In a letter submitted to the Federal Deposit Insurance Corp. (FDIC) today, the American Securitization Forum (ASF) laid out significant concerns regarding the government agency’s proposed new rules on safe harbor for securitizations.
The ASF thinks that the proposals, including new preconditions for safe harbor, will create considerable uncertainty for investors, thus harming the drive to reopen securitization markets and get credit flowing again to Main Street.
“Under the FDIC’s proposals, investors will bear the burden of the loss of the safe harbor if any of the securitization preconditions are not satisfied by the sponsor.” said Ralph Daloisio, managing director at Natixis and chairman of the ASF board of directors. “As an investor, it is imperative that I be able to determine whether the safe harbor will apply so that risks can be appropriately assessed and a transaction can be efficiently priced.”
The safe harbor was originally created so investors could look to securitized assets for payment without worrying that the assets would be interfered with by the FDIC in the event of a bank failure. The FDIC proposes to revise the rule to include numerous preconditions, such as requirements relating to a deal’s capital structure, disclosure, documentation, origination and compensation. For this reason, the ASF is proposing that the safe harbor's applicability not be based on the numerous requirements included in the FDIC’s Advance Notice of Proposed Rulemaking and instead limit any requirements to clear, bright-line conditions that allow investors to rely upon the safe harbor without fearing that its benefits could disappear.
The proposed safe harbor would not only affect investors, the ASF pointed out. The trade group said that the proposals could fundamentally change the economics of securitization for sponsors as well as might lead to the securitization's removal in some sectors. The proposals could prevent U.S.-insured depository institutions from re-engaging in securitization and force them to depend solely on deposits or other sources of funding, and therefore seriously harming the availability of credit for consumers and small businesses.
“We appreciate the FDIC’s ongoing support for sustainable securitization but we are concerned that their proposals would greatly inhibit the restart of these critical markets,” said Tom Deutsch, executive director of the ASF.
The association is also concerned about the potential impact of multiple layers of securitization regulation without legislators and regulators coordinating among themselves.
“The ASF is a strong advocate for targeted reforms in the securitization market, but we believe that reforms should only arise out of an interagency process to ensure a level playing field for market participants,” Deutsch said. “Securitization market reforms can have broad implications, so it is best to collectively seek solutions to ensure that unintended negative effects do not occur.”
The ASF has taken this collective approach with ASF Project RESTART under which the ASF develop loan-level disclosure and reporting templates, a unique identification number for tracking assets called the ASF LINC™, and model representations and warranties. The ASF will also be developing model repurchase provisions, model servicing provisions and due diligence standards throughout 2010.
Mortgage Bankers Association (MBA)
Meanwhile, the MBA also released their own comment. The MBA said that it appreciates the FDIC’s aim to increase investor confidence in a manner that balances its safety and soundness considerations with the market’s need for liquidity.
Like the FDIC, the MBA also believes securitization is a useful funding channel for financial institutions. However, MBA is concerned that some key features of the FDIC's advance notice of proposed rulemaking (ANPR), if enacted, would impose added deal costs, generate regulatory uncertainty as well as lead to other negative consequences that could pose considerable financial and operational obstacles to any securitization framework.
TheMBA thus requested the FDIC to withdraw the ANPR and collaborate with other federal regulatory agencies to evaluate the adequacy of existing supervisory requirements governing the securitization markets.
The ANPR, according to the MBA, could hinder the market’s and private label ABS' recovery, adding that a full recovery of the real estate finance system will be based on the return of private investors to the capital markets.
The private label MBS market is critical to affordable housing and to the finance of commercial properties used to further commerce and economic growth. For example, many households cannot qualify for single family conventional loans eligible for delivery into securities issued by Fannie Mae or Freddie Mac or for Federal Housing Administration (FHA) or Veterans Administration (VA) loans eligible for MBS guaranteed by Ginnie Mae.
In the past, these borrowers were served by financial institutions with expertise in securitizing their loans into private label MBS. Likewise, many multifamily housing projects cannot be financed through the Fannie Mae, Freddie Mac, or Ginnie Mae multifamily programs. Enactment of the ANPR would serve to reduce rental housing alternatives available to households that do not qualify for single family mortgages. Additionally, much of the financing for warehouses, office buildings, hospitals, and other commercial properties have traditionally been financed using private label commercial MBS.
The MBA is also concerned that the ANPR threatens any semblance of certainty that was beginning to emerge in this important market and is critical for investors, lenders and other financial market participants to be able to minimize costs and make sound investment decisions. As a result, financial institutions will be forced to add an uncertainty cost to their asset-backed transactions to offset the possibility their transactions may fall outside the boundaries of the FDIC’s receivership safe harbor. The specter of a delay in receiving cash flows from an FDIC receiver or conservator also will undoubtedly cause rating agency ratings to be heavily influenced by the financial strength of the servicer or master servicer of loans that underlie the private label MBS.
The ANPR’s "seasoning” requirement raises risks and reduces credit availability, the MBA said.
Under the ANPR, safe harbor status would apply only to securities comprising loans that were previously held on a depository institution’s balance sheet for a minimum of 12 months before securitization.
According to the FDIC, the ANPR’s 12-month holding period is intended to allocate credit risk to the originator thereby bolstering prudent underwriting practices. Unfortunately, this requirement also assigns other unforeseeable and unpredictable risks to the originator completely unrelated to underwriting practices.
