Credit Risk Retention

Federal RegisterApr 29, 2011

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DEPARTMENT OF THE TREASURY

Office of the Comptroller of the Currency

12 CFR Part 43

[Docket No. OCC-2011-0002]

RIN 1557-AD40

FEDERAL RESERVE SYSTEM

12 CFR Part 244

[Docket No. 2011-1411]

RIN 7100-AD-70

FEDERAL DEPOSIT INSURANCE CORPORATION

12 CFR Part 373

RIN 3064-AD74

FEDERAL HOUSING FINANCE AGENCY

12 CFR Part 1234

RIN 2590-AA43

SECURITIES AND EXCHANGE COMMISSION

17 CFR Part 246

[Release No. 34-64148; File No. S7-14-11]

RIN 3235-AK96

DEPARTMENT OF HOUSING AND URBAN DEVELOPMENT

24 CFR Part 267

RIN 2501-AD53

Credit Risk Retention

AGENCIES:

Office of the Comptroller of the Currency, Treasury (OCC); Board of Governors of the Federal Reserve System (Board); Federal Deposit Insurance Corporation (FDIC); U.S. Securities and Exchange Commission (Commission); Federal Housing Finance Agency (FHFA); and Department of Housing and Urban Development (HUD).

ACTION:

Proposed rule.

SUMMARY:

The OCC, Board, FDIC, Commission, FHFA, and HUD (the Agencies) are proposing rules to implement the credit risk retention requirements of section 15G of the Securities Exchange Act of 1934 (15 U.S.C. 78o-11), as added by section 941 of the Dodd-Frank Wall Street Reform and Consumer Protection Act. Section 15G generally requires the securitizer of asset-backed securities to retain not less than five percent of the credit risk of the assets collateralizing the asset-backed securities. Section 15G includes a variety of exemptions from these requirements, including an exemption for asset-backed securities that are collateralized exclusively by residential mortgages that qualify as “qualified residential mortgages,” as such term is defined by the Agencies by rule.

DATES:

Comments must be received by June 10, 2011.

ADDRESSES:

Interested parties are encouraged to submit written comments jointly to all of the Agencies. Commenters are encouraged to use the title “Credit Risk Retention” to facilitate the organization and distribution of comments among the Agencies. Commenters are also encouraged to identify the number of the specific request for comment to which they are responding.

Office of the Comptroller of the Currency:

Because paper mail in the Washington, DC, area and at the OCC is subject to delay, commenters are encouraged to submit comments by the Federal eRulemaking Portal or e-mail, if possible. Please use the title “Credit Risk Retention” to facilitate the organization and distribution of the comments. You may submit comments by any of the following methods:

•

Federal eRulemaking Portal—“Regulations.gov”:

Go to

http://www.regulations.gov,

under the “More Search Options” tab click next to the “Advanced Docket Search” option where indicated, select “Comptroller of the Currency” from the agency drop-down menu, then click “Submit.” In the “Docket ID” column, select “OCC-2011-0002” to submit or view public comments and to view supporting and related materials for this proposed rule. The “How to Use This Site” link on the Regulations.gov home page provides information on using Regulations.gov, including instructions for submitting or viewing public comments, viewing other supporting and related materials, and viewing the docket after the close of the comment period.

•

E-mail: regs.comments@occ.treas.gov.

•

Mail:

Office of the Comptroller of the Currency, 250 E Street, SW., Mail Stop 2-3, Washington, DC 20219.

•

Fax:

(202) 874-5274.

•

Hand Delivery/Courier:

250 E Street, SW., Mail Stop 2-3, Washington, DC 20219.

Instructions:

You must include “OCC” as the agency name and “Docket Number OCC-2011-0002” in your comment. In general, OCC will enter all comments received into the docket and publish them on the Regulations.gov Web site without change, including any business or personal information that you provide such as name and address information, e-mail addresses, or phone numbers. Comments received, including attachments and other supporting materials, are part of the public record and subject to public disclosure. Do not enclose any information in your comment or supporting materials that you consider confidential or inappropriate for public disclosure.

You may review comments and other related materials that pertain to this proposed rulemaking by any of the following methods:

•

Viewing Comments Electronically:

Go to

http://www.regulations.gov,

under the “More Search Options” tab click next to the “Advanced Document Search” option where indicated, select “Comptroller of the Currency” from the agency drop-down menu, then click “Submit.” In the “Docket ID” column, select “OCC-2011-0002” to view public comments for this rulemaking action.

•

Viewing Comments Personally:

You may personally inspect and photocopy comments at the OCC, 250 E Street, SW., Washington, DC. For security reasons, the OCC requires that visitors make an appointment to inspect comments. You may do so by calling (202) 874-4700. Upon arrival, visitors will be required to present valid government-issued photo identification and submit to security screening in order to inspect and photocopy comments.

•

Docket:

You may also view or request available background documents and project summaries using the methods described above.

Board of Governors of the Federal Reserve System:

You may submit comments, identified by Docket No. R-1411, by any of the following methods:

•

Agency Web Site:

http://www.federalreserve.gov.

Follow the instructions for submitting comments at

http://www.federalreserve.gov/generalinfo/foia/ProposedRegs.cfm.

•

Federal eRulemaking Portal: http://www.regulations.gov.

Follow the instructions for submitting comments.

•

E-mail: regs.comments@federalreserve.gov.

Include the docket number in the subject line of the message.

•

Fax:

(202) 452-3819 or (202) 452-3102.

•

Mail:

Address to Jennifer J. Johnson, Secretary, Board of Governors of the

Federal Reserve System, 20th Street and Constitution Avenue, NW., Washington, DC 20551.

All public comments will be made available on the Board's Web site at

http://www.federalreserve.gov/generalinfo/foia/ProposedRegs.cfm

as submitted, unless modified for technical reasons. Accordingly, comments will not be edited to remove any identifying or contact information. Public comments may also be viewed electronically or in paper in Room MP-500 of the Board's Martin Building (20th and C Streets, NW.) between 9 a.m. and 5 p.m. on weekdays.

Federal Deposit Insurance Corporation:

You may submit comments, identified by RIN number, by any of the following methods:

•

Agency Web Site: http://www.FDIC.gov/regulations/laws/federal/notices.html.

Follow instructions for submitting comments on the Agency Web Site.

•

E-mail: Comments@FDIC.gov.

Include the RIN number on the subject line of the message.

•

Mail:

Robert E. Feldman, Executive Secretary,

Attention:

Comments, Federal Deposit Insurance Corporation, 550 17th Street, NW., Washington, DC 20429.

•

Hand Delivery:

Comments may be hand delivered to the guard station at the rear of the 550 17th Street Building (located on F Street) on business days between 7 a.m. and 5 p.m.

Instructions:

All comments received must include the agency name and RIN for this rulemaking and will be posted without change to

http://www.fdic.gov/regulations/laws/federal/propose.html,

including any personal information provided.

Securities and Exchange Commission:

You may submit comments by the following method:

Electronic Comments

• Use the Commission's Internet comment form (

http://www.sec.gov/rules/proposed.shtml

); or

• Send an e-mail to

rule-comments@sec.gov.

Please include File Number S7-14-11 on the subject line; or

• Use the Federal eRulemaking Portal (

http://www.regulations.gov

). Follow the instructions for submitting comments.

Paper Comments

• Send paper comments in triplicate to Elizabeth M. Murphy, Secretary, Securities and Exchange Commission, 100 F Street, NE., Washington, DC 20549-1090.

• All submissions should refer to File Number S7-14-11. This file number should be included on the subject line if e-mail is used. To help us process and review your comments more efficiently, please use only one method. The Commission will post all comments on the Commission's Internet Web site (

http://www.sec.gov/rules/proposed.shtml

). Comments are also available for website viewing and printing in the Commission's Public Reference Room, 100 F Street, NE., Washington, DC 20549, on official business days between the hours of 10 a.m. and 3 p.m. All comments received will be posted without change; we do not edit personal identifying information from submissions. You should submit only information that you wish to make available publicly.

Federal Housing Finance Agency:

You may submit your written comments on the proposed rulemaking, identified by RIN number 2590-AA43, by any of the following methods:

•

E-mail:

Comments to Alfred M. Pollard, General Counsel, may be sent by e-mail at

RegComments@fhfa.gov.

Please include “RIN 2590-AA43” in the subject line of the message.

•

Federal eRulemaking Portal: http://www.regulations.gov.

Follow the instructions for submitting comments. If you submit your comment to the Federal eRulemaking Portal, please also send it by e-mail to FHFA at

RegComments@fhfa.gov

to ensure timely receipt by the Agency. Please include “RIN 2590-AA43” in the subject line of the message.

•

U.S. Mail, United Parcel Service, Federal Express, or Other Mail Service:

The mailing address for comments is: Alfred M. Pollard, General Counsel,

Attention:

Comments/RIN 2590-AA43, Federal Housing Finance Agency, Fourth Floor, 1700 G Street, NW., Washington, DC 20552.

•

Hand Delivery/Courier:

The hand delivery address is: Alfred M. Pollard, General Counsel, Attention: Comments/RIN 2590-AA43, Federal Housing Finance Agency, Fourth Floor, 1700 G Street, NW., Washington, DC 20552. A hand-delivered package should be logged at the Guard Desk, First Floor, on business days between 9 a.m. and 5 p.m.

All comments received by the deadline will be posted for public inspection without change, including any personal information you provide, such as your name and address, on the FHFA website at

http://www.fhfa.gov.

Copies of all comments timely received will be available for public inspection and copying at the address above on government-business days between the hours of 10 a.m. and 3 p.m. To make an appointment to inspect comments please call the Office of General Counsel at (202) 414-6924.

Department of Housing and Urban Development:

Interested persons are invited to submit comments regarding this rule to the Regulations Division, Office of General Counsel, Department of Housing and Urban Development, 451 7th Street, SW., Room 10276, Washington, DC 20410-0500. Communications must refer to the following docket number [FR-5504-P-01] and title of this rule. There are two methods for submitting public comments. All submissions must refer to the above docket number and title.

• Submission of Comments by Mail. Comments may be submitted by mail to the Regulations Division, Office of General Counsel, Department of Housing and Urban Development, 451 7th Street, SW., Room 10276, Washington, DC 20410-0500.

• Electronic Submission of Comments. Interested persons may submit comments electronically through the Federal eRulemaking Portal at www.regulations.gov. HUD strongly encourages commenters to submit comments electronically. Electronic submission of comments allows the commenter maximum time to prepare and submit a comment, ensures timely receipt by HUD, and enables HUD to make them immediately available to the public. Comments submitted electronically through the www.regulations.gov website can be viewed by other commenters and interested members of the public. Commenters should follow the instructions provided on that site to submit comments electronically.

•

Note:

To receive consideration as public comments, comments must be submitted through one of the two methods specified above. Again, all submissions must refer to the docket number and title of the rule.

• No Facsimile Comments. Facsimile (FAX) comments are not acceptable.

