The SEC received more than 40 comment letters in response to its proposal. In addition, the SEC included a number of older letters in the file. The letters are available on the SEC's website.
Two of the oldest letters are arguably the most important ones in the comment file. Those two are the letters submitted by the Association for Investment Management and Research (AIMR) and by the Investment Company Institute (ICI). Those letters likely rank high among the factors that originally prompted the SEC to pursue ABS/MBS disclosure issues in the first place.
As a whole, the new letters offer a seemingly lopsided collection of comments. Of the new letters, only three come from the buy-side: two investors and the ICI submitted comment letters. We find the buy-side's reticence somewhat disappointing and we expect that the SEC's staff will share our disappointment. The staff asked for comments and most of the buy-side ignored the request. If investors are dissatisfied with the final rules, they arguably will have to place some of the blame on themselves.
In contrast, the sell-side was heavily represented in the new comment letters. The SEC received 14 comment letters from issuers and underwriters, and roughly again as many from trade associations that represent primarily sell-side entities. The legal community and others account for the remainder of the new letters.
The longest comment letter (157 pages) came from the American Securitization Forum (ASF). The ASF billed itself as the spokesperson for the securitization industry and, in fact, a majority of the comment letters from issuers or underwriters explicitly endorsed the ASF letter (see chart, p. 12). However, none of the three buy-side letters did so. In addition, the ASF letter specifically does not address the issue of static pool data because it had not achieved a "true consensus" on the issue. Based on the overall content of the ASF letter, we feel that it primarily represents sell-side views.
Subsequently, the ASF submitted a second comment letter specifically addressing static pool data. Even there, clear disagreement between the buy-side and the sell-side was evident. Although the second letter gave its main emphasis to sell-side views, the buy-side was not entirely shut out.
Specific Items
Some of the comments struck us as extremely important and some seemed incomplete. Following are our reactions to a dozen particular items:
Static Pool Data - Items 1100(b), 1104(e)
As a general matter, static pool or vintage data is absolutely material and relevant to investors. Therefore, it is somewhat surprising that several letters from the sell-side argue that static pool data is not material.
However, depending on the context, the degree of detail with which an issuer should be required to display static pool data is reasonably debatable. For example, federally guaranteed student loans arguably should not need the same degree of extensive static pool disclosure as asset classes that display greater credit performance variability. Likewise, for master trusts backed by revolving pools, "vintage performance data" is a superior substitute for static pool data. And, admittedly, in a few exceptional cases, such as some CMBS, historical performance data about loans not included in a deal may not be relevant at all.
Therefore, we feel that while still adhering to a principles-based paradigm, the SEC could alleviate much angst on the part of issuers and underwriters by providing "Industry Guides" for the major asset classes. Industry guides could harmonize practices among issuers and provide the greater comparability that investors seek.
Incorporation by Reference
The SEC should broadly encourage issuers to use "incorporation by reference" as the means of including quantitative data in their prospectuses. Issuers could then file and periodically update the data in the ordinary course of business. This could help streamline the hectic process of bringing new deals to market. Encouraging the use of incorporation by reference may help alleviate frustrations voiced by some issuers.
Data File Formats
Market participants are generally able to use computer data files in any standard format (cdi, xls, csv, pdf, etc.). Virtually all market participants would benefit from being able to find the files on EDGAR and to download them for analysis into their computers.
Aggregated '34 Act Filings
Aggregated 34 Act filings may be more convenient for investors. If the SEC allows such filings, an investor would potentially be able to get complete performance data on all of an issuer's deals by downloading a single file from EDGAR.
Transition Period
The market is facing significant changes to the registration, disclosure and reporting framework for ABS and MBS. There should be a substantial transition period to allow market participants to adapt to the new regime. A transition period even as a long as a year might be appropriate.
There should be only limited "grandfathering" of old deals with respect to 34 Act reporting. For old deals, the 34 Act reporting requirement should be limited to filing reports that already are sent to investors.
No market participant can legitimately claim to have been blind-sided by the SEC's proposal. The letters from 1996 prove this.
Ownership of Residual Interests - Item 1112(d)(1)
Ownership of residual interests is relevant to ABS/MBS investors. Often the owner of a deal's residual interest has the option to excise a "clean-up call" after the balance of the underlying collateral has declined to a predetermined level (e.g., as a result of scheduled amortization, (prepayments or losses). If a frequent issuer retains the residual interests in its deals, it may establish a routine practice of exercising clean-up calls in order to satisfy investors' desires for stability and consistency across all the issuer's deals. In return, the issuer may receive better pricing on its new issues.
On the other hand, when a deal's residual is owned by an independent third party (i.e., an entity not affiliated with the issuer), the third party's decision to exercise the clean-up call is likely to be based solely on whether the underlying assets are worth more than par. The clean-up call options customarily provide for a strike price of par. Accordingly, if a deal's underlying assets are worth less than par exercise of the clean-up call is unlikely. Conversely, if the assets are worth more than par, exercise is likely.
Changes in Servicing Policies - Item 1107(a)(3)
Information about past changes in a servicer's servicing policies is relevant to investors. Such information helps to shed light on historical performance, especially when performance variations are evident.
Definition of ABS - Lease Residual Values - Item 1101(c)(2)(v)
To make calculations simpler, the calculation of the proportion of a deal backed by lease residuals should be simply the sum of the booked residual values of the underlying physical assets divided by the stated principal balance of the pool.
Definition of ABS - Prefunding - Item1101(c)(3)(ii)
Limits on prefunding are appropriate as a condition for an instrument to qualify as an asset-backed security and to qualify for the use of Form S-3. In the absence of any restrictions on prefunding, an offering potentially verges on becoming a "blind pool." While such offerings may be reasonable under appropriate conditions, they are not asset-backed securities and should not be treated as such.
Sponsor vs. Originator vs. Seller - Items 1101(j), 1101(l), 1104 and 1109
The definition of the term sponsor should be based on "organizing and initiating" an ABS/MBS transaction without regard to whether the sponsor sells or transfers assets to the issuing entity. Investors reasonably may want to understand a sponsor's motivations for effecting ABS/MBS transactions and whether the sponsor's past transactions have performed well.
As a separate matter, investors may also want to understand motivations and business practices of an originator of securitized assets and of a seller of the assets (if either or both of those entities is different from the sponsor). The SEC's proposal already includes a treatment of originators in Item 1109. The treatment could be expanded to encompass changes in origination practices over time. However, the SEC's proposal does not include a treatment of sellers.
Suspension of 34 Act Reporting - 34 Act 15(d)
ABS investors need a continuous flow of information in order to analyze ABS/MBS deals. Moreover, ABS investors should be protected from information that is inaccurate or false. Accordingly, an ABS/MBS issuer should be required not only to supply information for the life of its deals but arguably should also be required to file such information with the SEC. Ongoing filing requirements provide a strong assurance of reliability and accuracy of information supplied to ABS/MBS investors.
Additionally, a continuing flow of information is essential to the further development of synthetic CDOs that use ABS/MBS as their underlying reference assets. In order to use an ABS or MBS as a reference credit, CDO market participants must have confidence that they will have ongoing access to performance reports on the security.
Servicer Financials
Information about the financial condition of a master servicer or servicer can be very important to investors. Instances of fraud in ABS transactions have most often been associated with situations where a servicer experiences financial distress.
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