News on Securitization: US Federal Agencies Propose “Revised” Risk Retention Requirements

October 7, 2013:

Right after the financial crisis the regulators had geared up to tighten the regulatory noose for securitisation transaction. The retention of skin in the game was considered to be critical for sustenance of securitisation transaction. In this pretext, in the U.S., the risk retention requirements were coined in 2010 and were deliberated upon. The proposed rules (“Original Rules”) formed a part of the Dodd-Frank Wall Street Reform and Consumer Protection Act.

In the Original Rules, it was proposed that the excess proceeds from the sale of commercial mortgage through securitisation should remain in a “premium capture cash reserve account” and shall remain subordinated to other bonds to be captured over a period of time. Thereafter several countries took cue from the proposal and either adopted the risk retention requirements or made a proposal for a regulatory amendment.

Several of the industry players had expressed concerns on the Original Rules stating that the rules will lead to increase in cost for sponsors significantly discouraging new securitisation transactions. Considering the industry players concerns, very recently, in August, 2013 the six federal agencies — Board of Governors of the Federal Reserve System, the Department of Housing and Urban Development, the Federal Deposit Insurance Corporation, the Federal Housing Finance Agency, the Office of the Comptroller of the Currency, and the Securities Exchange Commission in the U.S. proposed an amendment to the risk retention requirements and have relaxed the rules governing risk retention in certain ways.

Comparative Analysis of the Original Rules and Revised Proposal:

Original Proposal	Revised proposal
Issuer to retain a 5% piece at par value and could be a vertical or horizontal piece or L-shaped piece in 50-50 proportion	The residuary interest is to be calculated on fair value instead of par value and the residuary interest can be held in any combination of vertical and horizontal piece. The fair value calculation would be determined as of the day on which the price of the ABS interests to be sold to third parties is determined [1]
The retained piece to be held for the life of the transaction	The parties will be able to trade in the retained piece after 5 years [2]
For a residential mortgage loan to be treated as a QRM, it would have to have a maximum 80% loan-to-value (“LTV”) ratio, a minimum 20% down payment, front-end and back-end debt-to-income(“DTI”) ratios of 28% and 36% or less respectively, and meet certain credit history requirements.	The proposed rule links the definition of QRMs to the definition of a “qualified mortgage” as defined by the Consumer Financial Protection Bureau. The QM rule does not include underwriting based on credit history, loan-to-value (LTV), or down payment. It does, however, include an analysis of the borrower’s ability to repay, with a maximum DTI of 43 percent. Loan terms could not exceed 30 years. The QM definition also prohibits interest-only loans, balloon payments, and negatively amortizing loans. The new proposal also requests comment on an alternative definition of QRM that would include certain underwriting standards in addition to the qualified mortgage criteria. [3]
ABSs to be excluded from the proposed rule’s credit risk retention requirements include (1) commercial loans, (2) commercial mortgages, and (3) low credit risk auto loans,	Same as original proposal
Unsecured REIT loans not be classified as commercial real estate loans	Same as original proposal
Full guarantee on payments of principal and interest provided by Fannie Mae and Freddie Mac for their residential mortgage-backed securities as meeting the risk retention requirements while Fannie Mae and Freddie Mac are in conservatorship or receivership and have capital support from the U.S. government.	Same as original proposal
Only CLO manager to retain risk	Lead arranger in the underlying loan also permitted to retain risk. [4]

Several of the industry players had expressed concerns on the proposed rules stating that the rules will lead to increase in cost for sponsors significantly discouraging new securitisation transactions. Considering the industry players concerns, very recently, in August, 2013 the Federal regulators in the U.S. proposed an amendment to the risk retention requirements and have relaxed the rules governing risk retention.

The revised rules are open for comments till 30th October, 2013.

Notes :

Reported by: Shambo Dey

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