the
loan, the borrower will have:
(A) A DSC ratio of 1.5 or greater, if the loan is a qualifying
leased CRE loan, net of any income derived from a tenant(s) who is not
a qualified tenant(s);
(B) A DSC ratio of 1.25 or greater, if the loan is a qualifying
multi-family property loan; or
(C) A DSC ratio of 1.7 or greater, if the loan is any other type of
CRE loan.
(3) The loan documentation for the CRE loan includes covenants
that:
(i) Require the borrower to provide the borrower's financial
statements and
[[Page 58041]]
supporting schedules to the servicer on an ongoing basis, but not less
frequently than quarterly, including information on existing, maturing
and new leasing or rent-roll activity for the property securing the
loan, as appropriate; and
(ii) Impose prohibitions on:
(A) The creation or existence of any other security interest with
respect to the collateral for the CRE loan described in paragraphs
(a)(1)(i) and (a)(1)(ii)(A) of this section, except as provided in
paragraph (a)(4) of this section;
(B) The transfer of any collateral for the CRE loan described in
paragraph (b)(1)(i) or (b)(1)(ii)(A) of this section or of any other
collateral consisting of fixtures, furniture, furnishings, machinery or
equipment other than any such fixture, furniture, furnishings,
machinery or equipment that is obsolete or surplus; and
(C) Any change to the name, location or organizational structure of
any borrower, operating affiliate or other pledgor unless such
borrower, operating affiliate or other pledgor shall have given the
holder of the loan at least 30 days advance notice and, pursuant to
applicable law governing perfection and priority, the holder of the
loan is able to take all steps necessary to continue its perfection and
priority during such 30-day period.
(iii) Require each borrower and each operating affiliate to:
(A) Maintain insurance that protects against loss on collateral for
the CRE loan described in paragraph (a)(1)(i) of this section at least
up to the amount of the loan, and names the originator or any
subsequent holder of the loan as an additional insured or loss payee;
(B) Pay taxes, charges, fees, and claims, where non-payment might
give rise to a lien on collateral for the CRE loan described in
paragraphs (a)(1)(i) and (a)(1)(ii) of this section;
(C) Take any action required to:
(1) protect the security interest and the enforceability and
priority thereof in the collateral described in paragraph (a)(1)(i) and
(a)(1)(ii)(A) of this section and defend such collateral against claims
adverse to the originator's or any subsequent holder's interest; and
(2) perfect the security interest of the originator or any
subsequent holder of the loan in any other collateral for the CRE loan
to the extent that such security interest is required by this section
to be perfected;
(D) Permit the originator or any subsequent holder of the loan, and
the servicer, to inspect any collateral for the CRE loan and the books
and records of the borrower or other party relating to any collateral
for the CRE loan;
(E) Maintain the physical condition of collateral for the CRE loan
described in paragraph (a)(1)(i) of this section;
(F) Comply with all environmental, zoning, building code, licensing
and other laws, regulations, agreements, covenants, use restrictions,
and proffers applicable to collateral for the CRE loan described in
paragraph (a)(1)(i) of this section;
(G) Comply with leases, franchise agreements, condominium
declarations, and other documents and agreements relating to the
operation of collateral for the CRE loan described in paragraph
(a)(1)(i) of this section, and to not modify any material terms and
conditions of such agreements over the term of the loan without the
consent of the originator or any subsequent holder of the loan, or the
servicer; and
(H) Not materially alter collateral for the CRE loan described in
paragraph (a)(1)(i) of this section without the consent of the
originator or any subsequent holder of the loan, or the servicer.
(4) The loan documentation for the CRE loan prohibits the borrower
and each operating affiliate from obtaining a loan secured by a junior
lien on collateral for the CRE loan described in paragraph (a)(1)(i) or
(a)(1)(ii)(A) of this section, unless:
(i) The sum of the principal amount of such junior lien loan, plus
the principal amount of all other loans secured by collateral described
in paragraph (a)(1)(i) or (a)(1)(ii)(A) of this section, does not
exceed the applicable CLTV ratio in paragraph (a)(5) of this section,
based on the appraisal at origination of such junior lien loan; or
(ii) Such loan is a purchase money obligation that financed the
acquisition of machinery or equipment and the borrower or operating
affiliate (as applicable) pledges such machinery and equipment as
additional collateral for the CRE loan.
(5) At origination, the applicable loan-to-value ratios for the
loan are:
(i) LTV less than or equal to 65 percent and CLTV less than or
equal to 70 percent; or
(ii) LTV less than or equal to 60 percent and CLTV less than or
equal to 65 percent, if the capitalization rate used in an appraisal
that meets the requirements set forth in paragraph (a)(2)(ii) of this
section is less than or equal to the sum of:
(A) The 10-year swap rate, as reported in the Federal Reserve's
H.15 Report (or any successor report) as of the date concurrent with
the effective date of an appraisal that meets the requirements set
forth in paragraph (a)(2)(ii) of this section; and
(B) 300 basis points.
(iii) The capitalization rate used in an appraisal under paragraph
(a)(2)(ii) of this section must be disclosed to potential investors in
the securitization.
(6) All loan payments required to be made under the loan agreement
are:
(i) Based on straight-line amortization of principal and interest
over a term that does not exceed 25 years, or 30 years for a qualifying
multifamily loan; and
(ii) To be made no less frequently than monthly over a term of at
least ten years.
(7) Under the terms of the loan agreement:
(i) Any maturity of the note occurs no earlier than ten years
following the date of origination;
(ii) The borrower is not permitted to defer repayment of principal
or payment of interest; and
(iii) The interest rate on the loan is:
(A) A fixed interest rate; or
(B) An adjustable interest rate and the borrower, prior to or
concurrently with origination of the CRE loan, obtained a derivative
that effectively results in a fixed interest rate.
(8) The originator does not establish an interest reserve at
origination to fund all or part of a payment on the loan.
