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FDIC Asset Plan Danger to Markets, Bankers Say

A Federal Deposit Insurance Corp. (FDIC) plan to restrict securitizations is drawing intense opposition from bankers, who claim it would damage the secondary market.

In a December proposal, the agency said it was considering imposing conditions to protect securitized assets from FDIC seizure after a bank failure, including a "skin in the game" requirement, a minimum hold period for underlying loans and limits on the number of tranches.

But banks — including Bank of America Corp., Capital One Financial Corp., JPMorgan Chase and Wells Fargo  — oppose the FDIC plan, arguing those conditions would harm the securitization market, which in turn would curb risk management and narrow credit availability.

"It is foreseeable that if the" proposals "were adopted without adjustment it could discourage appropriate risk transfer transactions and reduce credit availability," Greg Baer, deputy general counsel at BofA, wrote in a Feb. 22 comment letter to the agency. "The alternative to securitization is a banking market funded, to a larger degree, by deposits and wholesale funding — an outcome that may not be practical or feasible."

Trade groups, law firms and rating agencies have also expressed concerns, while consumer groups for the most part lauded the plan. "Imposing these changes risks an adverse impact that most significantly could be the elimination of securitization in some sectors," Tom Deutsch, the executive director of the American Securitization Forum, wrote in a Feb. 22 comment letter to the agency.

The FDIC received 34 comment letters, many from banks and their trade groups, which largely said the proposed reforms could scare off investors and give nonbanks a competitive advantage.
Some said that banks would not have enough time to adopt the plan if it were enacted and said any effort to restrict securitization should be coordinated with Congress and other federal regulatory agencies.

The proposal was sparked by new accounting requirements that force banks to report securitized assets on their balance sheets. The FDIC has long had a hands-off policy for securitized assets, but the accounting change essentially forced the agency's hand.

So in November, the FDIC said it would continue its existing policy through March, but warned that longer-term conditions for receiving the safe harbor would be needed.

The FDIC initially planned to propose enhanced disclosures, compensation limits and a requirement that originators retain a 5% piece of securitized assets. For mortgage assets, only loans kept on the books for a year could be securitized, and securitizations would be restricted to six tranches.

But amid objections from two FDIC board members — Comptroller of the Currency John Dugan and acting Office of Thrift Supervision Director John Bowman — the agency pulled back from proposing such specifics, and in December issued a less direct "advance notice of proposed rulemaking" that merely asked for comments on the possible restrictions and included the earlier proposal as sample text.

That pullback did not allay the industry's concerns.

Several commenters said the safe harbor was intended to reassure investors that they would be paid despite the condition of the originating bank, but the proposal would leave them wary about participating in the securitization market.

"By their very nature, the conditions contained in the ANPR are inconsistent with providing an effective safe harbor," Wells Fargo deputy general counsel David Moskowitz wrote in a Feb. 22 letter.

Bankers questioned the use of the FDIC safe harbor as a means for curbing the securitization market, which the FDIC has said contributed to the financial crisis. Regulatory reform legislation being debated in Congress is a better venue for addressing those changes, they said.

"Preconditions addressing capital structure, disclosures, documentations and record keeping, compensation, origination and retention requirements should not be tied to the determination of whether financial assets will be treated as having been legally isolated from the" insured bank, wrote Adam Gilbert, a managing director for corporate risk management with the JPMorgan Chase. "Delinking securitization reform from the legal isolation safe harbor would allow greater clarity in the construction of the safe harbor."

Stephen Linehan, Capital One's treasurer, agreed a broader approach is needed.

"While we recognize the importance of many of these proposed requirements in the wake of the financial crisis, such as the need for better underwriting and greater transparency, we believe they are more effectively developed and implemented as part of an interagency effort," Linehan wrote in a Feb. 22 letter.

Critics also said that since the rules would apply just to FDIC-insured institutions, the restrictions may shift securitization activity to nonbanks.

"Bank sponsors will be at a competitive disadvantage with domestic nonbank and foreign" institutions "that would not have to comply with new restrictions on the manner in which they structure securitization transactions," wrote Cristeena Naser, an associate general counsel with the American Bankers Association-affiliated ABA Securities Association. "Each of the specific requirements set forth in the sample regulatory text come with costs in terms of dollars and personnel. As these costs mount for bank sponsors, banks are likely to pass the increased costs on to their customers or diminish their securitization activities or exit the business altogether."

Echoing concerns that Dugan and Bowman aired at the FDIC's Dec. 15 meeting, several bankers urged the participation of other agencies in a more comprehensive effort to reform the securitization process.

"The unilateral approach taken by the FDIC … could further supervisory disparity and regulatory burden among various sectors of the financial services industry," wrote John Courson, the Mortgage Bankers Association's chief executive. "We also note that federal legislation addressing many of the sweeping policy changes addressed in the ANPR is progressing through Congress. In order to avoid conflicting simultaneous regulatory and legislative mandates, we further request that any action by the FDIC other than withdrawing the ANPR should be deferred until these issues are settled at the statutory level."

In responses to the agency's 35 questions for comment, respondents took issue with the specific proposals. Bankers said rigorous underwriting requirements for loans backing the securitizations would be a better solution than requiring issuers to retain 5%.

"Mandatory originator retention of a share of the credit risk is based on the assumption that to avoid losing the amount retained, the originator will maintain good underwriting practices," wrote Rich Whiting, the executive director of the Financial Services Roundtable, and John Dalton, the president of the Roundtable's Housing Policy Council. "If that is the case, why not bypass the secondary source (i.e., risk retention) and go directly to the primary source — good underwriting practices."

Meanwhile, the one-year-hold requirement for originators may hinder loans from being made, Baer said.

"This rule would arbitrarily restrict liquidity for mortgage assets … and may prevent extensions of credit to borrowers during the holding period," he said.

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