On 11th May, 2010, the Federal Deposit Insurance Corporation (FDIC) issued a notice of proposed rule making (NPR) with a 45 day comment period, seeking to introduce several preconditions for securitization transactions to avail of the safe harbor in the hands of FDIC as liquidator/conservator of FDIC-insured banks. The context of the safe harbor is that pursuant to FAS 167, many securitization transactions would lose their off-balance sheet status, and hence, the truth-of-sale inherent therein may be question. The same is the case with covered bonds – which are on-the-balance-sheet. In such cases, though the assets remain on the balance sheet, FDIC as conservator would, subject to satisfaction of the safe-harbor requirement, agree to allow the payments to bondholders to remain unaffected by the bankruptcy or similar proceedings against the originating bank. That is to say, the true-sale will not be questioned. It does not imply that for transactions not satisfying the safe harbor conditions, the true sale will not be admitted, but of course, such transactions will not have the immunity of the safe harbor.
The safe harbor rules lay down many stringent requirements for RMBS, which is where the subprime debacle supposedly started from.
Note that synthetic transactions do not need to benefit from the safe harbor rules, as there is no sale or true sale at all in such transactions.
Some of the safe harbor rules are:
- RMBS transactions cannot have more than 6 tranches, excluding sequential time tranches alone. In the past, transactions have had almost 20 tranches, differentially transferring interest rate risk, prepayment risk, PO and IO tranches, and so on. It is difficult to understand why should regulators put a limit to the complexity that the market may digest – complexity is always in the eyes of the beholder. Ideally, the marketplace should have decided whether simple is beautiful, or complex is exciting. This is clearly a reactive regulation.
- RMBS transactions cannot get pool level external credit support.
- Disclosure requirements are largely at par with the Reg AB amendments proposed by SEC
- Payments to rating agencies should not be more than 60% at closing, the balance being spread over a period of 5 years. Servicer payments should include incentives for performance, particulars on resolution of bad loans.
Originator risk retention: this has become a pet theme of regulators across the world (See Vinod Kothari’s article here). Accordingly, the FDIC proposes as follows:
- Minimum 5% originator risk retention. The regulation permits either a 5% vertical tranche, or retention of seller’s interest in at least 5% of the loans being securitized. The approach is consistent with that of EU regulators.
- RMBS transactions need to maintain a reserve fund of at least 5%, for 12 months after securitization, to provide for any repurchase of assets that do not qualify the representations and warranties on sale. This requirement does not have a match with international regulations.
- The underlying loans in all RMBS must comply with underwriting standards.
[Reported by: Vinod Kothari]