(9) At the closing of the securitization transaction, all payments
due on the loan are contractually current.
(10)(i) The depositor of the asset-backed security certifies that
it has evaluated the effectiveness of its internal supervisory controls
with respect to the process for ensuring that all qualifying CRE loans
that collateralize the asset-backed security and that reduce the
sponsor's risk retention requirement under Sec. ----.15 meet all of
the requirements set forth in paragraphs (a)(1) through (9) of this
section and has concluded that its internal supervisory controls are
effective;
(ii) The evaluation of the effectiveness of the depositor's
internal supervisory controls referenced in paragraph (a)(10)(i) of
this section shall be performed, for each issuance of an asset-backed
security, as of a date within 60 days of the cut-off date or similar
date for establishing the composition of the asset pool collateralizing
such asset-backed security;
(iii) The sponsor provides, or causes to be provided, a copy of the
certification described in paragraph (a)(10)(i) of this section to
potential investors a reasonable period of time prior to the sale of
asset-backed securities in the issuing entity, and, upon request, to
its appropriate Federal banking agency, if any; and
(11) Within two weeks of the closing of the CRE loan by its
originator or, if
[[Page 58042]]
sooner, prior to the transfer of such CRE loan to the issuing entity,
the originator shall have obtained a UCC lien search from the
jurisdiction of organization of the borrower and each operating
affiliate, that does not report, as of the time that the security
interest of the originator in the property described in paragraph
(a)(1)(iii) of this section was perfected, other higher priority liens
of record on any property described in paragraph (a)(1)(iii) of this
section, other than purchase money security interests.
(b) Cure or buy-back requirement. If a sponsor has relied on the
exception provided in Sec. ------.15 with respect to a qualifying CRE
loan and it is subsequently determined that the CRE loan did not meet
all of the requirements set forth in paragraphs (a)(1) through (a)(9)
and (a)(11) of this section, the sponsor shall not lose the benefit of
the exception with respect to the CRE loan if the depositor complied
with the certification requirement set forth in paragraph (a)(10) of
this section, and:
(1) The failure of the loan to meet any of the requirements set
forth in paragraphs (a)(1) through (a)(9) and (a)(11) of this section
is not material; or;
(2) No later than 90 days after the determination that the loan
does not meet one or more of the requirements of paragraphs (a)(1)
through (a)(9) or (a)(11) of this section, the sponsor:
(i) Effectuates cure, restoring conformity of the loan to the unmet
requirements as of the date of cure; or
(ii) Repurchases the loan(s) from the issuing entity at a price at
least equal to the remaining principal balance and accrued interest on
the loan(s) as of the date of repurchase.
(3) If the sponsor cures or repurchases pursuant to paragraph
(b)(2) of this section, the sponsor must promptly notify, or cause to
be notified, the holders of the asset-backed securities issued in the
securitization transaction of any loan(s) included in such
securitization transaction that is required to be cured or repurchased
by the sponsor pursuant to paragraph (b)(2) of this section, including
the principal amount of such repurchased loan(s) and the cause for such
cure or repurchase.
Sec. ----.18 Underwriting standards for qualifying automobile loans.
(a) Underwriting, product and other standards. (1) Prior to
origination of the automobile loan, the originator:
(i) Verified and documented that within 30 days of the date of
origination:
(A) The borrower was not currently 30 days or more past due, in
whole or in part, on any debt obligation;
(B) Within the previous 24 months, the borrower has not been 60
days or more past due, in whole or in part, on any debt obligation;
(C) Within the previous 36 months, the borrower has not:
(1) Been a debtor in a proceeding commenced under Chapter 7
(Liquidation), Chapter 11 (Reorganization), Chapter 12 (Family Farmer
or Family Fisherman plan), or Chapter 13 (Individual Debt Adjustment)
of the U.S. Bankruptcy Code; or
(2) Been the subject of any federal or State judicial judgment for
the collection of any unpaid debt;
(D) Within the previous 36 months, no one-to-four family property
owned by the borrower has been the subject of any foreclosure, deed in
lieu of foreclosure, or short sale; or
(E) Within the previous 36 months, the borrower has not had any
personal property repossessed;
(ii) Determined and documented that the borrower has at least 24
months of credit history; and
(iii) Determined and documented that, upon the origination of the
loan, the borrower's DTI ratio is less than or equal to 36 percent.
(A) For the purpose of making the determination under paragraph
(a)(1)(iii) of this section, the originator must:
(1) Verify and document all income of the borrower that the
originator includes in the borrower's effective monthly income (using
payroll stubs, tax returns, profit and loss statements, or other
similar documentation); and
(2) On or after the date of the borrower's written application and
prior to origination, obtain a credit report regarding the borrower
from a consumer reporting agency that compiles and maintain files on
consumers on a nationwide basis (within the meaning of 15 U.S.C.
1681a(p)) and verify that all outstanding debts reported in the
borrower's credit report are incorporated into the calculation of the
borrower's DTI ratio under paragraph (a)(1)(ii) of this section;
(2) An originator will be deemed to have met the requirements of
paragraph (a)(1)(i) of this section if:
(i) The originator, no more than 30 days before the closing of the
loan, obtains a credit report regarding the borrower from a consumer
reporting agency that compiles and maintains files on consumers on a
nationwide basis (within the meaning of 15 U.S.C. 1681a(p));
(ii) Based on the information in such credit report, the borrower
meets all of the requirements of paragraph (a)(1)(i) of this section,
and no information in a credit report subsequently obtained by the
originator before the closing of the loan contains contrary
information; and
(iii) The originator obtains electronic or hard copies of the
credit report.
(3) At closing of the automobile loan, the borrower makes a down
payment from the borrower's personal funds and trade-in allowance, if
any, that is at least equal to the sum of:
(i) The full cost of the vehicle title, tax, and registration fees;
(ii) Any dealer-imposed fees;
(iii) The full cost of any additional warranties, insurance or
other products purchased in connection with the purchase of the
vehicle; and
(iv) 10 percent of the vehicle purchase price.