For instance, the financial institution would be subject to the impact of borrower life events, natural disasters, and third party malfeasance. MBA also noted that this requirement deviates from existing market standards and expectations. For instance, most investors prefer pools of newly originated mortgages to seasoned mortgage pools, so long as the issuer agrees to repurchase loans from the MBS loan pool that default within the first three months.
In fact, seasoned loan securitizations generally are afforded a discount by the market. Moreover, presently, there is a sophisticated, robust and cost-efficient hedge market to protect against asset price declines until a loan is securitized during a holding period of 30 days or less. No cost effective hedges exist for 12-month holding periods. MBA also is concerned about the 12-month seasoning requirement’s impact on consumers.
The mortgage trade group's preliminary estimates suggested that the 12-month holding period would result in a 90% reduction in the amount of loans a depository institution can originate for sale, thus in less credit availability for consumers.
Securities Industry and Financial Markets Association (SIFMA)
In a comment letter filed today with the FDIC, the SIFMA's securitization group (SSG) expressed its support for the "coordinated, comprehensive and measured regulation to improve the safety and soundness of the securitization market and for an insolvency safe harbor to provide certainty to market participants and investors."
But, the association stressed the need for regulation to be coordinated within the broader context of regulatory reform, and to base criteria for a safe harbor on the legal principles of isolation of assets in insolvency.
“We support reasonable efforts to restore and reshape the securitization market, but we do not believe the proposed safe harbor is an appropriate means of regulation,” said Chris Killian, vice president at SIFMA. “Securitization is a key component to ensuring credit availability to consumers and businesses, and therefore plays a critically important role in the economic recovery. Changes to regulation of the securitization market must be done in a coordinated manner which incorporates the views of various market participants, regulators and policymakers, and is mindful of the impact of the sum total of the changes on the ability of institutions to utilize securitization to fund credit creation.”
The comment letter was filed in response to the FDIC's ANPR. SIFMA does not think the proposed safe harbor is the appropriate means to regulate the securitization market for two reasons.
The first is that regulation of the securitization market must be undertaken on a coordinated basis and considering on-going legislative reform efforts in Congress and in consultation with other relevant regulators.
The unilateral imposition of broad-based conditions on insured depository institutions (IDIs) by the FDIC is premature, according to SIFMA. It also poses an undue burden on IDIs and would front-run the large-scale, coordinated financial regulatory reform initiative cnow being undertaken by Congress as well as other relevant regulators.
SIFMA also said that an insolvency safe harbor should be based on insolvency principles and must not impose requirements unrelated to insolvency. Well-developed legal principles govern the securitized assets' treatment in insolvency. SIFMA added that the FDIC's ANPR eclipses those principles by using the Proposed Safe Harbor to introduce market regulation unrelated to insolvency as well as by suggesting that the treatment of assets under the generally accepted accounting principlesGAAP determines the treatment of assets in insolvency.
SIFMA also requests that the FDIC extend the interim period for the effectiveness of the 2000 Safe Harbor for at least six months beyond March 31, 2010 and that it work with industry participants during that time to outline safe harbor criteria that are based on the legal principles of isolation of assets in insolvency.
Commercial Mortgage Securities Association (CMSA)
CMSA agreed that the FDIC’s existing safe harbor rule must be updated to account for recent changes in accounting rules that will affect the ability of securitizations to meet the criteria for an accounting sale that are presently needed to comply with the safe harbor’s legal isolation requirement. However, the association urged the FDIC to take the following steps.
First, it asked the FDIC to be mindful that the FDIC’s securitization reform proposals come along with broader regulatory reform initiatives, such as securitization reform, that are being developed by Congress and the Securities and Exchange Commission to carry out its investor protection function.
"By proceeding with separate securitization reform provisions, the FDIC would be creating an environment of piecemeal regulation that fails to get at the root of the problem of imprudent underwriting and securitization practices that concern us all, since any FDIC regulations would apply only to insured depository institutions," the CMSA said.
The CMSA also suggested that the FDIC limit this initiative by focusing on the legal isolation criteria rather than risk unintended consequences that could end up perpetuating the decline of the securitization market and credit constraints.
A very clear instance of the potential for such consequences can be seen in the ANPR’s suggestion of a minimum five% credit risk retention by the sponsor institution to ensure that sponsors maintain adequate “skin in the game” to induce sound underwriting of the loans that are securitized.
The association also said to note that where securitization reforms such as minimum risk retention are ultimately adopted, it is very important that they recognize and account for the considerable differences between the different types of ABS, or they risk harming the markets they seek to reform.
In terms of timing, the CMSA noted that the amount of deliberation that obviously will be needed to formulate sound policy here, along with the amount of time that will be needed to implement the new safe harbor requirements, make it clear that the transition period bridging the old and new requirements must be extended beyond March 31.
Thus, the CMSA requested that any modified safe harbor requirements become effective no sooner than 12 months after Federal Register publication of the final rules.
The CMSA offers this recommendation with the caveat that it applies only if the FDIC decides not to include considerable securitization reform elements in a new rule such as risk retention, disclosure and documentation requirements.
CMSA is unable to opine, at this early stage, on the amount of lead time that would be needed if any of these sweeping changes are ultimately adopted into the safe harbor rule.