The Securities and Exchange Commission (SEC) would violate the Tower Amendment and the principles of federalism if it applies its proposed rules on ABS to municipal bonds, 14 market groups warned this week.
The groups, which represent municipal issuers, broker-dealers and financial advisers, issued the warning in a five-page comment letter they sent to the SEC Monday urging it to exclude munis from the two sets of ABS rules proposed on Oct. 4 and Oct. 13.
The SEC’s proposed rules would implement provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act that are designed to increase ABS transparency to ensure there is no replay of the events leading to the subprime loan-triggered fiscal crisis, when loan originators had no incentives to make sure the loans performed well and walked away from them when they did not.
The proposed rules generally would require issuers to provide investors with detailed information about the loans underlying ABS and would define ABS so broadly that they would encompass student loan and housing bonds as well as pooled financings, leases and installment sales in the muni market.
In its requests for comments, the SEC asked how, not whether, the proposed rules should be applied to munis.
But the 14 groups warned the commission that including munis within the definition of ABS would “clearly violate both the tenets of federalism and the Tower Amendment, which expressly prohibits the SEC from requiring municipal securities issuers to file with the SEC or [Municipal Securities Rulemaking Board] documents prior to the sale of securities.”
The Tower Amendment was added in 1975 to the Securities Exchange Act of 1934. But the groups claim the proposed ABS rules “attempt to partially repeal” it by requiring muni issuers to file documents through the SEC’s EDGAR system prior to going to market.
“We believe that Congress did not intend, without hearings or testimony ... to overturn the Tower Amendment and allow the SEC to have such authority over state and local government issuers of municipal securities,” the groups said. “Such an effort would be an unprecedented breach of the basic principles of federalism.”
Muni issuers already disclose information about their bonds via the MSRB’s online EMMA system, they pointed out.
“We are aware of no evidence to support, and there has been no determination by Congress or the SEC, that municipal disclosure is currently deficient as to the limited incidence of noncomplying pooled municipal securities assets,” the groups said.
In fact, including munis in the definition of ABS would be “inconsistent and in direct conflict” with another section of the Dodd-Frank law that calls for the Government Accountability Office to study municipal securities disclosure, the letter claims.
“Any SEC action on municipal securities should be delayed until after the GAO study is completed and congressional action, if any, is taken under the appropriate subtitle of the law,” the groups wrote.
Munis are very different financial products from ABS, they contended. The majority of munis are not solely or partially dependent on a pool of financial assets. And those that are, such as housing and student loan bonds, are distinguishable from ABS in that the issuers typically exercise active managerial control over their portfolios in order to meet the public-purpose goals of their programs. In addition, the programs are based on federal and state requirements.
Other issuers that sell pooled securities include municipal bond banks as well as state revolving funds for water and sewer facilities that have been set up under U.S. Environmental Protection Agency programs.
“None of the requirements of the proposed rules may be meaningfully or usefully applied to the securities of such issuers,” the groups said. “The overly broad and open-ended definition of ABS ... would appear to require a wide range of municipal securities to be inappropriately treated as ABS and thereby subjected to a number of new — and unnecessary — regulatory restrictions and burdens.”
Congress directed the SEC to provide munis a “total or partial exemption” from the proposed rules in the Dodd-Frank law conference report and explanatory statement, the groups said, adding: “Unfortunately the SEC’s proposed regulations do not recognize this important matter of congressional intent.”
The National Council of State Housing Agencies, which was one of the 14 groups, also sent separate comment letters to the SEC warning that the proposed rules “would impose on [housing finance agencies] an undue administrative burden that could increase the cost of issuance of HFA securities and reduce the benefits such securities provide homeowners and renters in bond-financed affordable housing.”
HFA bonds are different from ABS because they are secured by a pledge of the mortgage loans and various sources of cash derived from the bond sale, Barbara Thompson, the group’s executive director, told the SEC. Unlike most corporate bond financings, the assets that ultimately will end up as security in the typical HFA bond financing are not pre-identified or pre-purchased loans. Rather, the proceeds from the sale of agency bonds are deposited into trust accounts from which the HFA can requisition funds to purchase preexisting loans from originating lenders. The loans must meet federal tax law requirements and strict credit criteria established by each HFA.
In addition, “pools of assets securitized by HFAs have never been the target of investor complaints with regard to breaches of representations and warranties,” Thompson said. “In fact, to date no state housing finance agency has defaulted on bonds issued to finance any HFA-sponsored program.”
The National Association of Local Housing Finance Agencies, a nonprofit representing local agencies that finance affordable housing, also urged the SEC to exempt municipals from the proposed rules in the group’s letter as well as its own, separate letter.
Single-family housing bonds provide mortgage assistance to first-time homebuyers, while multifamily housing bonds provide below-market financing for the acquisition, construction and preservation of rental housing for lower-income households, John Murphy, the group’s executive director, told the SEC.
“These bonds derive their public purpose as a result of the requirements and restrictions of the Internal Revenue Code and serve to expand affordable housing opportunities for the nation’s low and moderate income renters and homebuyers. As such, they stand in sharp contrast to corporate bonds,” Murphy said.
The Education Finance Council (EFC), which represents nonprofit and state-based student lenders and was among the 14 groups, told the SEC in a separate letter that while its members include state agencies that finance student loans that are securitized, these are very different securities from ABS because the financing structures do not employ special-purpose vehicles.
“Moreover, the bonds issued by some municipal student-loan issuers carry a statutory pledge further reducing the possibility of default,” wrote Vince Sampson, the EFC’s president.
In addition, student loans made and guaranteed under the Federal Family Education Loan Program “are governed by a strict regimen set out by the Higher Education Act of 1965 and regulations promulgated by the U.S. Department of Education” that provide investors with a clear understanding of the underlying loans, he said.
Richard Lenna, executive director of both the Maine Municipal Bond Bank and the Maine Health and Higher Education Facilities Authority, told the SEC that its proposed rules would impose considerable costs on the bank and authority without providing any new benefits to investors.
He said both the bank and authority, which were created in 1972, have a total of 387 loans outstanding to local governments and provide information to the general public and investors through Freedom of Information Acts and notices required to be filed by the federal Tax Equity and Fiscal Responsibility Act.
In its comment letter, New York City officials urged the SEC to exempt its municipally sponsored tax-lien securitization program from the proposed rules, warning that including it could have “significant unintended and costly consequences.”
State laws permit the city to sell liens on unpaid property taxes, assessments and sewer and water charges through its tax lien securitization. Under the program, the city sells tax liens to Delaware-based business trusts that it creates and the trusts sell taxable bonds backed by the securitized tax liens.
The bonds are taxable and are privately placed. Since 1996, the city has sold 16 pools of tax liens to these special purpose entities, Mark Page, the city’s director of management and budget, wrote to the SEC.
“Because tax liens arise by operation of law, do not involve the extension of credit to a borrower, and do not entail any underwriting decision on the part of a municipality, municipal issuers of tax-lien backed securities should not be subject to rules meant to improve the quality of underwriting practices,” Page said in the letter. “Tax-lien securitizations play a significant rule in New York City’s exercise of an essential government function, and the city hopes to be able to continue to do so in as efficient and cost-effective manner as possible.”