(4) The originator records a first lien securing the loan on the
purchased vehicle in accordance with State law.
(5) The terms of the loan agreement provide a maturity date for the
loan that does not exceed the lesser of:
(i) Six years from the date of origination, or
(ii) 10 years minus the difference between the current model year
and the vehicle's model year.
(6) The terms of the loan agreement:
(i) Specify a fixed rate of interest for the life of the loan;
(ii) Provide for a level monthly payment amount that fully
amortizes the amount financed over the loan term;
(iii) Do not permit the borrower to defer repayment of principal or
payment of interest; and
(iv) Require the borrower to make the first payment on the
automobile loan within 45 days of the loan's contract date.
(7) At the closing of the securitization transaction, all payments
due on the loan are contractually current; and
(8)(i) The depositor of the asset-backed security certifies that it
has evaluated the effectiveness of its internal supervisory controls
with respect to the process for ensuring that all qualifying automobile
loans that collateralize the asset-backed security and that reduce the
sponsor's risk retention requirement under Sec. ----.15 meet all of
the requirements set forth in paragraphs (a)(1) through (a)(7) of this
section and has concluded that its internal supervisory controls are
effective;
(ii) The evaluation of the effectiveness of the depositor's
internal supervisory controls referenced in paragraph (a)(8)(i) of this
section shall be performed, for each issuance of an asset-backed
security, as of a date within 60 days of the cut-off date or similar
date for establishing the composition of the asset
[[Page 58043]]
pool collateralizing such asset-backed security; and
(iii) The sponsor provides, or causes to be provided, a copy of the
certification described in paragraph (a)(8)(i) of this section to
potential investors a reasonable period of time prior to the sale of
asset-backed securities in the issuing entity, and, upon request, to
its appropriate Federal banking agency, if any.
(b) Cure or buy-back requirement. If a sponsor has relied on the
exception provided in Sec. ------.15 with respect to a qualifying
automobile loan and it is subsequently determined that the loan did not
meet all of the requirements set forth in paragraphs (a)(1) through
(a)(7) of this section, the sponsor shall not lose the benefit of the
exception with respect to the automobile loan if the depositor complied
with the certification requirement set forth in paragraph (a)(8) of
this section, and:
(1) The failure of the loan to meet any of the requirements set
forth in paragraphs (a)(1) through (a)(7) of this section is not
material; or
(2) No later than ninety (90) days after the determination that the
loan does not meet one or more of the requirements of paragraphs (a)(1)
through (a)(7) of this section, the sponsor:
(i) Effectuates cure, establishing conformity of the loan to the
unmet requirements as of the date of cure; or
(ii) Repurchases the loan(s) from the issuing entity at a price at
least equal to the remaining principal balance and accrued interest on
the loan(s) as of the date of repurchase.
(3) If the sponsor cures or repurchases pursuant to paragraph
(b)(2) of this section, the sponsor must promptly notify, or cause to
be notified, the holders of the asset-backed securities issued in the
securitization transaction of any loan(s) included in such
securitization transaction that is required to be cured or repurchased
by the sponsor pursuant to paragraph (b)(2) of this section, including
the principal amount of such loan(s) and the cause for such cure or
repurchase.
Sec. ----.19 General exemptions.
(a) Definitions. For purposes of this section, the following
definitions shall apply:
First pay class means a class of ABS interests for which all
interests in the class are entitled to the same priority of payment and
that, at the time of closing of the transaction, is entitled to
repayments of principal and payments of interest prior to or pro-rata
with all other classes of securities collateralized by the same pool of
first-lien residential mortgages, until such class has no principal or
notional balance remaining.
Inverse floater means an ABS interest issued as part of a
securitization transaction for which interest or other income is
payable to the holder based on a rate or formula that varies inversely
to a reference rate of interest.
(b) This part shall not apply to:
(1) U.S. Government-backed securitizations. Any securitization
transaction that:
(i) Is collateralized solely by residential, multifamily, or health
care facility mortgage loan assets that are insured or guaranteed (in
whole or in part) as to the payment of principal and interest by the
United States or an agency of the United States, and servicing assets;
or
(ii) Involves the issuance of asset-backed securities that:
(A) Are insured or guaranteed as to the payment of principal and
interest by the United States or an agency of the United States; and
(B) Are collateralized solely by residential, multifamily, or
health care facility mortgage loan assets or interests in such assets,
and servicing assets.
(2) Certain agricultural loan securitizations. Any securitization
transaction that is collateralized solely by loans or other assets
made, insured, guaranteed, or purchased by any institution that is
subject to the supervision of the Farm Credit Administration, including
the Federal Agricultural Mortgage Corporation, and servicing assets;
(3) State and municipal securitizations. Any asset-backed security
that is a security issued or guaranteed by any State, or by any
political subdivision of a State, or by any public instrumentality of a
State that is exempt from the registration requirements of the
Securities Act of 1933 by reason of section 3(a)(2) of that Act (15
U.S.C. 77c(a)(2)); and
(4) Qualified scholarship funding bonds. Any asset-backed security
that meets the definition of a qualified scholarship funding bond, as
set forth in section 150(d)(2) of the Internal Revenue Code of 1986 (26
U.S.C. 150(d)(2)).
(5) Pass-through resecuritizations. Any securitization transaction
that:
(i) Is collateralized solely by servicing assets, and by existing
asset-backed securities:
(A) For which credit risk was retained as required under subpart B
of this part; or
(B) That was exempted from the credit risk retention requirements
of this part pursuant to subpart D of this part;
(ii) Is structured so that it involves the issuance of only a
single class of ABS interests; and
(iii) Provides for the pass-through of all principal and interest
payments received on the underlying ABS (net of expenses of the issuing
entity) to the holders of such class.
