The Securities and Exchange Commission (SEC) published a fact sheet this morning on a rule requiring ABS issuers to disclose the history of both the requests they received and repurchases they made related to their ABS outstanding.
The final rules approved today were proposed in October 2010. They implement Section 943 of the Dodd Frank Act, which requires the SEC to prescribe regulations on the use of representations and warranties in ABS.
The SEC explained that in the deal agreements governing securitization, ABS issuers usually make reps and warranties regarding the characteristics and the quality of those loans. If a loan does not comply with the rep or warranty, an ABS issuer can be required to repurchase the loan from the pool or replace it with a substitute asset.
Since the financial crisis, the SEC said that many investors and other parties in these deals have questioned whether the pooled loans in meet the characteristics specified by the reps and warranties, and have been seeking to enforce repurchase provisions. The Dodd-Frank Act imposes new disclosure obligations regarding the representations, warranties and repurchase history for investors to know which originators have clear underwriting deficiencies.
“There were few surprises, although there were some areas where the SEC did give some wiggle room in favor of issuers,” said Kenneth Kohler, an attorney with Morrison & Foerster. For instance, issuers are merely required to disclose their repurchase activity every quarter after the initial filing with the SEC. “That’s a fairly mechanical thing for issuers, they should be able to do that,” he said.
The newly minted rules have two basic components: one has to do with the disclosure rules on reps and warranties and repurchases and the due diligence review required of issuers. The second element would be the onus on the rating agencies to look at the issuers’ repurchase history and how these firms and their deals stack up against one another.
The final rules require ABS issuers to file with the SEC in tabular format, the history of the requests they received and repurchases they made regarding their outstanding ABS. The table should offer comparable disclosures so that investors can know the originators that have clear underwriting deficiencies. Specifically, issuers are required to disclose the last three years of repurchase history in an initial filing on EDGAR that is due by Feb. 14, 2012.
After the initial filing, the ABS issuer is required to file updated information on a quarterly basis, including: repurchase history for all outstanding ABS (regardless of whether the securities were offered in an SEC-registered deal) if the underlying transaction agreements include a covenant to repurchase or replace a pool asset as well as the history of all fulfilled and unfulfilled repurchase requests, including investor demands upon a trustee and pending requests.
“Reporting their losses and disputes due to repurchases will require issuers to show their hand on their repurchase history,” Kohler said. It will allow investors to “compare issuers, perhaps giving them a feel as to which issuers are more difficult to deal with in terms the repurchases,” he said.
By making it public, Kohler said, that this might push issuers to be more willing to repurchase.
However, he said that historically regulators tried to protect the banks from potentially giving investors implicit recourse. “The regulators were concerned about the banks’ liability if these financial institutions just bought back loans that were delinquent,” he said. He explained that some issuers used to buyback these loans just to have a good reputation with investors. “It’s almost come full circle where now regulators are almost encouraging investors,” Kohler said.
The disclosure requirements will apply to issuers of unregistered ABS, such as municipal ABS. But, municipal ABS are given an added three years as a phase-in period and will be allowed to provide their information through EMMA, which is the Municipal Securities Rulemaking Board's centralized public database for information about municipal securities issuers and offerings.
It is unclear how many municipal securities, including student loan or housing bonds, the proposed rule would affect, according to ASR sister publication The Bond Buyer. Sources said this provision was made for municipal issuers because the government wants to give cash-strapped municipalities a break. "The SEC is not looking to impose substantial expenses for municipalities holding on to dear life," a source said.
The final rules also give investors immediate access to the most current information about an issuer's repurchase history by requiring an issuer in a registered ABS offering to include in the body of a prospectus repurchase history for the last three years for ABS of the same asset class as the securities being registered. This information should part of registered offerings in a phase-in period, which begins Feb. 14, 2012. In its ongoing reports, issuers should offer updated repurchase history for the particular, related asset pool starting with distribution reports required to be filed on Form 10-D after Dec. 31.
As required by Section 943(1) of the Dodd-Frank Act, the final rules also require Nationally Recognized Statistical Rating Organizations (NRSROs) to offer a description of the representations, warranties and enforcement mechanisms available to investors in an ABS offering. NRSROs will be required to disclose how the representations, warranties, and enforcement mechanisms are different from those of similar ABS. NRSROs should make the disclosures in any report accompanying a credit rating, including in presale reports that are distributed before the the security's sale. NRSROs will be required to provide this information for any report issued on or after six months after the effective date of the rules.
“There is certainly liability for the rating agencies required to compare reps and warranties between various issuers,” Kohler said. The problem, he said, is that for representations contained in pooling and trust agreements, the devil’s in the details. “The differences are a lot more nuanced — one wonders how willing the rating agencies will be to do something they historically have not done."
He mentioned that these firms already put their foot down in terms of their status as experts under the Dodd-Frank Act. “The rating agencies got some short-term dispensation on disclosures of their ratings, and they might have a similar pushback on this requirement,” Kohler said.
“We commend the Commission for seeking industry input regarding reforms in the asset-backed securities market and appreciate that the final rules approved today for repurchase disclosure address our suggestions to implement a quarterly filing requirement and allow issuers with no repurchase requests to suspend quarterly filing, but instead provide an annual filing," said Tom Deutsch, the executive director of the American Securitization Forum.
However, Deutsch said that if the rules have the effect that third-party due diligence providers take on expert liability, the outcome might be counterproductive to the Dodd-Frank legislation's intent. He gave the example of the NRSROs and Rule 436(g) where "the grave consequences of expert liability" might stop third parties from performing due diligence for issuers.
"While the Commission did announce steps attempting to alleviate this concern, it is unclear without seeing the final rules whether issuers will continue to be able to offer investors cost-effective due diligence by independent third parties,” Deutsch said.