• Public Inspection of Public Comments. All properly submitted comments and communications submitted to HUD will be available for public inspection and copying between 8 a.m. and 5 p.m. weekdays at the above address. Due to security measures at the HUD Headquarters building, an appointment to review the public comments must be scheduled in advance by calling the Regulations Division at 202-708-3055 (this is not a toll-free number). Individuals with speech or hearing impairments may access this number via TTY by calling the Federal Information Relay Service at 800-877-8339. Copies of all comments submitted are available for inspection and downloading at

http://www.regulations.gov

FOR FURTHER INFORMATION CONTACT:

OCC:

Chris Downey, Risk Specialist, Financial Markets Group, (202) 874-4660; Kevin Russell, Director, Retail Credit Risk, (202) 874-5170; Darrin Benhart, Director, Commercial Credit Risk, (202) 874-5670; or Jamey Basham, Assistant Director, or Carl Kaminski, Senior Attorney, Legislative and Regulatory Activities Division, (202) 874-5090, Office of the Comptroller of the Currency, 250 E Street, SW., Washington, DC 20219.

Board:

Benjamin W. McDonough, Counsel, (202) 452-2036; April C. Snyder, Counsel, (202) 452-3099; Sebastian R. Astrada, Attorney, (202) 452-3594; or Flora H. Ahn, Attorney, (202) 452-2317, Legal Division; Thomas R. Boemio, Manager, (202) 452-2982; Donald N. Gabbai, Senior Supervisory Financial Analyst, (202) 452-3358; or Sviatlana A. Phelan, Financial Analyst, (202) 912-4306, Division of Banking Supervision and Regulation; Andreas Lehnert, Deputy Director, Office of Financial Stability Policy and Research, (202) 452-3325; or Brent Lattin, Counsel, (202) 452-3367, Division of Consumer and Community Affairs, Board of Governors of the Federal Reserve System, 20th and C Streets, NW., Washington, DC 20551.

FDIC:

Beverlea S. Gardner, Special Assistant to the Chairman, (202) 898-3640; Mark L. Handzlik, Counsel, (202) 898-3990; Phillip E. Sloan, Counsel, (703) 562-6137; or Petrina R. Dawson, Counsel, (703) 562-2688, Federal Deposit Insurance Corporation, 550 17th Street, NW., Washington, DC 20429.

Commission:

Jay Knight, Attorney-Advisor in the Office of Rulemaking, or Katherine Hsu, Chief of the Office of Structured Finance, Division of Corporation Finance, at (202) 551-3753, U.S. Securities and Exchange Commission, 100 F Street, NE., Washington, DC 20549-3628.

FHFA:

Patrick J. Lawler, Associate Director and Chief Economist,

Patrick.Lawler@fhfa.gov,

(202) 414-3746; Austin Kelly, Associate Director for Housing Finance Research,

Austin.Kelly@fhfa.gov,

(202) 343-1336; Phillip Millman, Principal Capital Markets Specialist,

Phillip.Millman@fhfa.gov,

(202) 343-1507; or Thomas E. Joseph, Senior Attorney Advisor,

Thomas.Joseph@fhfa.gov,

(202) 414-3095; Federal Housing Finance Agency, Third Floor, 1700 G Street, NW., Washington, DC 20552. The telephone number for the Telecommunications Device for the Hearing Impaired is (800) 877-8339.

HUD:

Robert C. Ryan, Deputy Assistant Secretary for Risk Management and Regulatory Affairs, Office of Housing, Department of Housing and Urban Development, 451 7th Street, SW., Room 9106, Washington, DC 20410; telephone number 202-402-5216 (this is not a toll-free number). Persons with hearing or speech impairments may access this number through TTY by calling the toll-free Federal Information Relay Service at 800-877-8339.

SUPPLEMENTARY INFORMATION:

Table of Contents

I. Introduction

II. General Definitions and Scope

A. Asset-Backed Securities, Securitization Transaction and ABS Interests

B. Securitizer, Sponsor, and Depositor

C. Originator

III. General Risk Retention Requirement

A. Minimum 5 Percent Risk Retention Required

B. Permissible Forms of Risk Retention

1. Vertical Risk Retention

2. Horizontal Risk Retention

3. L-Shaped Risk Retention

4. Revolving Asset Master Trusts (Seller's Interest)

5. Representative Sample

6. Asset-Backed Commercial Paper Conduits

7. Commercial Mortgage-Backed Securities

8. Treatment of Government-Sponsored Enterprises

9. Premium Capture Cash Reserve Account

C. Allocation to the Originator

D. Hedging, Transfer, and Financing Restrictions

IV. Qualified Residential Mortgages

A. Overall Approach to Defining Qualified Residential Mortgages

B. Exemption for QRMs

C. Eligibility Criteria

1. Eligible Loans, First Lien, No Subordinate Liens, Original Maturity and Written Application Requirements

2. Borrower Credit History

3. Payment Terms

4. Loan-to-Value Ratio

5. Down Payment

6. Qualifying Appraisal

7. Ability To Repay

8. Points and Fees

9. Assumability Prohibition

D. Repurchase of Loans Subsequently Determined To Be Non-Qualified After Closing

E. Request for Comment on Possible Alternative Approach

V. Reduced Risk Retention Requirements for ABS Backed by Qualifying Commercial Real Estate, Commercial, or Automobile Loans

A. Asset Classes

B. ABS Collateralized Exclusively by Qualifying CRE Loans, Commercial Loans, or Automobile Loans

C. Qualifying Commercial Loans

1. Ability To Repay

2. Risk Management and Monitoring Requirements

D. Qualifying CRE Loans

1. Ability To Repay

2. Loan-to-Value Requirement

3. Valuation of the Collateral

4. Risk Management and Monitoring Requirements

E. Qualifying Automobile Loans

1. Ability to Repay

2. Loan Terms

3. Reviewing Credit History

4. Loan-to-Value

F. Buy-Back Requirements for ABS Issuances Collateralized by Qualifying Commercial, CRE or Automobile Loans

VI. General Exemptions

A. Exemption for Federally Insured or Guaranteed Residential, Multifamily and Health Care Mortgage Assets

B. Other Exemptions

C. Exemption for Certain Resecuritization Transactions

D. Additional Exemptions

E. Safe Harbor for Certain Foreign-Related Transactions

VII. Solicitation of Comments on Use of Plain Language

VIII. Administrative Law Matters

A. Regulatory Flexibility Act

B. Paperwork Reduction Act

C. Commission Economic Analysis

D. Executive Order 12866 Determination

E. OCC Unfunded Mandates Reform Act of 1995 Determination

F. Commission: Small Business Regulatory Enforcement Fairness Act

G. FHFA: Considerations of Differences Between the Federal Home Loan Banks and the Enterprises

I. Introduction

The Agencies are requesting comment on proposed rules (proposal or proposed rules) to implement the requirements of section 941(b) of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the Act, or Dodd-Frank Act),

which is codified as new section 15G of the Securities Exchange Act of 1934 (the Exchange Act).

Section 15G of the Exchange Act, as added by section 941(b) of the Dodd-Frank Act, generally requires the Board, the FDIC, the OCC (collectively, referred to as the Federal banking agencies), the Commission, and, in the case of the securitization of any “residential mortgage asset,” together with HUD and FHFA, to jointly prescribe regulations that (i) require a securitizer to retain not less than five percent of the credit risk of any asset that the securitizer, through the issuance of an asset-backed security (ABS), transfers, sells, or conveys to a third party, and (ii) prohibit a securitizer from directly or indirectly hedging or otherwise transferring the credit risk that the securitizer is required to retain under section 15G and the Agencies' implementing rules.

Public Law 111-203, 124 Stat. 1376 (2010).

15 U.S.C. 78o-11.

See

15 U.S.C. 78o-11(b), (c)(1)(A) and (c)(1)(B)(ii).

Section 15G of the Exchange Act exempts certain types of securitization transactions from these risk retention requirements and authorizes the Agencies to exempt or establish a lower risk retention requirement for other types of securitization transactions. For example, section 15G specifically provides that a securitizer shall not be required to retain any part of the credit risk for an asset that is transferred, sold, or conveyed through the issuance of ABS by the securitizer, if all of the assets that collateralize the ABS are qualified residential mortgages (QRMs), as that term is jointly defined by the Agencies.

In addition, section 15G states that the Agencies must permit a securitizer to retain less than five percent of the credit risk of commercial mortgages, commercial loans, and automobile loans that are transferred, sold, or conveyed through the issuance of ABS by the securitizer if the loans meet underwriting standards established by the Federal banking agencies.

See

15 U.S.C. 78o-11(c)(1)(C)(iii), (4)(A) and (B).

See id.

at sec. 78o-11(c)(1)(B)(ii) and (2).

As shown in tables A, B, C, and D below, the securitization markets are an important source of credit to U.S. households and businesses and state and local governments.

Data are through September 2010. All data from Asset Backed Alert except: CMBS data from Commercial Mortgage Alert, CLO data from Securities Industry and Financial Markets Association. The tables do not include any data on securities issued or guaranteed by the Federal National Mortgage Association or the Federal Home Loan Mortgage Corporation.

BILLING CODE 4810-33-P

EP29AP11.000

EP29AP11.001

BILLING CODE 4810-33-C

Table D—Total U.S. Asset and Mortgage Backed Securitizations Issued per Year

[Dollars in millions]

2002

2003

2004

2005

2006

2007

2008

2009

2010

Total 2002

3Q2010

Auto

95,484

86,350

72,881

103,717

82,000

66,773

35,469

53,944

43,104

639,724

CLO

30,388

22,584

32,192

69,441

171,906

138,827

27,489

2,033

494,860

CMBS

89,900

107,354

136,986

245,883

305,714

319,863

33,583

38,750

27,297

1,305,329

Credit Cards

73,004

67,385

51,188

62,916

72,518

94,470

61,628

46,581

6,149

535,839

Equipment

7,062

9,022

6,288

9,030

8,404

6,066

3,014

7,240

5,010

61,137

Floorplan

3,000

6,315

11,848

12,670

12,173

6,925

1,000

4,959

8,619

67,510

Other

135,384

196,769

330,161

444,137

516,175

165,515

19,872

10,652

24,936

1,843,601

RMBS

287,916

396,288

503,911

724,115

723,257

641,808

28,612

48,082

39,830

3,393,819

Student Loan

25,367

40,067

45,759

62,212

65,745

5,812,212

28,199

20,839

13,899

360,210

Total

747,506

932,134

1,191,216

1,734,122

1,957,891

1,498,370

238,868

233,079

168,843

Note:

2010 Data are through the month of September.

When properly structured, securitization provides economic benefits that lower the cost of credit to households and businesses.

However, when incentives are not properly aligned and there is a lack of discipline in the origination process, securitization can result in harm to investors, consumers, financial institutions, and the financial system. During the financial crisis, securitization displayed significant vulnerabilities to informational and incentive problems among various parties involved in the process.

Securitization may reduce the cost of funding, which is accomplished through several different mechanisms. For example, firms that specialize in originating new loans and that have difficulty funding existing loans may use securitization to access more liquid capital markets for funding. In addition, securitization can create opportunities for more efficient management of the asset-liability duration mismatch generally associated with the funding of long-term loans, for example, with short-term bank deposits. Securitization also allows the structuring of securities with differing maturity and credit risk profiles that may appeal to a broad range of investors from a single pool of assets. Moreover, securitization that involves the transfer of credit risk allows financial institutions that primarily originate loans to particular classes of borrowers, or in particular geographic areas, to limit concentrated exposure to these idiosyncratic risks on their balance sheets.

See generally Report to the Congress on Risk Retention,

Board of Governors of the Federal Reserve System, at 8 (October 2010),

available at http://federalreserve.gov/boarddocs/rptcongress/securitization/riskretention.pdf

(Board Report).

See

Board Report at 8-9.