(6) First-pay-class securitizations. Any securitization transaction
that:
(i) Is collateralized solely by servicing assets, and by first-pay
classes of asset-backed securities collateralized by first-lien
residential mortgages on properties located in any state and servicing
assets:
(A) For which credit risk was retained as required under subpart B
of this part; or
(B) That was exempted from the credit risk retention requirements
of this part pursuant to subpart D of this part;
(ii) Does not provide for any ABS interest issued in the
securitization transaction to share in realized principal losses other
than pro rata with all other ABS interests based on current unpaid
principal balance of the ABS interests at the time the loss is
realized;
(iii) Is structured to reallocate prepayment risk;
(iv) Does not reallocate credit risk (other than as a consequence
of reallocation of prepayment risk); and
(v) Does not include any inverse floater or similarly structured
ABS interest.
(7) Seasoned loans. (i) Any securitization transaction that is
collateralized solely by servicing assets, and by seasoned loans that
meet the following requirements:
(A) The loans have not been modified since origination; and
(B) None of the loans have been delinquent for 30 days or more.
(ii) For purposes of this paragraph, a seasoned loan means:
(A) With respect to asset-backed securities backed by residential
mortgages, a loan that has been outstanding and performing for the
longer of:
(1) A period of five years; or
(2) Until the outstanding principal balance of the loan has been
reduced to 25 percent of the original principal balance.
(3) Notwithstanding paragraphs (b)(7)(ii)(A)(1) and
(b)(7)(ii)(A)(2) of this section, any residential mortgage loan that
has been outstanding and performing for a period of at least seven
years shall be deemed a seasoned loan.
(B) With respect to all other classes of asset-backed securities, a
loan that has been outstanding and performing for the longer of:
(1) A period of at least two years; or
(2) Until the outstanding principal balance of the loan has been
reduced to
[[Page 58044]]
33 percent of the original principal balance.
(8) Certain public utility securitizations. (i) Any securitization
transaction where the asset-back securities issued in the transaction
are secured by the intangible property right to collect charges for the
recovery of specified costs and such other assets, if any, of an
issuing entity that is wholly owned, directly or indirectly by an
investor owned utility company that is subject to the regulatory
authority of a State public utility commission or other appropriate
State agency.
(ii) For purposes of this paragraph:
(A) Specified cost means any cost identified by a State legislature
as appropriate for recovery through securitization pursuant to
specified cost recovery legislation; and
(B) Specified cost recovery legislation means legislation enacted
by a State that:
(1) Authorizes the investor owned utility company to apply for, and
authorizes the public utility commission or other appropriate State
agency to issue, a financing order determining the amount of specified
costs the utility will be allowed to recover;
(2) Provides that pursuant to a financing order, the utility
acquires an intangible property right to charge, collect, and receive
amounts necessary to provide for the full recovery of the specified
costs determined to be recoverable, and assures that the charges are
non-bypassable and will be paid by customers within the utility's
historic service territory who receive utility goods or services
through the utility's transmission and distribution system, even if
those customers elect to purchase these goods or services from a third
party; and
(3) Guarantees that neither the State nor any of its agencies has
the authority to rescind or amend the financing order, to revise the
amount of specified costs, or in any way to reduce or impair the value
of the intangible property right, except as may be contemplated by
periodic adjustments authorized by the specified cost recovery
legislation.
(c) Exemption for securitizations of assets issued, insured or
guaranteed by the United States. This part shall not apply to any
securitization transaction if the asset-backed securities issued in the
transaction are:
(1) Collateralized solely by obligations issued by the United
States or an agency of the United States and servicing assets;
(2) Collateralized solely by assets that are fully insured or
guaranteed as to the payment of principal and interest by the United
States or an agency of the United States (other than those referred to
in paragraph (b)(1)(i) of this section) and servicing assets; or
(3) Fully guaranteed as to the timely payment of principal and
interest by the United States or any agency of the United States;
(d) Federal Deposit Insurance Corporation securitizations. This
part shall not apply to any securitization transaction that is
sponsored by the Federal Deposit Insurance Corporation acting as
conservator or receiver under any provision of the Federal Deposit
Insurance Act or of Title II of the Dodd-Frank Wall Street Reform and
Consumer Protection Act.
(e) Reduced requirement for certain student loan securitizations.
The 5 percent risk retention requirement set forth in Sec. ----.4
shall be modified as follows:
(1) With respect to a securitization transaction that is
collateralized solely by student loans made under the Federal Family
Education Loan Program (``FFELP loans'') that are guaranteed as to 100
percent of defaulted principal and accrued interest, and servicing
assets, the risk retention requirement shall be 0 percent;
(2) With respect to a securitization transaction that is
collateralized solely by FFELP loans that are guaranteed as to at least
98 percent of defaulted principal and accrued interest, and servicing
assets, the risk retention requirement shall be 2 percent; and
(3) With respect to any other securitization transaction that is
collateralized solely by FFELP loans, and servicing assets, the risk
retention requirement shall be 3 percent.
(f) Rule of construction. Securitization transactions involving the
issuance of asset-backed securities that are either issued, insured, or
guaranteed by, or are collateralized by obligations issued by, or loans
that are issued, insured, or guaranteed by, the Federal National
Mortgage Association, the Federal Home Loan Mortgage Corporation, or a
Federal home loan bank shall not on that basis qualify for exemption
under this section.
Sec. ----.20 Safe harbor for certain foreign-related transactions.
