Regulators Soften Dodd-Frank ABS Risk Retention Rules | Practical Law

Regulators Soften Dodd-Frank ABS Risk Retention Rules | Practical Law

Federal regulators have re-proposed the rule on risk retention requirements for US securitization transactions under the Dodd-Frank Act.

Regulators Soften Dodd-Frank ABS Risk Retention Rules

Practical Law Legal Update 8-539-6445 (Approx. 3 pages)

Regulators Soften Dodd-Frank ABS Risk Retention Rules

by Practical Law Finance
Published on 28 Aug 2013 • USA (National/Federal)
Federal regulators have re-proposed the rule on risk retention requirements for US securitization transactions under the Dodd-Frank Act.
On August 28, 2013, federal regulators re-proposed Dodd-Frank risk retention rules, often referred to as "skin in the game," for US asset-backed securities (ABS). The rules are designed to align the interests of originators and securitizers of loans with the interests of ABS investors. However, the original proposal, released in 2011, was widely criticized as overly stringent, as market participants felt few transactions would qualify for exemption from retention, potentially threatening lending activity.
While many basic elements of the proposal remain from the original (including the requirement that securitizers retain 5% of the credit risk of a non-qualifying ABS transaction), the re-proposed rule eliminates the 20% down-payment requirement for a residential mortgage loan to qualify for inclusion in an exempt residential mortgage-backed securities (RMBS) transaction under the original proposal. The re-proposal is widely viewed as another victory for the banking industry in softening Dodd-Frank rules, though impediments remain for certain transaction types such as collateralized loan obligations (CLOs).
Under the re-proposed risk retention rules, as under the original proposal:
  • A 5% risk retention requirement is imposed on any sponsor of an ABS securitization transaction, regardless of the sponsor's entity type.
  • The following would be exempt from the risk retention requirements:
    • qualified residential mortgages (QRMs);
    • QRM equivalents for securitizations of high quality commercial loans, commercial mortgages and low credit risk automobile loans; and
    • loans guaranteed by Fannie Mae and Freddie Mac, so long as the companies operate under US conservatorship.
Under the re-proposed risk retention rules, unlike under the original proposal:
  • A "combined standard risk retention option" replaces the "horizontal," "vertical" and "L-shaped" retention options from the original proposal, providing ABS sponsors with greater flexibility. The re-proposed rules would permit a sponsor to satisfy its risk retention obligations by retaining an “eligible vertical interest,” an “eligible horizontal residual interest,” or any combination thereof, as long as the total amount is equal to no less than 5% of the fair value of all ABS interests in the issuing entity that are issued as part of the securitization transaction.
  • The measure of compliance with the risk retention requirement would be based on fair value measurements (the original proposal used the undefined term "par value" for these measurements under certain circumstances) without a so-called premium capture provision (for a discussion of premium capture, see Practice Note, ABS Risk Retention under Dodd-Frank: CMBS Issues). The originally proposed risk retention rule included this provision and also based the compliance measure on the par value of securities issued in a transaction.
  • The 20% down payment requirement for a QRM to be included in an exempt RMBS transaction has been eliminated, as have LTV ratio requirements and standards related to a borrower's credit history.
  • According to preliminary analysis conducted by Thomson Reuters Accelus Compliance Complete, the new definition requires banks to retain risk if a borrower uses over 43% of its monthly income on repayment, loosening the original proposal which had a restriction of 36%. The definition has also been broadened to potentially include loans secured on any type of dwelling, not solely a principal dwelling.
The re-proposed rule defines QRM to have the same meaning as the term "Qualified Mortgage," which the Consumer Financial Protection Bureau (CFPB) defined in a regulation it issued in January 2013 (see Practice Note, The Ability-to-Repay and Qualified Mortgage Rule).
Regulators are accepting comments on the re-proposed retention rules until October 30, 2013. Practical Law Finance will provide greater detail on the rules shortly.
For a detailed explanation of the revised risk retention proposal, see Practice Note, ABS Risk Retention under Dodd-Frank.