For example, as noted in the legislative history of section 15G, under the “originate to distribute” model, loans were made expressly to be sold into securitization pools, with lenders often not expecting to bear the credit risk of borrower default.

In addition, participants in the securitization chain may be able to affect the value of the ABS in opaque ways, both before and after the sale of the securities, particularly if those assets are resecuritized into complex instruments

such as collateralized debt obligations (CDOs) and CDOs-squared.

Moreover, some lenders using an “originate-to-distribute” business model loosened their underwriting standards knowing that the loans could be sold through a securitization and retained little or no continuing exposure to the quality of those assets.

See

S. Rep. No. 111-176, at 128 (2010).

See id.

The risk retention requirements added by section 15G are intended to help address problems in the securitization markets by requiring that securitizers, as a general matter, retain an economic interest in the credit risk of the assets they securitize. As indicated in the legislative history of section 15G, “When securitizers retain a material amount of risk, they have ‘skin in the game,’ aligning their economic interest with those of investors in asset-backed securities.”

By requiring that the securitizer retain a portion of the credit risk of the assets being securitized, section 15G provides securitizers an incentive to monitor and ensure the quality of the assets underlying a securitization transaction, and thereby helps align the interests of the securitizer with the interests of investors. Additionally, in circumstances where the assets collateralizing the ABS meet underwriting and other standards that should ensure the assets pose low credit risk, the statute provides or permits an exemption.

See id.

at 129.

See

15 U.S.C. 78o-11(c)(1)(B)(ii), (e)(1)-(2).

The credit risk retention requirements of section 15G are an important part of the legislative and regulatory efforts to address weaknesses and failures in the securitization process and the securitization markets. Section 15G complements other parts of the Dodd-Frank Act intended to improve the securitization markets. These include, among others, provisions that strengthen the regulation and supervision of nationally recognized statistical rating agencies (NRSROs) and improve the transparency of credit ratings;

provide for issuers of registered ABS offerings to perform a review of the assets underlying the ABS and disclose the nature of the review;

and require issuers of ABS to disclose the history of the repurchase requests they received and repurchases they made related to their outstanding ABS.

See,

e.g., sections 932, 935, 936, 938, and 943 of the Dodd-Frank Act.

See

section 945 of the Dodd-Frank Act.

See

section 943 of the Dodd-Frank Act.

In developing the proposed rules, the Agencies have taken into account the diversity of assets that are securitized, the structures historically used in securitizations, and the manner in which securitizers may have retained exposure to the credit risk of the assets they securitize.

As described in detail below, the proposed rules provide several options securitizers may choose from in meeting the risk retention requirements of section 15G, including, but not limited to, retention of a five percent “vertical” slice of each class of interests issued in the securitization or retention of a five percent “horizontal” first-loss interest in the securitization, as well as other risk retention options that take into account the manners in which risk retention often has occurred in credit card receivable and automobile loan and lease securitizations and in connection with the issuance of asset-backed commercial paper. The proposed rules also include a special “premium capture” mechanism designed to prevent a securitizer from structuring an ABS transaction in a manner that would allow the securitizer to effectively negate or reduce its retained economic exposure to the securitized assets by immediately monetizing the excess spread created by the securitization transaction.

In designing these options and the proposed rules in general, the Agencies have sought to ensure that the amount of credit risk retained is meaningful—consistent with the purposes of section 15G—while reducing the potential for the proposed rules to negatively affect the availability and costs of credit to consumers and businesses.

Both the language and legislative history of section 15G indicate that Congress expected the agencies to be mindful of the heterogeneity of securitization markets.

See,

e.g., 15 U.S.C. 78o-11(c)(1)(E), (c)(2), (e); S. Rep. No. 111-76, at 130 (2010) (“The Committee believes that implementation of risk retention obligations should recognize the differences in securitization practices for various asset classes.”)

“Excess spread” is the difference between the gross yield on the pool of securitized assets less the cost of financing those assets (weighted average coupon paid on the investor certificates), charge-offs, servicing costs, and any other trust expenses (such as insurance premiums, if any).

As required by section 15G, the proposed rules provide a complete exemption from the risk retention requirements for ABS that are collateralized solely by QRMs and establish the terms and conditions under which a residential mortgage would qualify as a QRM. In developing the proposed definition of a QRM, the Agencies carefully considered the terms and purposes of section 15G, public input, and the potential impact of a broad or narrow definition of QRMs on the housing and housing finance markets.

As discussed in greater detail in Part V of this Supplementary Information, the proposed rules would generally prohibit QRMs from having product features that contributed significantly to the high levels of delinquencies and foreclosures since 2007—such as terms permitting negative amortization, interest-only payments, or significant interest rate increases—and also would establish underwriting standards designed to ensure that QRMs are of very high credit quality consistent with their exemption from risk retention requirements. These underwriting standards include, among other things, maximum front-end and back-end debt-to-income ratios of 28 percent and 36 percent, respectively;

a maximum loan-to-value (LTV) ratio of 80 percent in the case of a purchase transaction (with a lesser combined LTV permitted for refinance transactions); a 20 percent down payment requirement in the case of a purchase transaction; and credit history restrictions.

A front-end debt-to-income ratio measures how much of the borrower's gross (pretax) monthly income is represented by the borrower's required payment on the first-lien mortgage, including real estate taxes and insurance. A back-end debt-to-income ratio measures how much of a borrower's gross (pretax) monthly income would go toward monthly mortgage and nonmortgage debt service obligations.

The proposed rules also would not require a securitizer to retain any portion of the credit risk associated with a securitization transaction if the ABS issued are exclusively collateralized by commercial loans, commercial mortgages, or automobile loans that meet underwriting standards included in the proposed rules for the individual asset class. As for QRMs, these underwriting standards are designed to be robust and ensure that the loans backing the ABS are of very low credit risk. In this Supplementary Information, the Agencies refer to these assets (including QRMs) as “qualified assets.”

The Agencies recognize that many prudently underwritten residential and mortgage loans, commercial loans, and automobile loans may not satisfy all the underwriting and other criteria in the proposed rules for qualified assets. Securitizers of ABS backed by such prudently underwritten loans would, as a general matter, be required to retain credit risk under the rule. However, as noted above, the Agencies have sought to structure the proposed risk retention requirements in a flexible manner that would allow the securitization markets for non-qualified assets to function in a

manner that both facilitates the flow of credit to consumers and businesses on economically viable terms and is consistent with the protection of investors.

Section 15G allocates the authority for writing rules to implement its provisions among the Agencies in various ways. As a general matter, the Agencies collectively are responsible for adopting joint rules to implement the risk retention requirements of section 15G for securitizations that are backed by residential mortgage assets and for defining what constitutes a QRM for purposes of the exemption for QRM-backed ABS.

The Federal banking agencies and the Commission, however, are responsible for adopting joint rules that implement section 15G for securitizations backed by all other types of assets,

and also are the agencies authorized to adopt rules in several specific areas under section 15G.

In addition, the Federal banking agencies are responsible for establishing, by rule, the underwriting standards for non-QRM residential mortgages, commercial mortgages, commercial loans and automobile loans that would qualify ABS backed by these types of loans for a less than five percent risk retention requirement.

Accordingly, when used in this proposal, the term “Agencies” shall be deemed to refer to the appropriate Agencies that have rulewriting authority with respect to the asset class, securitization transaction, or other matter discussed. The Secretary of the Treasury, as Chairperson of the Financial Stability Oversight Council, coordinated the development of these joint proposed rules in accordance with the requirements of section 15G.

See id.

at sec. 78o-11(b)(2), (e)(4)(A) and (B).

See id.

at sec. 78o-11(b)(1).

See,

e.g.

id.

at sec. 78o-11(b)(1)(E) (relating to the risk retention requirements for ABS collateralized by commercial mortgages); (b)(1)(G)(ii) (relating to additional exemptions for assets issued or guaranteed by the United States or an agency of the United States); (d) (relating to the allocation of risk retention obligations between a securitizer and an originator); and (e)(1) (relating to additional exemptions, exceptions or adjustments for classes of institutions or assets).

See id.

at sec. 78o-11(b)(2)(B). Therefore, pursuant to section 15G, only the Federal banking agencies are proposing the underwriting definitions in § _.16 (except the asset class definitions of automobile loan, commercial loan, and commercial real estate loan, which are being proposed by the Federal banking agencies and the Commission), and the underwriting standards in §§ _.18(b)(1)-(6), _.19(b)(1)-(9), and _.20(b)(1)-(8) of the proposed rules. At the final rule stage, FHFA proposes to adopt only those provisions of the common rules that address the types of asset securitization transactions in which its regulated entities could be authorized to engage under existing law. The remaining provisions, such as those addressing underwriting standards for non-residential commercial loans and auto loans, would be designated as [reserved], and the provisions adopted would be numbered and otherwise designated so as to correspond to the equivalent provisions appearing in the regulations of the other Agencies.

See id.

at 78o-11(h).

For ease of reference, the proposed rules of the Agencies are referenced using a common designation of § _.1 to § _.23 (excluding the title and part designations for each Agency). With the exception of HUD, each Agency will codify the rules, when adopted in final form, within each of their respective titles of the Code of Federal Regulations.

Section _.1 of each Agency's proposed rules identifies the entities or transactions that would be subject to such Agency's rules.

Specifically, the agencies propose to codify the rules as follows: 12 CFR part 43 (OCC); 12 CFR part 244 (Regulation RR) (Board); 12 CFR part 373 (FDIC); 17 CFR part 246 (Commission); 12 CFR part 1234 (FHFA). As required by section 15G, HUD has jointly prescribed the proposed rules for a securitization that is backed by any residential mortgage asset and for purposes of defining a qualified residential mortgage. HUD's codification in 24 CFR part 267 indicates that the proposed rules include exceptions and exemptions in Subpart D of each of these rules for certain transactions involving programs and entities under the jurisdiction of HUD.

The joint proposed rules being adopted by the Agencies would apply to all sponsors that fall within the scope of 15G, including state and federal savings associations and savings and loan holding companies. These entities are currently regulated and supervised by the Office of Thrift Supervision (OTS), which is not among the Federal banking agencies with rulemaking authority under section 15G. Authority of the OTS under the Home Owners' Loan Act (12 U.S.C. 1461

et seq.

) with respect to such entities will transfer from the OTS to the Board, FDIC, and OCC on the transfer date provided in section 311 of the Dodd-Frank Act. This transfer will take place well before the effective date of the Federal banking agencies' final rules under section 15G. Accordingly, the final rules issued by the appropriate Federal banking agency would include the relevant set of these entities in the agency's Purpose, Authority, and Scope section (§ _.1).

In light of the joint nature of the Agencies' rulewriting authority under section 15G, the appropriate Agencies will jointly approve any written interpretations, written responses to requests for no-action letters and legal opinions, or other written interpretive guidance concerning the scope or terms of section 15G and the final rules issued thereunder that are intended to be relied on by the public generally.

Similarly, the appropriate Agencies will jointly approve any exemptions, exceptions, or adjustments to the final rules.

For these purposes, the phrase “appropriate Agencies” refers to the Agencies with rulewriting authority for the asset class, securitization transaction, or other matter addressed by the interpretation, guidance, exemption, exceptions, or adjustments. The Agencies expect to coordinate with each other to facilitate the processing, review and action on requests for such written interpretations or guidance, or additional exemptions, exceptions or adjustments.