(a) Definitions. For purposes of this section, the following
definition shall apply:
U.S. person means:
(1) Any of the following:
(i) Any natural person resident in the United States;
(ii) Any partnership, corporation, limited liability company, or
other organization or entity organized or incorporated under the laws
of any State or of the United States;
(iii) Any estate of which any executor or administrator is a U.S.
person;
(iv) Any trust of which any trustee is a U.S. person;
(v) Any agency or branch of a foreign entity located in the United
States;
(vi) Any non-discretionary account or similar account (other than
an estate or trust) held by a dealer or other fiduciary for the benefit
or account of a U.S. person;
(vii) Any discretionary account or similar account (other than an
estate or trust) held by a dealer or other fiduciary organized,
incorporated, or (if an individual) resident in the United States; and
(viii) Any partnership, corporation, limited liability company, or
other organization or entity if:
(A) Organized or incorporated under the laws of any foreign
jurisdiction; and
(B) Formed by a U.S. person principally for the purpose of
investing in securities not registered under the Act; and
(2) ``U.S. person(s)'' does not include:
(i) Any discretionary account or similar account (other than an
estate or trust) held for the benefit or account of a non-U.S. person
by a dealer or other professional fiduciary organized, incorporated, or
(if an individual) resident in the United States;
(ii) Any estate of which any professional fiduciary acting as
executor or administrator is a U.S. person if:
(A) An executor or administrator of the estate who is not a U.S.
person has sole or shared investment discretion with respect to the
assets of the estate; and
(B) The estate is governed by foreign law;
(iii) Any trust of which any professional fiduciary acting as
trustee is a U.S. person, if a trustee who is not a U.S. person has
sole or shared investment discretion with respect to the trust assets,
and no beneficiary of the trust (and no settlor if the trust is
revocable) is a U.S. person;
(iv) An employee benefit plan established and administered in
accordance with the law of a country other than the United States and
customary practices and documentation of such country;
(v) Any agency or branch of a U.S. person located outside the
United States if:
(A) The agency or branch operates for valid business reasons; and
(B) The agency or branch is engaged in the business of insurance or
banking and is subject to substantive insurance or banking regulation,
respectively, in the jurisdiction where located;
(vi) The International Monetary Fund, the International Bank for
[[Page 58045]]
Reconstruction and Development, the Inter-American Development Bank,
the Asian Development Bank, the African Development Bank, the United
Nations, and their agencies, affiliates and pension plans, and any
other similar international organizations, their agencies, affiliates
and pension plans.
(b) In general. This part shall not apply to a securitization
transaction if all the following conditions are met:
(1) The securitization transaction is not required to be and is not
registered under the Securities Act of 1933 (15 U.S.C. 77a et seq.);
(2) No more than 10 percent of the dollar value (or equivalent
amount in the currency in which the ABS is issued, as applicable) of
all classes of ABS interests in the securitization transaction are sold
or transferred to U.S. persons or for the account or benefit of U.S.
persons;
(3) Neither the sponsor of the securitization transaction nor the
issuing entity is:
(i) Chartered, incorporated, or organized under the laws of the
United States or any State;
(ii) An unincorporated branch or office (wherever located) of an
entity chartered, incorporated, or organized under the laws of the
United States or any State; or
(iii) An unincorporated branch or office located in the United
States or any State of an entity that is chartered, incorporated, or
organized under the laws of a jurisdiction other than the United States
or any State; and
(4) If the sponsor or issuing entity is chartered, incorporated, or
organized under the laws of a jurisdiction other than the United States
or any State, no more than 25 percent (as determined based on unpaid
principal balance) of the assets that collateralize the ABS interests
sold in the securitization transaction were acquired by the sponsor or
issuing entity, directly or indirectly, from:
(i) A majority-owned affiliate of the sponsor or issuing entity
that is chartered, incorporated, or organized under the laws of the
United States or any State; or
(ii) An unincorporated branch or office of the sponsor or issuing
entity that is located in the United States or any State.
(b) Evasions prohibited. In view of the objective of these rules
and the policies underlying Section 15G of the Exchange Act, the safe
harbor described in paragraph (a) of this section is not available with
respect to any transaction or series of transactions that, although in
technical compliance with such paragraph (a) of this section, is part
of a plan or scheme to evade the requirements of section 15G and this
Regulation. In such cases, compliance with section 15G and this part is
required.
Sec. ----.21 Additional exemptions.
(a) Securitization transactions. The federal agencies with
rulewriting authority under section 15G(b) of the Exchange Act (15
U.S.C. 78o-11(b)) with respect to the type of assets involved may
jointly provide a total or partial exemption of any securitization
transaction as such agencies determine may be appropriate in the public
interest and for the protection of investors.
(b) Exceptions, exemptions, and adjustments. The Federal banking
agencies and the Commission, in consultation with the Federal Housing
Finance Agency and the Department of Housing and Urban Development, may
jointly adopt or issue exemptions, exceptions or adjustments to the
requirements of this part, including exemptions, exceptions or
adjustments for classes of institutions or assets in accordance with
section 15G(e) of the Exchange Act (15 U.S.C. 78o-11(e)).
End of Common Rule
List of Subjects
12 CFR Part 43
Automobile loans, Banks and banking, Commercial loans, Commercial
real estate, Credit risk, Mortgages, National banks, Reporting and
recordkeeping requirements, Risk retention, Securitization.
12 CFR Part 244
Auto loans, Banks and banking, Bank holding companies, Commercial
loans, Commercial real estate, Credit risk, Edge and agreement
corporations, Foreign banking organizations, Mortgages, Nonbank
financial companies, Reporting and recordkeeping requirements, Risk
retention, Savings and loan holding companies, Securitization, State
member banks.
12 CFR Part 373
Automobile loans, Banks and banking, Commercial loans, Commercial
real estate, Credit risk, Mortgages, Reporting and recordkeeping
requirements, Risk retention, Savings associations, Securitization.
12 CFR Part 1234
Government sponsored enterprises, Mortgages, Securities.
17 CFR Part 246
Reporting and recordkeeping requirements, Securities.
24 CFR Part 267
Mortgages.
