Last Monday, the Federal Deposit Insurance Corp.'s (FDIC) board of directors approved the final rule to replace its Safe Harbor transition rule on securitization. The finalized version extends until Dec 31 the transitional Safe Harbor - allowing the ABS market three months to adjust to the final rule's requirements.
Although generally shedding light on the issue of qualifying for the securitization Safe Harbor, there are still questions that ABS market participants have that remain unanswered. Most specifically, according to Barclays Capital analysts, there is still not enough clarity on the Safe Harbor's scope.
The agency's final rule offers four instances when it will grant Safe Harbor, which are the same as those in the Notice of Proposed Rulemaking (NPR). These are: the participations that qualify for sale accounting treatment; the participations or securitizations grandfathered under the transition rule; the securitizations that meet the final rule's requirements and FAS 166/167 sale accounting requirements; and the securitizations that meet the final rules requirements and do not meet FAS 166/167 sale accounting requirements.
Barclays analysts noted that the Safe Harbor language in the last three items mentioned above, particularly as they refer to ABS issued out of revolving or master trusts, has been changed from the NPR. For instance, according to the Staff Memorandum to the FDIC board, the transition rule Safe Harbor, or the second item mentioned above, currently applies to the obligations of revolving trusts or master trusts "for which one or more obligations were issued on or before the date of adoption of the rule." This is granting that the trust complied with the requirements for sale accounting that were effective before the implementation of FAS 166/167. The Safe Harbor also contemplated - under the third and fourth items mentioned above - securitizations from a master trust or revolving trust that were established after the adoption of the rule.
"There were a lot of questions around the grandfathering provision for master trusts since the final rule was more generous than some market participants expected," said Julie Gillespie, a partner at Mayer Brown. "We read the final rule as grandfathering an existing master trust, and any future deals issued from that trust." This is referring to existing master trusts that had issued one or more obligations as of Sept. 27, when the final rule was adopted.
She said the FDIC in its final rule addressed the concerns that the securitization market had in terms of implementing the risk retention provision in advance of the joint interagency regulation mandated by the Dodd-Frank Act. "Once the risk retention regulations required by the Dodd-Frank Act become effective, then those regulations will govern the risk retention requirement under the Safe Harbor," she said. "This addressed one of the concerns that the market had with respect to the proposed rule."
Although Kenneth Kohler, a partner at Morrison & Foerster, said that the final rule was rather "anti-climactic, the FDIC proposed one thing that is different and is a clever step to counter some of the criticism against it by putting in place what they call "auto-conform" language, which means that the agency's rule will ultimately adopt what the Dodd-Frank Act's mandated regulations ultimately require in the risk retention and Reg AB areas," he said.
The market has to trust, Kohler said, that the new rules on risk retention would have to be released together by all the agencies. "The implementation would not be automatic without going through administrative requirements and the required comment period," Kohler said.
Despite the clarifications that have been provided by the FDIC thus far, there are still certain grey areas that need to be sorted out. For instance, how the interagency rules will apply to specific FDIC requirements. "It is a legitimate concern how the auto conform provision is implemented in terms of risk retention since it's not really clear in advance what in the FDIC's rule will be supplanted by the new interagency rules," he said. "For instance, in terms of the qualified mortgages definition under the Dodd-Frank Act, would it mean that what is exempt under the Act will be exempt under the FDIC rule as well? "
Additionally, some of the provisions that many in the ABS market found troublesome in the NPR are still in the final rule.
"There are a number of aspects that the market had hoped would be ameliorated, but were retained," Kohler said. Examples of which, from the issuer's standpoint, are: the requirement to hedge the retained interest during the life of the transaction; the establishment of a one-year reserve fund of at least 5% of the cash proceeds on residential MBS deals to cover repurchase demands for breaches of representations and warranties; and the lack of structuring flexibility where RMBS transactions are limited to six tranches, as well the prohibition on external credit enhancement.
Gillespie said that one thing that has yet to be seen is whether the rating agencies as the final arbiters are able to get comfortable with provisions in the final rule.
Despite these potential setbacks, the three months given by the FDIC for the market to adjust to the final rule might not be a big hurdle. "It's another three months more than participants were expecting and, in a sense, is not that critical since there aren't too many deals being done," Kohler said. "Complying with the [Securities and Exchange Commission's] Reg AB proposal would require more time because of the need to implement systems whereas the FDIC's regulations are limited to legal and structural aspects of the deals."