These items would not include staff comment letters and informal written guidance provided to specific institutions or matters raised in a report of examination or inspection of a supervised institution, which are not intended to be relied on by the public generally.

See

15 U.S.C. 78o-11(c)(1)(G)(i) and (e)(1); proposed rules at § _.22.

II. General Definitions and Scope

Section _.2 of the proposed rules defines terms used throughout the proposed rules. Certain of these definitions are discussed in this part of the Supplementary Information. Other terms are discussed together with the section of the proposed rules where they are used. For example, certain definitions that relate solely to the exemptions for securitizations based on QRMs and certain qualifying commercial, commercial real estate, and automobile loans, are contained in, and are discussed in the context of, those sections (

see

subpart C of the proposed rules).

A. Asset-Backed Securities, Securitization Transaction and ABS Interests

The proposed risk retention rules would apply to securitizers in securitizations that involve the issuance of “asset-backed securities” as defined in section 3(a)(77) of the Exchange Act, which also was added to the Exchange Act by section 941 of the Dodd-Frank Act.

Section 3(a)(77) of the Exchange Act generally defines an “asset-backed security” to mean “a fixed-income or other security collateralized by any type of self-liquidating financial asset (including a loan, lease, mortgage, or other secured or unsecured receivable) that allows the holder of the security to receive payments that depend primarily on cash flow from the asset.”

The proposed rules incorporate by reference this definition of asset-backed security from the Exchange Act.

Consistent with this definition, the proposed rules also define the term “asset” to mean a self-liquidating financial asset, including loans, leases, or other

receivables.

The proposal defines the term “securitized asset” to mean an asset that is transferred, sold, or conveyed to an issuing entity and that collateralizes the ABS interests issued by the issuing entity.

See

section 941(a) of the Dodd-Frank Act.

See

15 U.S.C. § 78c(a)(77). The term also (i) includes any other security that the Commission, by rule, determines to be an asset-backed security for purposes of section 15G of the Exchange Act; and (ii) does not include a security that is issued by a finance subsidiary and held by the parent company of the finance subsidiary or a company that is controlled by such parent company provided that none of the securities issued by the finance subsidiary are held by an entity that is not controlled by the parent company.

See

proposed rules at § _.2 (definition of “asset-backed security”).

See

proposed rules at § _.2 (definition of “asset”). Because the term “asset-backed security” for purposes of section 15G includes only those securities that are collateralized by self-liquidating financial assets, “synthetic” securitizations are not within the scope of the proposed rules.

See

proposed rules at § _.2. Assets or other property collateralize an issuance of ABS interests if the assets or property serves as collateral for such issuance. Assets or other property serve as collateral for an ABS issuance if they provide the cash flow for the ABS interests issued by the issuing entity (regardless of the legal structure of the issuance), and may include security interests in assets or other property of the issuing entity, fractional undivided property interests in the assets or other property of the issuing entity, or any other property interest in such assets or other property. The term collateral includes leases that may convert to cash proceeds from the disposition of the physical property underlying the assets. The cash flow from an asset includes any proceeds of a foreclosure on, or sale of, the asset.

See

proposed rules at § _.2 (definition of “collateral” for an ABS transaction).

Section 15G does not appear to distinguish between transactions that are registered with the Commission under the Securities Act of 1933 (the “Securities Act”) and those that are exempt from registration under the Securities Act. For example, section 15G provides authority for exempting from the risk retention requirements certain securities that are exempt from registration under the Securities Act.

In addition, the statutory definition of asset-backed security is broader than the definition of asset-backed security in the Commission's Regulation AB,

which governs the disclosure requirements for ABS offerings that are registered under the Securities Act.

The definition of asset-backed security for purposes of section 15G also includes securities that are typically sold in transactions that are exempt from registration under the Securities Act, such as CDOs, as well as securities issued or guaranteed by a government sponsored entity (GSE), such as the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac). In light of the foregoing, the proposed risk retention requirements would apply to securitizers of ABS offerings whether or not the offering is registered with the Commission under the Securities Act.

See,

e.g., 15 U.S.C. 78o-11(c)(1)(G) (authorizing exemptions from the risk retention requirements certain transactions that are typically exempt from Securities Act registration); 15 U.S.C. 78o-11(e)(3)(B)(providing for certain exemptions for certain assets, or securitizations based on assets, which are insured or guaranteed by the United States).

17 CFR 229.1100 through 17 CFR 229.1123.

See

15 U.S.C. 78b.

As discussed further below, the proposed rules generally apply the risk retention requirements to the securitizer in each “securitization transaction,” which is defined as a transaction involving the offer and sale of ABS by an issuing entity.

Applying the risk retention requirements to the securitizer of each issuance of ABS ensures that the requirements apply in the aggregate to all ABS issued by an issuing entity, including an issuing entity—such as a master trust—that issues ABS periodically.

An “issuing entity” is defined to mean, with respect to a securitization transaction, the trust or other entity created at the direction of the sponsor that owns or holds the pool of assets to be securitized, and in whose name the ABS are issued.

See

proposed rules at § _.2.

The proposed rules use the term “ABS interest” to refer to all types of interests or obligations issued by an issuing entity, whether or not in certificated form, including a security, obligation, beneficial interest or residual interest, the payments on which are primarily dependent on the cash flows on the collateral held by the issuing entity. The term, however, does not include common or preferred stock, limited liability interests, partnership interests, trust certificates, or similar interests in an issuing entity that are issued primarily to evidence ownership of the issuing entity, and the payments, if any, on which are not primarily dependent on the cash flows of the collateral held by the issuing entity.

See

proposed rules at § _.2. In securitization transactions where ABS interests are issued and some or all of the cash proceeds of the transaction are retained by the issuing entity to purchase, during a limited time period after the closing of the securitization, self-liquidating financial assets to support the securitization, the terms “asset,” “collateral,” and “securitized assets” should be construed to include such cash proceeds as well as the assets purchased with such proceeds and any assets transferred to the issuing entity on the closing date. Accordingly, the terms “asset-backed security” and “ABS interest” should also be construed to include securities and other interests backed by such proceeds. Such securitization transactions are commonly referred to as including a “pre-funding account.”

B. Securitizer, Sponsor, and Depositor

Section 15G generally provides for the Agencies to apply the risk retention requirements of the statute to a “securitizer” of ABS. Section 15G(a)(3) in turn provides that the term “securitizer” with respect to an issuance of ABS includes both “(A) an issuer of an asset-backed security; or (B) a person who organizes and initiates an asset-backed securities transaction by selling or transferring assets, either directly or indirectly, including through an affiliate, to the issuer.”

See

15 U.S.C. 78o-11(a)(3).

The Agencies note that the second prong of this definition (i.e., the person who organizes and initiates the ABS transaction by selling or transferring assets, either directly or indirectly, including through an affiliate, to the issuer) is substantially identical to the definition of a “sponsor” of a securitization transaction in the Commission's Regulation AB governing disclosures for ABS offerings registered under the Securities Act.

In light of this, the proposed rules provide that a “sponsor” of an ABS transaction is a “securitizer” for the purposes of section 15G, and define the term “sponsor” in a manner consistent with the definition of that term in the Commission's Regulation AB.

See

Item 1101 of the Commission's Regulation AB (17 CFR 229.1101) (defining a sponsor as “a person who organizes and initiates an asset-backed securities transaction by selling or transferring assets, either directly or indirectly, including through an affiliate, to the issuing entity.”)

See

proposed rules at § __.2. Consistent with the Commission's definition of sponsor, the Agencies interpret the term “issuer” as used in section 15G(a)(3)(B) to refer to the issuing entity that issues the ABS.

The proposal would, as a general matter, require that a sponsor of a securitization transaction retain the credit risk of the securitized assets in the form and amount required by the proposed rules. The Agencies believe that proposing to apply the risk retention requirement to the sponsor of the ABS—as permitted by section 15G—is appropriate in light of the active and direct role that a sponsor typically has in arranging a securitization transaction and selecting the assets to be securitized.

In circumstances where two or more entities each meet the definition of sponsor for a single securitization transaction, the proposed rules would require that one of the sponsors retain a portion of the credit risk of the underlying assets in accordance with the requirements of this proposal.

Each sponsor in the transaction, however, would remain responsible for ensuring that at least one

sponsor complied with the requirements.

For example, in the context of collateralized loan obligations (CLOs), the CLO manager generally acts as the sponsor by selecting the commercial loans to be purchased by an agent bank for inclusion in the CLO collateral pool, and then manages the securitized assets once deposited in the CLO structure.

See

proposed rules at § _.3(a). Because the term sponsor is used throughout the proposed rules, the term is separately defined in § _.2 of the proposed rules. The definition of “sponsor” in § _.2 is identical to the sponsor part of the proposed rules' definition of a “securitizer.”

As noted above, the definition of “securitizer” in section 15G(a)(3)(A) includes the “issuer of an asset-backed security.” The term “issuer” when used in the federal securities laws may have different meanings depending on the context in which it is used. For example, for several purposes under the federal securities laws, including the Securities Act

and the Exchange Act

and the rules promulgated under these Acts,

the term “issuer” when used with respect to an ABS transaction is defined to mean the entity—the depositor—that deposits the assets that collateralize the ABS with the issuing entity. The Agencies interpret the reference in section 15G(a)(3)(A) to an “issuer of an asset-backed security” as referring to the “depositor” of the ABS, consistent with how that term has been defined and used under the federal securities laws in connection with ABS.

As noted above, the proposed rules generally would apply the risk retention requirements of section 15G to a sponsor of a securitization transaction (and not the depositor for the securitization transaction).

Section 2(a)(4) of Securities Act (15 U.S.C. 77b(a)(4)) defines the term “issuer” in part to include every person who issues or proposes to issue any security, except that with respect to certificates of deposit, voting-trust certificates, or collateral trust certificates, or with respect to certificates of interest or shares in an unincorporated investment trust not having a board of directors (or persons performing similar functions), the term issuer means the person or persons performing the acts and assuming the duties of depositor or manager pursuant to the provisions of the trust or other agreement or instrument under which the securities are issued.

See

Exchange Act sec. 3(a)(8) (15 U.S.C. 78c(a)(8) (defining “issuer” under the Exchange Act).

See,

e.g., Securities Act Rule 191 (17 CFR 230.191) and Exchange Act Rule 3b-19 (17 CFR 240.3b-19).

For asset-backed securities transactions where there is not an intermediate transfer of the assets from the sponsor to the issuing entity, the term depositor refers to the sponsor. For asset-backed securities transactions where the person transferring or selling the pool assets is itself a trust (such as in an issuance trust structure), the depositor of the issuing entity is the depositor of that trust.

See

proposed rules at § _.2. Securities Act Rule 191 and Exchange Act Rule 3b-19 also note that the person acting as the depositor in its capacity as depositor to the issuing entity is a different “issuer” from that person in respect of its own securities in order to make clear—for example—that any applicable exemptions from Securities Act registration that person may have with respect to its own securities are not applicable to the asset-backed securities. That distinction does not appear relevant here.

Originator

As permitted by section 15G, § _.13 of the proposed rules permit a sponsor to allocate its risk retention obligations to the originator(s) of the securitized assets in certain circumstances and subject to certain conditions. The proposed rules define the term originator in the same manner as section 15G, that is, as a person who, through the extension of credit or otherwise, creates a financial asset that collateralizes an asset-backed security, and sells the asset directly or indirectly to a securitizer (i.e., a sponsor or depositor). Because this definition refers to the person that “creates” a loan or other receivable, only the original creditor under a loan or receivable—and not a subsequent purchaser or transferee—is an “originator” of the loan or receivable for purposes of section 15G.