Adoption of the Common Rule Text
The proposed adoption of the common rules by the agencies, as
modified by agency-specific text, is set forth below:
DEPARTMENT OF THE TREASURY
Office of the Comptroller of the Currency
12 CFR Chapter I
Authority and Issuance
For the reasons stated in the common preamble and under the
authority of 12 U.S.C. 93a, 1464, 5412(b)(2)(B), and 15 U.S.C. 78o-11,
the Office of the Comptroller of the Currency proposes to amend chapter
I of title 12, Code of Federal Regulations as follows:
PART 43--CREDIT RISK RETENTION
0
1. The authority for part 43 is added to read as follows:
Authority: 12 U.S.C. 1 et seq., 93a, 161, 1464, 1818,
5412(b)(2)(B), and 15 U.S.C. 78o-11.
0
2. Part 43 is added as set forth at the end of the Common Preamble.
0
3. Section 43.1 is added to read as follows:
Sec. 43.1 Authority, purpose, scope, and reservation of authority.
(a) Authority. This part is issued under the authority of 12 U.S.C.
1 et seq., 93a, 161, 1464, 1818, 5412(b)(2)(B), and 15 U.S.C. 78o-11.
(b) Purpose. (1) This part requires securitizers to retain an
economic interest in a portion of the credit risk for any asset that
the securitizer, through the issuance of an asset-backed security,
transfers, sells, or conveys to a third party. This part specifies the
permissible types, forms, and amounts of credit risk retention, and it
establishes certain exemptions for securitizations collateralized by
assets that meet specified underwriting standards.
(2) Nothing in this part shall be read to limit the authority of
the OCC to take supervisory or enforcement action, including action to
address unsafe or unsound practices or conditions, or violations of
law.
(c) Scope. This part applies to any securitizer that is a national
bank, a Federal savings association, a Federal branch or agency of a
foreign bank, or a subsidiary thereof.
(d) Effective dates. This part shall become effective:
(1) With respect to any securitization transaction collateralized
by residential
[[Page 58046]]
mortgages, one year after the date on which final rules under section
15G(b) of the Exchange Act (15 U.S.C. 78o-11(b)) are published in the
Federal Register; and
(2) With respect to any other securitization transaction, two years
after the date on which final rules under section 15G(b) of the
Exchange Act (15 U.S.C. 78o-11(b)) are published in the Federal
Register.
Board of Governors of the Federal Reserve System
12 CFR Chapter II
Authority and Issuance
For the reasons set forth in the Supplementary Information, the
Board of Governors of the Federal Reserve System proposes to add the
text of the common rule as set forth at the end of the Supplementary
Information as part 244 to chapter II of title 12, Code of Federal
Regulations, modified as follows:
PART 244--CREDIT RISK RETENTION (REGULATION RR)
0
4. The authority citation for part 244 is added to reads as follows:
Authority: 12 U.S.C. 221 et seq., 1461 et seq., 1818, 1841 et
seq., 3103 et seq., and 15 U.S.C. 78o-11.
0
4a. The part heading for part 244 is revised as set forth above.
0
5. Section 244.1 is added to read as follows:
Sec. 244.1 Authority, purpose, and scope.
(a) Authority--(1) In general. This part (Regulation RR) is issued
by the Board of Governors of the Federal Reserve System under section
15G of the Securities Exchange Act of 1934, as amended (Exchange Act)
(15 U.S.C. 78o-11), as well as under the Federal Reserve Act, as
amended (12 U.S.C. 221 et seq.); section 8 of the Federal Deposit
Insurance Act (FDI Act), as amended (12 U.S.C. 1818); the Bank Holding
Company Act of 1956, as amended (BHC Act) (12 U.S.C. 1841 et seq.); the
Home Owners' Loan Act of 1933 (HOLA) (12 U.S.C. 1461 et seq.); section
165 of the Dodd-Frank Wall Street Reform and Consumer Protection Act
(Dodd-Frank Act) (12 U.S.C. 5365); and the International Banking Act of
1978, as amended (12 U.S.C. 3101 et seq.).
(2) Nothing in this part shall be read to limit the authority of
the Board to take action under provisions of law other than 15 U.S.C.
78o-11, including action to address unsafe or unsound practices or
conditions, or violations of law or regulation, under section 8 of the
FDI Act.
(b) Purpose. This part requires any securitizer to retain an
economic interest in a portion of the credit risk for any asset that
the securitizer, through the issuance of an asset-backed security,
transfers, sells, or conveys to a third party in a transaction within
the scope of section 15G of the Exchange Act. This part specifies the
permissible types, forms, and amounts of credit risk retention, and
establishes certain exemptions for securitizations collateralized by
assets that meet specified underwriting standards or that otherwise
qualify for an exemption.
(c) Scope. (1) This part applies to any securitizer that is:
(i) A state member bank (as defined in 12 CFR 208.2(g)); or
(ii) Any subsidiary of a state member bank.
(2) Section 15G of the Exchange Act and the rules issued thereunder
apply to any securitizer that is:
(i) A bank holding company (as defined in 12 U.S.C. 1842);
(ii) A foreign banking organization (as defined in 12 CFR
211.21(o));
(iii) An Edge or agreement corporation (as defined in 12 CFR
211.1(c)(2) and (3));
(iv) A nonbank financial company that the Financial Stability
Oversight Council has determined under section 113 of the Dodd-Frank
Wall Street Reform and Consumer Protection Act (the Dodd-Frank Act) (12
U.S.C. 5323) shall be supervised by the Board and for which such
determination is still in effect; or
(v) A savings and loan holding company (as defined in 12 U.S.C.
1467a); and
(vi) Any subsidiary of the foregoing. The Federal Reserve will
enforce section 15G of the Exchange Act and the rules issued thereunder
under section 8 of the FDI Act against any of the foregoing entities.
