In an initiative led by the Federal Deposit Insurance Corp., the bank regulators of the Federal Financial Institutions Examination Council (FFIEC) recently distributed new guidelines warning that securitization structures featuring covenants associated with supervisory actions will be considered unsafe and unsound (see ASR 5/27 Whispers).

The implications of safety and soundness considerations are enormous for banking entities, an attorney said. In the extreme case, a bank could lose its FDIC membership, if its practices are considered unsound.

While different parties have varying opinions as to the actual impact of this new guidance on the market, several were disturbed that the regulators did not solicit industry commentary before setting this in stone.

Officials at the FDIC, however, did not feel the need to distribute a proposal for commentary, because the ruling is guidance and not actual regulation. "We wanted to get word out promptly to the industry about the safety and soundness implications of early amortization triggers that are tied to supervisory actions," said Keith Ligon, a manager at the FDIC.

As of last week, the Bond Market Association was distributing discussion material to its members and to the members of the America Securitization Forum, but was not ready to formally state its position, said George Miller, general counsel to the BMA.

"I do think it's worth noting, however, that the agencies of the FFIEC have become quite active in issuing securitization guidance," Miller added.

These new guidelines state that banks with existing transactions containing these covenants should modify or remove them or else document the impediments and notify the bank's primary supervisor. In this sense, there is no grandfathering.

Zeroing in on language

As reported, the FDIC is targeting covenants - such as a bank being taken into FDIC receivership - that act as triggers for early amortization or a transfer of servicing, both of which are fundamental protective features of securitization. The regulators argue that an early amortization, and/or transfer of servicing, can starve off liquidity and further damage an already impaired bank, given that supervisory action was deemed necessary in the first place.

Also, the regulators are concerned with language in these covenants meant to appear not directly related to supervisory actions or thresholds. For example, to avoid having a trigger tied to a regulatory determination that a bank is "undercapitalized," a covenant might state a trigger is hit if a banking entity's capital level falls below a certain preset threshold, which might essentially be the same event.

The regulators are arguing that, in a true-sale, off-balance securitization, early amortization triggers should be associated only with the condition of the assets and not the condition of the seller.

"I don't think that it is inconsistent with the way regulators have been viewing securitization," said David Katz of the Washington office of Orrick Herrington & Sutcliffe. "Their view is basically that there should be greater distance between the bank seller and the securitization entity."

The issue is likely associated with the NextBank seizure, when the FDIC exercised its prerogative to stop the NextCard securitizations from early amortizing.

At least one source from a rating agency does not see a material impact on bank credit card ABS from these new guidelines. "I don't see anything new," the analyst said. "[The FDIC] will void the amortization if they feel it's necessary. They feel they have the ability to do so, and they have exhibited that they have the ability."

Early amortizations triggers in most securitizations (and certainly those required by the rating agencies) are associated with performance triggers, apparently outside the scope of this guidance.

According to the ratings analyst, most of the deals that have these covenants are conduit financings and a small handful of recent term deals. The FDIC concurs: "Our information is that these are recent developments and that the use is relatively infrequent," Ligon said.

Further, rating agencies are not the parties that are structuring these enforcement-action driven covenants, as ratings triggers are generally reliant upon collateral performance. "I don't see how this would impact credit enhancement levels," the analyst said.

Other asset classes included in the guidelines are revolving CLOs and home-equity lines of credit (HELOC).

As for trend impacts, in the short term at least, "People will try to use language more along the lines of events having a material impact on the bank, without using regulatory actions or thresholds as the events," said Orrick's Katz.

"I think that in the short run, bond insurers and investors are going to take some time getting used to it," he added.

Other possible developments include a greater use of "hot" backup servicers in these deals as a way to get investors, sureties, and possibly rating agencies more comfortable.

MBIA/Spiegel update

It happens that many of the said triggers are put in place as part of the issuer's contract with the insurance providers, generally the monoline sureties.

Slightly off topic, MBIA and Spiegel have entered into a letter agreement, which has resulted in the withdrawal of MBIA's payout event letter and the discontinuation of litigation against MBIA. Further, under the terms of the letter agreement, the insured transactions have been strengthened, said an MBIA spokesman.

It should be noted that the alleged trigger hit by Spiegel's deals was not associated with regulatory enforcement orders or the financial condition of the seller or Spiegel's banking subsidiary First Consumers National Bank, but instead related to the performance of the collateral, according to court documents.

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