See

15 U.S.C. 78o-11(a)(3).

Request for Comment

1. Do the proposed rules appropriately implement the terms “securitizer” and “originator” as used in section 15G and consistent with its purpose?

2. Are there other terms, beyond those defined in § _.2 of the proposed rules, that the Agencies should define?

3(a). As a general matter, is it appropriate to impose the risk retention requirements on the sponsor of an ABS transaction, rather than the depositor for the transaction? 3(b). If not, why?

4(a). With respect to the terms defined, would you define any of the terms differently? 4(b). If so, which ones would you define differently, and how would you define them? For example, credit risk is defined to mean, among other things, the risk of loss that could result from failure of the issuing entity to make required payments or from bankruptcy of the issuing entity.

5. Is it appropriate for the definition of credit risk to include risk of non-payment by the issuing entity unrelated to the assets, such as risk that the issuing entity is not bankruptcy remote?

6. Are all of the definitions in § _.2 of the proposed rules necessary? For instance, is a definition of “asset” necessary?

7(a). As proposed, where two or more entities each meet the definition of sponsor for a single securitization transaction, the proposed rules would require that one of the sponsors retain a portion of the credit risk of the underlying assets in accordance with the requirements of the rules. Is this the best approach to take when there are multiple sponsors in a single securitization transaction? 7(b). If not, what is a better approach and why? For example, should all sponsors be required to retain credit risk in some proportional amount, should the sponsor selling the greatest number of assets or with a particular attribute be required to retain the risk, or should the proposed rules only allow a sponsor that has transferred a minimum percentage (e.g., 10 percent, 20 percent, or 50 percent) of the total assets into the trust to retain the risk?

8(a). Should the proposed rules allow for allocation of risk to a sponsor (among multiple sponsors in a single transaction) similar to the proposed rules' parameters for allocation of risk among multiple originators? 8(b). Why or why not?

9. A securitization transaction is proposed to be defined as a transaction involving the offer and sale of asset-backed securities by an issuing entity. In a single securitization transaction, there may be intermediate steps; however, the proposed rules would only require the sponsor to retain risk for the securitization transaction as a whole.

Should the rules provide additional guidance for when a transaction with intermediate steps constitutes one or more securitization transactions that each should be subject to the rules' risk retention requirements?

For example, in auto lease securitizations, the auto leases and car titles are originated in the name of a separate trust to avoid the administrative expenses of retitling the physical property underlying the leases. The separate trust will issue to the issuing entity for the asset-backed security a collateral certificate, often called a “special unit of beneficial interest” (SUBI). The issuing entity will then issue the asset-backed securities backed by the SUBI certificate.

III. General Risk Retention Requirement

A. Minimum 5 Percent Risk Retention Required

Section 15G of the Exchange Act generally requires that the Agencies jointly prescribe regulations that require a securitizer to retain not less than five percent of the credit risk for any asset that the securitizer, through the issuance of an ABS, transfers, sells, or conveys to a third party, unless an exemption from the risk retention requirements for the securities or transaction is otherwise available (e.g., if the ABS is collateralized exclusively by QRMs). Consistent with the statute, the proposed rules generally would require that a sponsor retain an economic interest equal to at least five percent of the aggregate credit risk of the assets collateralizing an issuance of ABS (the “base” risk retention requirement).

This exposure should provide a sponsor with an incentive to monitor and control the quality of the assets being securitized and help align the interests of the sponsor with those of investors in the ABS. As discussed in Part III.D of this Supplementary Information, the sponsor also would be prohibited from hedging or otherwise transferring this retained interest.

See

proposed rules at § _.3 through § _.11. We note that the proposed rules, in some instances, permit a sponsor to allow another person to retain the required amount of credit risk (e.g., originators,

third-party purchasers in commercial mortgage-backed securities transactions, and originator-sellers in asset-backed commercial paper conduit securitizations). However, in such circumstances the proposal includes limitations and conditions designed to ensure that the purposes of section 15G continue to be fulfilled. Further, we note that even when a sponsor would be permitted to allow another person to retain risk, the sponsor would still remain responsible under the rule for compliance with the risk retention requirements.

As required by section 15G, the proposed risk retention requirements would apply to all ABS transactions that are within the scope of section 15G, regardless of whether the sponsor is an insured depository institution, a bank holding company or subsidiary thereof, a registered broker-dealer, or other type of federally supervised financial institution. Thus, for example, it would apply to securitization transactions by any nonbank entity that is not an insured depository institution (such as an independent mortgage firm), as well as by Fannie Mae and Freddie Mac.

The Agencies note that the five percent risk retention requirement established by the proposed rules would be a regulatory

minimum.

The sponsor, originator, or other party to a securitization may retain, or be required to retain, additional exposure to the credit risk of assets that the sponsor, originator, or other party helps securitize beyond that required by the proposed rules, either on its own initiative or in response to the demands of private market participants. Moreover, the proposed rules would require that a sponsor, in certain circumstances, fund a premium capture cash reserve account in connection with a securitization transaction (see Part III.B.9 of this Supplementary Information). Any amount a sponsor might be required to place in a premium capture cash reserve account would be in addition to the five percent “base” risk retention requirement of the proposed rules.

Request for Comment

10. The Agencies request comment on whether the minimum five percent risk retention requirement established by the proposed rules for non-exempt ABS transactions is appropriate, or whether a higher risk retention requirement should be established for all non-exempt ABS transactions or for any particular classes or types of non-exempt ABS.

11. If a higher minimum requirement should be established, what minimum should be established and what factors should the Agencies take into account in determining that higher minimum? For example, should the amount of credit risk be based on expected losses, or a market-based test based on the interest rate spread relative to a benchmark index?

12(a). Would the minimum five percent risk retention requirement, as proposed to be implemented, have a significant adverse effect on liquidity or pricing in the securitization markets for certain types of assets (such as, for example, prudently underwritten residential mortgage loans that do not satisfy all of the requirements to be a QRM)? 12(b). If so, what markets would be adversely affected and how? What adjustments to the proposed rules (e.g., the minimum risk retention amount, the manner in which credit exposure is measured for purposes of applying the risk retention requirement, or the form of risk retention) could be made to the proposed rules to address these concerns in a manner consistent with the purposes of section 15G? Please provide details and supporting data.

B. Permissible Forms of Risk Retention

As recognized in recent studies and reports on securitization and risk retention that have examined historical market practices, there are several ways in which a sponsor or other entity may have retained exposure to the credit risk of securitized assets.

These include (i) a “vertical” slice of the ABS interests, whereby the sponsor or other entity retains a specified

pro rata

piece of every class of interests issued in the transaction; (ii) a “horizontal” first-loss position, whereby the sponsor or other entity retains a subordinate interest in the issuing entity that bears losses on the assets before any other classes of interests; (iii) a “seller's interest” in securitizations structured using a master trust collateralized by revolving assets whereby the sponsor or other entity holds a separate interest that is

pari passu

with the investors' interest in the pool of receivables (unless and until the occurrence of an early amortization event); or (iv) a representative sample, whereby the sponsor retains a representative sample of the assets to be securitized that exposes the sponsor to credit risk that is equivalent to that of the securitized assets. These examples are not exclusive.

See

Board Report;

see also

S. Rep. No. 111-176, at 130 (2010) (“The Committee [on Banking, Housing, and Urban Affairs] believes that implementation of risk retention obligations should recognize the differences in securitization practices for various asset classes.”).

The Agencies note that a variation of the vertical, horizontal, seller's interest and representative sample options described below are forms of eligible risk retention in the proposed European Union capital requirement directive relating to securitizations.

See

“Call for Technical Advice on the Effectiveness of a Minimum Retention Requirement for Securitizations,” Committee of European Bank Supervisors (October 30, 2009) (CEBS proposal).

Request for Comment

13. Is the proposed menu of options approach to risk retention, which would allow a sponsor to choose the form of risk retention (subject to all applicable terms and conditions), appropriate?

14(a). Should the Agencies mandate that sponsors use a particular form of risk retention (e.g., a vertical slice or a horizontal slice) for all or specific types of asset classes or specific types of transactions? 14(b). If so, which forms should be required for with which asset classes and why?

15. Does the proposed menu approach achieve the objectives of the statute to provide securitizers an incentive to monitor and control the underwriting quality of securitized assets and help align incentives among originators, sponsors, and investors?

16. Is each of the proposed forms of risk retention appropriate? In particular, the Agencies seek comment on the potential effectiveness of the proposed forms of risk retention in achieving the purposes of section 15G, their potential effect on securitization markets, and any operational or other problems these forms may present.

17. Are there any kinds of securitizations for which a particular form of risk retention is not appropriate?

18. How effective would each of the proposed risk retention options be in creating incentives to monitor and control the quality of assets that are securitized and in aligning the interests among the parties in a securitization transaction?

19(a). Are there other forms of risk retention that the Agencies should permit? 19(b). If so, please provide a detailed description of the form(s), how such form(s) could be implemented, and whether such form(s) would be appropriate for all, or just certain, classes of assets.

20. Should the proposed rules require disclosure as to why the sponsor chose a particular risk retention option?

21(a). Are there ways that sponsors could avoid the risk retention requirements in an effort to reduce or eliminate their risk retention requirements? 21(b). If so, how should we modify the proposed rules to address this potential?

22. Are the methodologies proposed for calculating the required five percent exposure under each of the options appropriate?

23(a). Are there other ways that the minimum five percent requirement should be calculated? 23(b). Would such calculation methods be difficult to enforce? 23(c). If so, how can we address those difficulties? 23(d). Are there other alternatives?

1. Vertical Risk Retention

As proposed, a sponsor may satisfy its risk retention requirements with respect to a securitization transaction by retaining at least five percent of each class of ABS interests issued as part of the securitization transaction.

A sponsor using this approach must retain at least five percent of each class of ABS interests issued in the securitization transaction regardless of the nature of the class of ABS interests (e.g., senior or subordinated) and regardless of whether the class of interests has a par value, was issued in certificated form, or was sold to unaffiliated investors. For example, if four classes of ABS interests were issued by an issuing entity as part of a securitization—a senior AAA-rated class, a subordinated class, an interest-only class, and a residual interest—a sponsor using this approach with respect to the transaction would have to retain at least five percent of each such class or interest.

The proposed rules do not specify a method of measuring the amount of each class, because the amount retained, regardless of method of measurement, should equal at least five percent of the par value (if any), fair value, and number of shares or units of each class.

See

proposed rules at § _.4.

As noted previously, the proposed definition of ABS interests does not include common or preferred stock, limited liability interests, partnership interests, trust certificates or similar interests that are issued primarily to evidence ownership of the issuing entity and the payments, if any, on which are not primarily dependent on the cash flows of the assets of the issuing entity.

See

proposed rules at § _.2 (definition of “ABS interests”).

Under the vertical risk retention option, by holding a five percent vertical slice in an ABS issuance, a sponsor is exposed to five percent of the credit risk that each class of investors has to the underlying collateral. This provides the sponsor an interest in the entire structure of the securitization transaction.