Federal Deposit Insurance Corporation
12 CFR Chapter III
Authority and Issuance
For the reasons set forth in the SUPPLEMENTARY INFORMATION, the
Federal Deposit Insurance Corporation proposes to add the text of the
common rule as set forth at the end of the SUPPLEMENTARY INFORMATION as
part 373 to chapter III of title 12, Code of Federal Regulations,
modified as follows:
PART 373--CREDIT RISK RETENTION
0
6. The authority citation for part 373 is added to reads as follows:
Authority: 12 U.S.C. 1801 et seq. and 3103 et seq., and 15
U.S.C. 78o-11.
0
7. Section 373.1 is added to read as follows:
Sec. 373.1 Purpose and scope.
(a) Authority--(1) In general. This part is issued by the Federal
Deposit Insurance Corporation (FDIC) under section 15G of the
Securities Exchange Act of 1934, as amended (Exchange Act) (15 U.S.C.
78o-11), as well as the Federal Deposit Insurance Act (12 U.S.C. 1801
et seq.) and the International Banking Act of 1978, as amended (12
U.S.C. 3101 et seq.).
(2) Nothing in this part shall be read to limit the authority of
the FDIC to take action under provisions of law other than 15 U.S.C.
78o-11, including to address unsafe or unsound practices or conditions,
or violations of law or regulation under section 8 of the Federal
Deposit Insurance Act (12 U.S.C. 1818).
(b) Purpose. (1) This part requires securitizers to retain an
economic interest in a portion of the credit risk for any asset that
the securitizer, through the issuance of an asset-backed security,
transfers, sells, or conveys to a third party in a transaction within
the scope of section 15G of the Exchange Act. This part specifies the
permissible types, forms, and amounts of credit risk retention, and it
establishes certain exemptions for securitizations collateralized by
assets that meet specified underwriting standards or that otherwise
qualify for an exemption.
(c) Scope. This part applies to any securitizer that is:
(1) A state nonmember bank (as defined in 12 U.S.C. 1813(e)(2));
(2) An insured federal or state branch of a foreign bank (as
defined in 12 CFR 347.202);
(3) A state savings association (as defined in 12 U.S.C.
1813(b)(3)); or
(4) Any subsidiary of an entity described in paragraphs (1), (2),
or (3) of this section.
Federal Housing Finance Agency
For the reasons stated in the SUPPLEMENTARY INFORMATION, and under
the authority of 12 U.S.C. 4526, the Federal Housing Finance Agency
proposes to add the text of the common rule as set forth at the end of
the Supplementary Information as part 1234 of subchapter B of chapter
XII of title 12 of the Code of Federal Regulations, modified as
follows:
Chapter XII--Federal Housing Finance Agency
Subchapter B--Entity Regulations
PART 1234--CREDIT RISK RETENTION
0
8. The authority citation for part 1234 is added to read as follows:
[[Page 58047]]
Authority: 12 U.S.C. 4511(b), 4526, 4617; 15 U.S.C. 78o-
11(b)(2).
0
9. Section 1234.1 is added to read as follows:
Sec. 1234.1 Purpose, scope and reservation of authority.
(a) Purpose. This part requires securitizers to retain an economic
interest in a portion of the credit risk for any residential mortgage
asset that the securitizer, through the issuance of an asset-backed
security, transfers, sells, or conveys to a third party in a
transaction within the scope of section 15G of the Exchange Act. This
part specifies the permissible types, forms, and amounts of credit risk
retention, and it establishes certain exemptions for securitizations
collateralized by assets that meet specified underwriting standards or
that otherwise qualify for an exemption.
(b) Scope. Effective [INSERT DATE ONE YEAR AFTER DATE OF
PUBLICATION IN THE Federal Register AS A FINAL RULE], this part will
apply to any securitizer that is an entity regulated by the Federal
Housing Finance Agency.
(c) Reservation of authority. Nothing in this part shall be read to
limit the authority of the Director of the Federal Housing Finance
Agency to take supervisory or enforcement action, including action to
address unsafe or unsound practices or conditions, or violations of
law.
0
10. Amend Sec. 1234.14 as follows:
0
a. Revise the heading to read as set forth below.
0
b. In the introductory paragraph, remove the words ``Sec. Sec. 1234.15
through 1234.18'' and add in their place the words ``Sec. Sec. 1234.15
and 1234.17''.
0
c. Remove the definitions of ``Automobile loan'', ``Commercial loan'',
``Debt-to-income (DTI) ratio'', ``Earnings before interest, taxes,
depreciation, and amortization (EBITDA)'', ``Lease financing'',
``Leverage Ratio'', ``Machinery and equipment (M&E) collateral'',
``Model year'', ``Payment-in-kind'', ``Purchase price'', ``Salvage
title'', ``Total debt'', ``Total liabilities ratio'', and ``Trade-in
allowance''.
0
d. Revise the definition of ``Debt service coverage (DSC) ratio'' to
read as follows:
Sec. 1234.14 Definitions applicable to qualifying commercial real
estate loans.
* * * * *
Debt service coverage (DSC) ratio means the ratio of:
(1) The annual NOI less the annual replacement reserve of the CRE
property at the time of origination of the CRE loans; to
(2) The sum of the borrower's annual payments for principal and
interest on any debt obligation.
* * * * *
0
11. Revise Sec. 1234.15 to read as follows:
Sec. 1234.15 Qualifying commercial real estate loans.
