Jason Kravitt, senior partner in the securitization practice at Mayer Brown, focused on the implications of last week’s Department of the Treasury announcement of new regulations on securitization.
Kravitt spoke on a conference call late last week to discuss the significant components of the new regulations, specifically the rule that requires issuers to hold on to 5% of the loans they securitize.

“If this is not handled the right way, this defeats the purpose securitization is supposed to serve which is to allow firms to reuse capital so that they can keep generating new credit,” Kravitt said.

He added that there is no existing research that definitely proves that retaining part of the securitization pool improves the credit quality of the loans that issuers originate.

However, research done by the NERA Economic Consulting as commissioned by the American Securitization Forum showed that there might not be a credit quality difference between the originate to distribute and the originate to hold models. “However, it’s research and certainly not a consensus,” he said, “and many industry participants strongly believe their experience shows otherwise.”

The question is how to make the retention requirement work? A problem, according to Kravitt, might arise when a firm retains the securities in the bottom part of the waterfall. This could create problems  because the issuer might have to be responsible for 100% of the expected loss of these securities, thus retaining all of the likely risk. Kravitt said that it’s also going to be more difficult to isolate the assets from the risk and to create a true sale. “It’s getting issuers funding but does not provide balance sheet or capital relief,” he said.

Kravitt said that there are some ways that the 5% retention rule could work and there are alternatives to keeping 5% of the most subordinated piece of the transaction. One way, he said, is to  keep 5% of each tranche of a deal or what is known as the "vertical slice." Another way is to securitize only part of each pool and retain the rest of it.

However, the 5% rule will likely present problems for non-bank issuers, which is problematic in the case of the U.S. because this type of originators make up twice as much as there are in Europe.

“The question is whether the U.S. could live without some of the non-bank originators,” Kravitt said.

One advantage to the Obama plan, according to Kravitt, is that it leaves a lot on how the rule is going to be implemented to regulators. “The Obama proposal does not mandate the form of retention, it leaves such things as how long should the capital be outstanding or whether there will be hedging in the appropriate circumstances to the regulators, who I’m confident, are sophisticated and would be reasonable about the implementation.”


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