Under the proposed rules, a sponsor that elects to retain risk through the vertical slice option would be required to provide, or cause to be provided, to potential investors a reasonable time prior to the sale of the asset-backed securities in the securitization transaction and, upon request, to the Commission and to its appropriate Federal banking agency (if any), the amount (expressed as a percentage and a dollar amount) of each class of ABS interests in the issuing entity that the sponsor will retain (or did retain) at closing as well as the amount (expressed, again, as a percentage and dollar amount) that the sponsor is required to retain under the proposed rules. This disclosure would allow investors to know what risk the sponsor will actually retain in the transaction and compare this amount to the risk that the sponsor is required to retain under the proposed rules. In addition, the proposed rules would require a sponsor to disclose, or cause to be disclosed, the material assumptions and methodologies it used to determine the aggregate dollar amount of ABS interests issued by the issuing entity in the securitization transaction, including those pertaining to any estimated cash flows and the discount rate used. Disclosure of these assumptions and methodologies should help investors and the Agencies monitor the sponsor's compliance with its risk retention requirements because the five percent risk retention requirement is based on the aggregate amount of each class of ABS interests issued as part of the transaction.

For similar reasons, disclosure of such assumptions and methodologies would be required under the other risk retention options where the amount of the sponsor's required amount of risk retention is based on the amount of interests issued by the issuing entity or the amount of the collateral underlying such interests. Depending on the circumstances, a sponsor may have an incentive to inflate the value of the underlying collateral and the ABS supported by such collateral (for example, to increase the proceeds from the securitization transaction) or to underestimate the value of such collateral and ABS (for example, to reduce the sponsor's risk retention requirement). The material assumptions relating to estimated cash flows likely would include those relating to the estimated default rate, prepayment rate, the time between default and recoveries on the underlying assets, as well as interest rate projections for assets with variable interest rates.

Request for Comment

24. Are the disclosures proposed sufficient to provide investors with all material information concerning the sponsor's retained interest in a securitization transaction, as well as to enable investors and the Agencies to monitor the sponsor's compliance with the rule?

25(a). Should additional disclosures be required? 25(b). If so, what should be required and why?

26. Are there any additional factors, such as cost considerations, that the Agencies should consider in formulating an appropriate vertical risk retention option?

2. Horizontal Risk Retention

As proposed, the second risk retention option permits a sponsor to satisfy its risk retention obligations by retaining an “eligible horizontal residual interest” in the issuing entity in an amount that is equal to at least five percent of the par value of all ABS interests in the issuing entity that are issued as part of the securitization transaction.

As discussed below, the eligible horizontal residual interest would expose the sponsor to a five percent first-loss exposure to the credit risk of the entire pool of securitized assets.

See

proposed rules at § _.4.

The proposed rules include a number of terms and conditions governing the structure of an eligible horizontal residual interest in order to ensure that the interest would be a “first-loss” position,

and could not be reduced in principal amount (other than through the absorption of losses) more quickly than more senior interests and, thus, would remain available to absorb losses on the securitized assets. Specifically, an interest qualifies as an “eligible horizontal residual interest” under the proposed rules only if it is an ABS interest that is allocated all losses on the securitized assets until the par value of the class is reduced to zero and has the most subordinated claim to payments of both principal and interest by the issuing entity.

As discussed in Part III.B.9 of this Supplemental Information, if a sponsor is required to establish and fund a premium capture cash reserve account in connection with a securitization transaction, such account would first bear losses on the securitized assets (even before an eligible horizontal residual interest) until the account was depleted.

See

proposed rules at § _.2 (definition of “eligible horizontal residual interest”).

Moreover, until all other ABS interests in the issuing entity are paid in full, the eligible horizontal residual interest generally cannot receive any payments of principal made on a securitized asset. However, the interest may receive its proportionate share of scheduled payments of principal received on the securitized assets in accordance with the relevant transaction documents. For example, so long as any other ABS interests are outstanding, a sponsor, through its ownership of the eligible horizontal residual interest, would be prohibited from receiving any prepayments of principal made on the underlying assets because these are, by definition, unscheduled payments. This sponsor also would be prohibited from receiving principal payments made on the underlying assets derived from proceeds from the sale of, or foreclosure on, an underlying asset. The prohibition of unscheduled payments to the eligible horizontal residual interest is designed to ensure that unscheduled payments would not accelerate the payoff of the eligible horizontal residual interest before other ABS interests. Such acceleration would reduce the capacity of the eligible horizontal residual interest to absorb losses on the securitized assets as well as the duration of the sponsor's interest in the securitized assets. The proposed rules would, however, permit the eligible horizontal residual interest to receive its pro rata share of scheduled principal payments on the underlying assets.

Thus, an eligible horizontal residual interest with a par value of five percent of the aggregate par value of all ABS interests could, subject to its most subordinate place in the payments waterfall, (i) initially be entitled to receive up to five percent of scheduled principal payments received on the securitized assets, and (ii) if losses reduced the par value of the interest to three percent, receive no more than three percent of scheduled principal payments received on the securitized assets.

Similar to the vertical slice risk retention option, under the proposed rules, a sponsor using the horizontal risk retention option would be required to provide, or cause to be provided, to potential investors a reasonable period of time prior to the sale of ABS interests in the issuing entity and, upon request, to the Commission and its appropriate Federal banking agency (if any): the amount (expressed as a percentage and dollar amount) of the eligible horizontal residual interest that will be retained (or was retained) by the sponsor at closing, and the amount (expressed as a percentage and dollar amount) of the eligible horizontal residual interest required to be retained by the sponsor in connection with the securitization transaction; a description of the material terms of the eligible horizontal residual interest, such as when such interest is allocated losses or may receive payments; and the material assumptions and methodologies used in determining the aggregate dollar amount of ABS interests issued by the issuing entity in the securitization transaction, including those pertaining to any estimated cash flows and the discount rate used.

In lieu of holding an eligible horizontal residual interest, the proposed rules would allow a sponsor to cause to be established and funded, in cash, a reserve account at closing

(horizontal cash reserve account) in an amount equal to at least five percent of the par value of all the ABS interests issued as part of the transaction (i.e., the same dollar amount as would be required if the sponsor held an eligible horizontal residual interest).

This horizontal cash reserve account would have to be held by the trustee (or person performing functions similar to a trustee) for the benefit of the issuing entity. The proposed rules include several important restrictions and limitations on such a horizontal cash reserve account. These limitations and restrictions are intended to ensure that a sponsor that establishes a horizontal cash reserve account would be exposed to the same amount and type of first-loss credit risk on the underlying assets as would be the case if the sponsor held an eligible horizontal residual interest.

See

proposed rules at § _.4(b).

Specifically, the proposed rules would provide that, until all ABS interests in the issuing entity are paid in full or the issuing entity is dissolved, the horizontal cash reserve account must be used to satisfy payments on ABS interests on any payment date when the issuing entity has insufficient funds from any source (including any premium capture cash reserve account established under § _.12 of the proposed rules) to satisfy an amount due on any ABS interest.

Thus, the amounts in the account would bear first loss on the securitized assets in the same way as an eligible horizontal residual interest. In addition, until all ABS interests in the issuing entity are paid in full or the issuing entity is dissolved, the proposed rules would prohibit any other amounts from being withdrawn or distributed from the account, with only two exceptions. The first exception would allow amounts in the account to be released to the sponsor (or any other person) due to receipt by the issuing entity of scheduled payments of principal on the securitized assets, provided that the issuing entity distributes such payments of principal in accordance with the transaction documents and the amount released from the horizontal cash reserve account on any date does not exceed the product of: (i) The amount of scheduled payments of principal on the securitized assets received by the issuing entity and for which the release is being made; and (ii) the ratio of the current balance in the horizontal cash reserve account to the aggregate remaining principal balance of all ABS interests in the issuing entity. This limitation is intended to ensure that, like an eligible horizontal residual interest, a horizontal cash reserve account would not be depleted by unscheduled payments of principal on the underlying assets. The second exception would be that the sponsor would be permitted to receive interest payments (but not principal payments) received by the horizontal cash reserve account on its permitted investments.

See

proposed rules at § _.4(b)(3)(i).

Under the proposed rules, amounts in a horizontal cash reserve account may only be invested in (i) United States Treasury securities with remaining maturities of 1 year or less; and (ii) deposits in one or more insured depository institutions (as defined in section 3 of the Federal Deposit Insurance Act (12 U.S.C. 1813)) that are fully insured by federal deposit insurance.

See

proposed rules at § _.4(b)(2).

A sponsor electing to establish and fund a horizontal cash reserve account would be required to provide disclosures similar to those required with respect to an eligible horizontal residual interest, except that these disclosures have been modified to reflect the different nature of the account.

Request for Comment

27. Do the conditions and limitations in the proposed rules effectively limit the ability of the sponsor to structure away its risk exposure?

28(a). Is the restriction on certain payments to the sponsor with respect to the eligible horizontal residual interest appropriate and sufficient? 28(b). Why or why not?

29(a). Is the proposed approach to measuring the size of horizontal risk retention (five percent of the par value of all ABS interests in the issuing entity that are issued as part of the securitization transaction) appropriate? 29(b). Would a different measurement be better? Please provide details and data supporting any alternative measurements.

30. Are the disclosures proposed sufficient to provide investors with all material information concerning the sponsor's retained interest in a securitization transaction, as well as enable investors and the Agencies to monitor whether the sponsor has complied with the rule?

31(a). Should additional disclosures be required? 31(b). If so, what should be required and why?

32. Are there any additional factors, such as accounting or cost considerations that the Agencies should consider with respect to horizontal risk retention?

33. Should a sponsor be prohibited from utilizing the horizontal risk retention option if the sponsor (or an affiliate) acts as servicer for the securitized assets?

34. Are the terms and conditions of the horizontal cash reserve account appropriate?

35. Do the terms and conditions ensure that such an account will expose the sponsor to the same type and amount of credit risk and have the same incentive effects as an eligible horizontal residual interest?

36(a). Should the eligible horizontal residual interest be required to be structured as a “Z bond” such that it pays no interest while principal is being paid down on more senior interests? 36(b). Why or why not?

3. L-Shaped Risk Retention

The next risk retention option in the proposed rules would allow a sponsor, subject to certain conditions, to use an equal combination of vertical risk retention and horizontal risk retention as a means of retaining the required five percent exposure to the credit risk of the securitized assets. This form of risk retention is referred to as an “L-Shaped” form of risk retention because it combines both vertical and horizontal forms. Specifically, § _.6 of the proposed rules would allow a sponsor to meet its risk retention obligations under the rules by retaining:

(i) Not less than 2.5 percent of each class of ABS interests in the issuing entity issued as part of the securitization transaction (the vertical component); and

(ii) An eligible horizontal residual interest in the issuing entity in an amount equal to at least 2.564 percent of the par value of all ABS interests in the issuing entity issued as part of the securitization transaction, other than those interests required to be retained as part of the vertical component (the horizontal component).

As under the horizontal risk retention option itself, a sponsor would have the option of establishing and funding, in cash, a horizontal cash reserve account at the closing of the securitization transaction in this amount rather than holding an eligible horizontal residual interest.

See

proposed rules at § _.4(b). Any such horizontal cash reserve account would be subject to the same restrictions and limitations as under the horizontal risk retention option.