(a) General exception. Commercial real estate loans that are
securitized through a securitization transaction shall be subject to a
0 percent risk retention requirement under subpart B, provided that the
following conditions are met:
(1) The CRE assets meet the underwriting standards set forth in
Sec. 1234.16;
(2) The securitization transaction is collateralized solely by CRE
loans and by servicing assets;
(3) The securitization transaction does not permit reinvestment
periods; and
(4) The sponsor provides, or causes to be provided, to potential
investors a reasonable period of time prior to the sale of asset-backed
securities of the issuing entity, and, upon request, to the Commission,
and to the FHFA, in written form under the caption ``Credit Risk
Retention'':
(i) A description of the manner in which the sponsor determined the
aggregate risk retention requirement for the securitization transaction
after including qualifying CRE loans with 0 percent risk retention; and
(ii) Descriptions of the qualifying CRE loans and descriptions of
the CRE loans that are not qualifying CRE loans, and the material
differences between the group of qualifying CRE loans and CRE loans
that are not qualifying loans with respect to the composition of each
group's loan balances, loan terms, interest rates, borrower credit
information, and characteristics of any loan collateral.
(b) Risk retention requirement. For any securitization transaction
described in paragraph (a) of this section, the amount of risk
retention required under Sec. 1234.3(b)(1) is reduced by the same
amount as the ratio of the unpaid principal balance of the qualifying
CRE loans to the total unpaid principal balance of CRE loans that are
included in the pool of assets collateralizing the asset-backed
securities issued pursuant to the securitization transaction (the
qualifying asset ratio); provided that;
(1) The qualifying asset ratio is measured as of the cut-off date
or similar date for establishing the composition of the pool assets
collateralizing the asset-backed securities issued pursuant to the
securitization transaction; and
(2) The qualifying asset ratio does not exceed 50 percent.
(c) Exception for securitizations of qualifying CRE only.
Notwithstanding other provisions of this section, the risk retention
requirements of subpart B of this part shall not apply to
securitization transactions where the transaction is collateralized
solely by servicing assets and qualifying CRE loans.
Sec. Sec. 1234.16 and 1234.18 [Removed and Reserved]
0
12. Remove and reserve Sec. Sec. 1234.16 and 1234.18.
Securities and Exchange Commission
For the reasons stated in the Supplementary Information, the
Securities and Exchange Commission proposes the amendments under the
authority set forth in Sections 7, 10, 19(a), and 28 of the Securities
Act and Sections 3, 13, 15, 15G, 23 and 36 of the Exchange Act.
For the reasons set out above, title 17, chapter II of the Code of
Federal Regulations is proposed to be amended as follows:
PART 246--CREDIT RISK RETENTION
0
13. The authority citation for part 246 is added to read as follows:
Authority: 15 U.S.C. 77g, 77j, 77s, 77z-3, 78c, 78m, 78o, 78o-
11, 78w, 78mm
0
14. Part 246 is added as set forth at the end of the Common Preamble.
0
15. Section 246.1 is added to read as follows:
Sec. 246.1 Purpose, scope, and authority.
(a) Authority and purpose. This part (Regulation RR) is issued by
the Securities and Exchange Commission (``Commission'') jointly with
the Board of Governors of the Federal Reserve System, the Federal
Deposit Insurance Corporation, the Office of the Comptroller of the
Currency, and, in the case of the securitization of any residential
mortgage asset, together with the Secretary of Housing and Urban
Development and the Federal Housing Finance Agency, pursuant to Section
15G of the Securities Exchange Act of 1934 (15 U.S.C. 78o-11). The
Commission also is issuing this part pursuant to its authority under
Sections 7, 10, 19(a), and 28 of the Securities Act and Sections 3, 13,
15, 23, and 36 of the Exchange Act. This part requires securitizers to
retain an economic interest in a portion of the credit risk for any
asset that the securitizer, through the issuance of an asset-backed
security, transfers, sells, or conveys to a third party. This part
specifies the
[[Page 58048]]
permissible types, forms, and amounts of credit risk retention, and
establishes certain exemptions for securitizations collateralized by
assets that meet specified underwriting standards or otherwise qualify
for an exemption.
(b) The authority of the Commission under this part shall be in
addition to the authority of the Commission to otherwise enforce the
federal securities laws, including, without limitation, the antifraud
provisions of the securities laws.
Department of Housing and Urban Development
Authority and Issuance
For the reasons stated in the SUPPLEMENTARY INFORMATION, HUD
proposes to add the text of the common rule as set forth at the end of
the SUPPLEMENTARY INFORMATION to 24 CFR chapter II, subchapter B, as a
new part 267 to read as follows:
PART 267--CREDIT RISK RETENTION
0
16. The authority citation for part 267 is added to read as follows:
Authority: 15 U.S.C. 78-o-11; 42 U.S.C. 3535(d).
0
17. Section 267.1 is added to read as follows:
Sec. 267.1 Credit risk retention exceptions and exemptions for HUD
programs.
The credit risk retention regulations codified at 12 CFR part 43
(Office of the Comptroller of the Currency); 12 CFR part 244 (Federal
Reserve System); 12 CFR part 373 (Federal Deposit Insurance
Corporation); 17 CFR part 246 (Securities and Exchange Commission); and
12 CFR part 1234 (Federal Housing Finance Agency) include exceptions
and exemptions in subpart D of each of these codified regulations for
certain transactions involving programs and entities under the
jurisdiction of the Department of Housing and Urban Development.
Dated: August 28, 2013.
Thomas J. Curry,
Comptroller of the Currency.
By order of the Board of Governors of the Federal Reserve
System, August 27, 2013.
Robert deV. Frierson,
Secretary of the Board.
Dated at Washington, DC, this 28 of August 2013.
By order of the Board of Directors.
Federal Deposit Insurance Corporation.
Robert E. Feldman,
Executive Secretary.
Dated: August 28, 2013.
By the Securities and Exchange Commission.
Elizabeth M. Murphy
Secretary.
Dated: August 28, 2013.
Edward J. DeMarco,
Acting Director, Federal Housing Finance Agency.
Dated: August 26, 2013.
By the Department of Housing and Urban Development.
Shaun Donovan,
Secretary.
[FR Doc. 2013-21677 Filed 9-19-13; 8:45 am]
BILLING CODE 4810-33-P; 6210-01-P; 6741-01-P; 8010-01-P; 8070-01-P;