The amount of the horizontal component is calibrated to avoid double counting that portion of an eligible horizontal residual interest that the sponsor is required to hold as part of the vertical component. This calibration also ensures that the combined amount of the vertical component and the horizontal component would be five percent of the aggregate transaction. For example, in a securitization transaction structured with three classes of interests: A certificated senior class whose par value is equal to $950, an

uncertificated subordinated class of $24 and an uncertificated eligible horizontal residual interest whose par value is equal to $26, a sponsor would be required to retain $23.75 of the senior class ($950*2.5%), $0.60 of the subordinated class ($24*2.5%) and $25.65 of the eligible horizontal residual interest (($26*2.5%) + ($1000 − ($23.75 + $0.60 + $0.65))*2.564%) for a total of $50 in risk retention requirements. Because the required size of the sponsor's retained eligible horizontal residual interest ($25.65) is less than the amount of the eligible horizontal residual interest, retention of the entire horizontal residual interest by the sponsor complies with the minimum L-shape retention requirements for the securitization.

This example is provided for simple illustration only.

The proposal would require that a sponsor hold 50 percent of its required risk retention amount in the form of a vertical component and 50 percent in the form of a horizontal component in order to help ensure that each component is large enough to affect the sponsor's incentives and to help align the incentives of the sponsor and investors. In addition, requiring that each component represent 50 percent of the total minimum risk retention requirement should assist investors and the Agencies with monitoring compliance with the proposed rules.

Because a sponsor using the L-shape risk retention option would retain both a vertical and a horizontal component, the proposed rules would require that the sponsor provide the disclosures required under the vertical risk retention option, as well as those required under the horizontal risk retention option.

Request for Comment

37. Are the disclosures proposed sufficient to provide investors with all material information concerning the sponsor's retained interest in a securitization transaction, as well as enable investors and the Agencies to monitor whether the sponsor has complied with the rule?

38(a). Should additional disclosures be required? 38(b). If so, what should be required and why?

39. Are there any additional factors, such as cost considerations, that the Agencies should consider with respect to L-shape risk retention?

40(a). Should the Agencies permit or require that a higher proportion of the risk retention held by a sponsor under this option be composed of a vertical component or a horizontal component? 40(b). What implications might such changes have on the effectiveness of the option in helping achieving the purposes of section 15G?

4. Revolving Asset Master Trusts (Seller's Interest)

Securitizations backed by revolving lines of credit, such as credit card accounts or dealer floorplan loans, often are structured using a revolving master trust, which allows the trust to issue more than one series of ABS backed by a single pool of the revolving assets.

In these types of transactions, the sponsor typically holds an interest known as a “seller's interest.” This interest is

pari passu

with the investors' interest in the receivables backing the ABS interests of the issuing entity until the occurrence of an early amortization event. A seller's interest is a direct, shared interest with all of the investors in the performance of the underlying assets and, thus, exposes the sponsor to the credit risk of the pool or receivables.

In a master trust securitization, assets (e.g., credit card receivables or dealer floorplan financings) may be added to the pool in connection with future issuances of the securities backed by the pool.

In light of and to accommodate those types of securitizations, the proposed rules would allow a sponsor of a revolving asset master trust that is collateralized by loans or other extensions of credit that arise under revolving accounts to meet its base risk retention requirement by retaining a seller's interest in an amount not less than five percent of the unpaid principal balance of all the assets held by the issuing entity.

The proposed rules define a “revolving asset master trust” as an issuing entity that (i) is a master trust; and (ii) is established to issue more than one series of ABS, all of which are collateralized by a single pool of revolving securitized assets that are expected to change in composition over time. The proposed rules also define a “seller's interest” as an ABS interest (i) in all of the assets that are held by the issuing entity and that do not collateralize any other ABS interests issued by the entity; (ii) that is

pari passu

with all other ABS interests issued by the issuing entity with respect to the allocation of all payments and losses prior to an early amortization event (as defined in the transaction documents); and (iii) that adjusts for fluctuations in the outstanding principal balances of the securitized assets. The definitions of a seller's interest and a revolving asset master trust are intended to be consistent with market practices and, with respect to seller's interest, designed to ensure that any seller's interest retained by a sponsor under the proposal would expose the sponsor to the credit risk of the underlying assets.

See

proposed rules at § _.7.

Under the proposed rules, a sponsor using the seller's interest option would be required to provide, or cause to be provided, in writing to potential investors a reasonable period of time prior to the sale of the asset-backed securities in the securitization transaction and, upon request, to the Commission and its appropriate Federal banking agency (if any) the amount (expressed as a percentage and dollar amount) of the seller's interest that the sponsor will retain (or has retained) in the transaction at closing and the amount (expressed as a percentage and dollar amount) that the sponsor is required to retain pursuant to § _.7 of the rule; a description of the material terms of the seller's interest; and the material assumptions and methodology used in determining the aggregate dollar amount of ABS interests issued by the issuing entity in the securitization transaction, including those pertaining to any estimated cash flows and the discount rate used.

Request for Comment

41(a). Should a sponsor of a revolving asset master trust be permitted to satisfy its base risk retention requirement by retaining the seller's interest, as proposed? 41(b). Why or why not?

42(a). Are there additional or different conditions that should be placed on this option? 42(b). If so, please explain in detail what other conditions would be appropriate.

43. Are there alternative methods of structuring risk retention for revolving asset master trust securitization transactions that should be permitted? Provide detailed descriptions and data or other support for any alternatives.

44. Are the proposed disclosures sufficient to provide investors with all material information concerning the sponsor's retained interest in a securitization transaction, as well as enable investors and the Agencies to monitor whether the sponsor has complied with the rule?

45(a). Should additional disclosures be required? 45(b). If so, what should be required and why?

46. Should a seller's interest form of risk retention be applied to any other types of securitization transactions? If so, explain in detail and provide data or other support for application to other types of securitization transactions.

5. Representative Sample

The next proposed risk retention option permits a sponsor of a

securitization transaction to meet its risk retention requirements by retaining a randomly selected representative sample of assets that is equivalent, in all material respects, to the assets that are transferred to the issuing entity and securitized, subject to certain conditions.

This method of risk retention has been used in connection with securitizations involving automobile loans where the underlying loans are not originated purely for distribution, but are securitized by the sponsor as part of a broader funding strategy. By retaining a randomly selected representative sample of assets, the sponsor retains exposure to substantially the same type of credit risk as investors in the ABS. Therefore, this structure provides a sponsor incentives to monitor and control the quality of the underwriting of the securitized assets and helps align the sponsor's incentives with those of investors in the ABS.

See

proposed rules at § _.8.

Consistent with other risk retention options, a sponsor using the representative sample approach would be required to retain at least five percent of the credit risk of the assets the sponsor identifies for securitization. Therefore, the unpaid principal balance of all the assets in the representative sample would be required to equal at least five percent of the aggregate unpaid principal balance of all the assets in the pool of assets initially identified for securitization (including those that end up in the representative sample). For example, if the assets that are identified for securitization have an aggregate unpaid principal balance of $100 million, the aggregate unpaid principal balance of the assets in the representative sample would be required to equal at least $5 million.

Stated otherwise, the unpaid principal balance of the assets comprising the representative sample must be no less than 5/95ths (5.264 percent) of the aggregate unpaid principal balance of all the assets that ultimately are securitized in the securitization transaction. The proposed rules use this approach to defining the minimum size of a representative sample.

See

proposed rules at § _.8(b)(1)(i).

To ensure that a sponsor that retains a representative sample remains exposed to substantially the same aggregate credit risks as investors in the ABS, the proposal would require the sponsor to construct a representative sample according to a specific process. As an initial step, the sponsor would need to designate a pool of at least 1,000 separate assets for securitization (the “designated pool”). The representative sample would be required to be drawn exclusively from the designated pool. Also, the designated pool would be prohibited from containing any assets other than those that are either securitized or selected for the representative sample. In the second step, the sponsor must use a random selection process to identify those loans from within the designated pool that will be included in the representative sample. This random selection process may not take account of any characteristic of the assets other than their unpaid principal balance.

After the sponsor randomly selects a representative sample from the designated pool, it would be required to assess that sample to ensure that, for each material characteristic of the assets, including the average unpaid principal balance, in the designated pool the mean of any quantitative characteristic, and the proportion of any characteristic that is categorical in nature, of the sample of assets randomly selected from the designated pool is within a 95 percent two-tailed confidence interval of the mean or proportion, respectively, of the same characteristic of all the assets in the designated pool.

Depending on the type of assets involved in the securitization, the material characteristics other than the unpaid principal balance of the assets might include, for example, the geographical location of the property securing the loan, the debt-to-income ratio(s) of the borrower (DTI ratio), and the interest rate payable on the loan. Characteristics such as the DTI ratio and the interest rate payable on the loan would be considered quantitative characteristics, and characteristics such as the geographic location of the property securing the loan would be considered categorical characteristics. Assuming the factors above are material, a sponsor using the representative sample option would be required to test the

mean

of the DTI ratio of loans in the representative sample against the

mean

of the DTI ratio of all assets in the designated pool (including the ones selected for the random sample). In addition, the sponsor would be required to test the

proportion

of the number of assets from one geographic location in the representative sample to the total number of assets in the representative sample against the

proportion

of the number of assets from the same geographic location in the designated pool to the total number of assets in the designated pool.

Without these statistical tests, a sample could be biased towards, for example, assets with a larger dollar value or assets with a lower expected risk of default. In summary, this process is designed to ensure that the assets randomly selected from the designated pool are, in fact, representative of the securitized pool. If this process does not produce a sample with equivalent material characteristics (as measured by the required two-tailed confidence level), the sponsor must repeat it as necessary in order to achieve an equivalent result or rely on another permissible option for retaining credit risk. The proposal permits this re-selection and testing process.

The proposal contains a variety of safeguards to ensure that the sponsor has constructed the representative sample in conformance with the requirements described above. For example, the sponsor would be required to have in place, and adhere to, policies and procedures for (i) identifying and documenting the material characteristics of the assets in the designated pool; (ii) selecting assets randomly from the designated pool for inclusion in the representative sample; (iii) testing the randomly selected sample of assets in the designated pool; (iv) maintaining, until all ABS interests are paid in full, documentation that clearly identifies the assets included in the representative sample; and (v) prohibiting, until all ABS interests are paid in full, assets in the representative sample from being included in the designated pool of any other securitization transaction.

In addition, prior to the sale of the asset-backed securities as part of the securitization transaction, the sponsor would be required to obtain an agreed upon procedures report from an independent, public accounting firm. At a minimum, the independent, public accounting firm must report on whether the sponsor has the policies and procedures mentioned above.

Once an acceptable agreed upon procedures report has been obtained, the sponsor may rely on such report for subsequent securitizations. However, if the sponsor's policies and procedures change in any material respect, a new agreed upon procedures report would be required. Under the proposal, the independent public accounting firm providing the agreed upon procedures report must report on the following minimum items:

See

proposed rules at § _.8(d)(2)(i)-(v).

(i) Policies and procedures that require the sponsor to identify and document the material characteristics of assets included in a designated pool of assets that meets the requirements of the proposal;

(ii) Policies and procedures that require the sponsor to select assets randomly in accordance with the proposal;

(iii) Policies and procedures that require the sponsor to test the randomly-selected sample of assets in accordance with the proposal of this section;

(iv) Policies and procedures that require the sponsor to maintain, until all ABS interests are paid in full, documentation that identifies the assets in the representative sample established in accordance with the proposal; and

(v) Policies and procedures that require the sponsor to prohibit, until all ABS interests are paid in full, assets in the representative sample from being included in the designated pool of any other securitization transaction.

Because the performance of the assets included in the representative sample could differ from the performance of the securitized assets if the two sets of assets were serviced under different standards or procedures, the proposal provides that, until such time as all ABS interests in the issuing entity have been fully paid or the issuing entity has been dissolved, servicing of the assets included in the representative sample must be conducted by the same entity and under the same contractual standards as the servicing of the securitized assets. In addition, the individuals responsible for servicing the assets comprising the representative sample or the securitized assets must not be able to determine whether an asset is held by the sponsor or held by the issuing entity.

A sponsor would also be required to comply with the hedging, transfer and sale restrictions in section _.14 with respect to the assets in the representative sample. Additionally, the sponsor would be prohibited from removing any assets from the representative sample and, until all ABS interests are repaid, causing or permitting the assets in the representative sample to be included in any other designated pool or representative sample established in connection with any other securitization transaction.

See

proposed rules at § _.8(f).

To help ensure that potential investors and the Agencies can monitor and assess the sponsor's compliance with these requirements, the proposal would require the sponsor to provide, or cause to be provided, the following disclosures to potential investors a reasonable period of time prior to the sale of asset-backed securities as part of the securitization transaction and to provide, or cause to be provided, the same information, upon request, to the Commission and its appropriate Federal banking agency (if any):

(i) The amount (expressed as a percentage of the designated pool and dollar amount) of assets included in the representative sample to be retained by the sponsor;

(ii) The amount (expressed as a percentage of the designated pool and dollar amount) of assets required to be included in the representative sample and retained by the sponsor;

(iii) A description of the material characteristics of the designated pool and the representative sample, including, but not limited to, the average unpaid principal balance of the assets in the designated pool and the representative sample, the means of the quantitative characteristics and proportions of characteristics that are categorical in nature with respect to each of the material characteristics of the assets in the designated pool and the representative sample, of appropriate introductory and explanatory information to introduce the characteristics, the methodology used in determining or calculating the characteristics, and any terms or abbreviations used;

See,

e.g., disclosure of pool characteristics required in registered transactions in the Commission's Regulation AB, Item 1111(b).

(iv) A description of the policies and procedures that the sponsor used for ensuring that the process for identifying the representative sample complies with the proposal and that the representative sample has equivalent material characteristics to those of the pool of securitized assets;

(v) Confirmation that an agreed upon procedures report was obtained as required by the proposal; and

(vi) The material assumptions and methodology used in determining the aggregate dollar amount of ABS interests issued by the issuing entity in the securitization transaction, including those pertaining to any estimated cash flows and the discount rate used.

Further, after the sale of the ABS, the sponsor would be required to provide, or cause to be provided, to investors at the end of each distribution period (as specified in the governing transaction documents) a comparison of the performance of the pool of securitized assets for the related distribution period with the performance of the assets in the representative sample for the related distribution period. A sponsor selecting the representative sample option also would be required to provide investors disclosure concerning the assets in the representative sample in the same form, level, and manner as it provides, pursuant to rule or otherwise, concerning the securitized assets. Therefore, if loan-level disclosure concerning the securitized assets was required, by rule or otherwise, to be provided to investors, the same level of disclosure would also be required concerning the representative sample.

Request for Comment

47. Should we include the representative sample alternative as a risk retention option?

48. Are the mechanisms that we have proposed adequate to ensure monitoring of the randomization process if such an alternative were permitted?

49. Is the requirement that the designated pool contain at least 1000 assets appropriate, or should a greater number of assets be required or a lesser number be permitted?

50. Are there material characteristics other than the average unpaid principal balance of all the assets that should be identified in the rule for purposes of the equivalent risk determination and disclosure requirements?

51. Are there any better ways to ensure an adequate randomization process and the equivalence of the representative sample to the pool of securitized assets? For example, would it be appropriate and sufficient if the sponsor were required to use a third party to conduct the random selection with no subsequent testing to determine if the sample constructed has material characteristics equivalent to those of the securitized assets?

52(a). Alternatively, would it be adequate if the sponsor was required to provide a third-party opinion that the selection process was random and that retained exposures are equivalent (i.e., share a similar risk profile) to the securitized exposures? 52(b). Would this opinion resemble a credit rating, thereby raising concerns about undue reliance on credit ratings? 52(c). If this approach were adopted, should the Agencies impose any standards of performance to be followed by such a third party, or that such third party have certain characteristics?

53. If the Agencies adopt a representative sample option, should the same disclosures be required regarding the securitized assets subject to risk retention that are required for the assets in the pool at the time of securitization and on an ongoing basis?

54. Should the retained exposures, as proposed, be subject to the same servicing standards as the securitized exposures?

55. Are the disclosures proposed sufficient to provide investors with all material information concerning the sponsor's retained interest in a securitization transaction, as well as enable investors and the Agencies to monitor whether the sponsor has complied with the rule?

56(a). Should additional disclosures be required? 56(b). If so, what should be required and why?

57(a). Is the condition that a sponsor obtain an agreed upon procedures report from an independent, public accounting firm appropriate? 57(b). If not, is there another mechanism that should be included in the option that helps ensure that the sponsor has constructed the representative sample in conformance with the requirements of the rule?

58(a). Is the requirement that the sponsor determine equivalency with a 95 percent two-tailed confidence appropriate? 58(b). If not, what measurement of equivalency do you recommend and why?

6. Asset-Backed Commercial Paper Conduits

The next risk retention option under the proposed rules is an option specifically designed for structures involving asset-backed commercial paper (ABCP) that is supported by receivables originated by one or more originators and that is issued by a conduit that meets certain conditions.

This option is designed to take account of the special structures through which this type of ABCP typically is issued, as well as the manner in which exposure to the credit risk of the underlying assets typically is retained by participants in the securitization chain for this type of ABCP.

See

proposed rules at § _.9.

ABCP is a type of liability that is typically issued by a special purpose vehicle (or conduit) sponsored by a financial institution or other sponsor. The commercial paper issued by the conduit is collateralized by a pool of assets, which may change over the life of the entity. Depending on the type of ABCP program being conducted, the assets collateralizing the ABCP may consist of a wide range of assets including auto loans, commercial loans, trade receivables, credit card receivables, student loans, and other securities. Like other types of commercial paper, the term of ABCP typically is short, and the liabilities are “rolled,” or refinanced, at regular intervals. Thus, ABCP conduits generally fund longer-term assets with shorter-term liabilities.

As proposed, this risk retention option in § __.9 of the proposed rules would be available only for short-term ABCP collateralized by receivables or loans and supported by a liquidity facility that provides 100 percent liquidity coverage from a regulated institution. This risk retention option would not be available to entities or ABCP programs that operate as securities or arbitrage programs.

ABCP conduits that purchase loans or receivables from one originator or multiple originators are commonly referred to as single-seller ABCP programs and multi-seller ABCP programs, respectively. In each of these programs, the sponsor of the ABCP conduit approves the originators whose loans or receivables will collateralize the ABCP issued by the conduit. An “originator-seller” will sell the eligible loans or receivables to an intermediate, bankruptcy remote SPV established by the originator-seller. The credit risk of the receivables transferred to the intermediate SPV then typically is separated into two classes—a senior interest that is purchased by the ABCP conduit and a residual interest that absorbs first losses on the receivables and is retained by the originator-seller. The residual interest retained by the originator-seller typically is sized so that it is sufficiently large to absorb all losses on the underlying receivables.

Structured investment vehicles (SIVs) and securities arbitrage ABCP programs both purchase securities (rather than receivables and loans from originators). SIVs typically lack liquidity facilities covering all of these liabilities issued by the SIV, while securities arbitrage ABCP programs typically have such liquidity support.

The ABCP conduit, in turn, issues short-term ABCP that is collateralized by the senior interests purchased from the intermediate SPVs (which itself is supported by the subordination provided by the residual interest retained by the originator-seller). The sponsor of these types of ABCP conduit, which is usually a bank or other regulated financial institution, also typically provides (or arranges for another regulated financial institution to provide) 100 percent liquidity coverage on the ABCP issued by the conduit. This liquidity support typically requires the support provider to provide funding to, or purchase assets from, the ABCP conduit in the event that the conduit lacks the funds necessary to repay maturing ABCP issued by the conduit.

The proposal includes several conditions designed to ensure that this option is available only to the type of single-seller or multi-seller ABCP conduits described above. For example, this option is available only with respect to ABCP issued by an “eligible ABCP conduit,” as defined by the proposal. The proposal defines an eligible ABCP conduit as an issuing entity that issues ABCP and that meets each of the following criteria.

First, the issuing entity must be bankruptcy remote or otherwise isolated for insolvency purposes from the sponsor and any intermediate SPV. Second, the ABS issued by an intermediate SPV to the issuing entity must be collateralized solely by assets originated by a single originator-seller.

Third, all the interests issued by an intermediate SPV must be transferred to one or more ABCP conduits or retained by the originator-seller. Fourth, a regulated liquidity provider must have entered into a legally binding commitment to provide 100 percent liquidity coverage (in the form of a lending facility, an asset purchase agreement, a repurchase agreement, or similar arrangement) to all the ABCP issued by the issuing entity by lending to, or purchasing assets from, the issuing entity in the event that funds are required to repay maturing ABCP issued by the issuing entity.

See

proposed rules at § _.2 (definition of “eligible ABCP conduit”).

Under the proposal, an originator-seller would mean an entity that creates assets through one or more extensions of credit and sells those assets (and no other assets) to an intermediate SPV, which in turn sells interests collateralized by those assets to one or more ABCP conduits. The proposal defines an intermediate SPV as a special purpose vehicle that is bankruptcy remote or otherwise isolated for insolvency purposes that purchases assets from an originator-seller and that issues interests collateralized by such assets to one or more ABCP conduits.

See

proposed rules at § _.2 (definitions of “originator-seller” and “intermediate SPV”).

The proposal defines a regulated liquidity provider as a depository institution (as defined in section 3 of the Federal Deposit Insurance Act (12 U.S.C. 1813)); a bank holding company (as defined in 12 U.S.C. 1841) or a subsidiary thereof; a savings and loan holding company (as defined in 12 U.S.C. 1467a) provided all or substantially all of the holding company's activities are permissible for a financial holding company under 12 U.S.C. 1843(k) or a subsidiary thereof; or a foreign bank (or a subsidiary thereof) whose home country supervisor (as defined in § 211.21 of the Federal Reserve Board's Regulation K (12 CFR 211.21)) has adopted capital standards consistent with the Capital Accord of the Basel Committee on Banking Supervision, as amended, provided the foreign bank is subject to such standards.

See http://www.bis.org/bcbs/index.htm

for more information about the Basel Capital Accord.

Under the proposed risk retention option applicable to ABCP conduit structures, the sponsor of an eligible ABCP conduit would be permitted to satisfy its base risk retention obligations under the rule if each originator-seller that transfers assets to collateralize the ABCP issued by the conduit retains the same amount and type of credit risk as would be required under the horizontal risk retention option as if the originator-seller was the sponsor of the intermediate SPV. Specifically, the proposal provides that a sponsor of an ABCP securitization transaction would satisfy its base risk retention requirement with respect to the issuance of ABCP by an eligible ABCP conduit if each originator-seller retains an eligible horizontal residual interest in each intermediate SPV established by or on

behalf of that originator-seller for purposes of issuing interests to the eligible ABCP conduit. The eligible horizontal residual interest retained by the originator-seller must equal at least five percent of the par value of all interests issued by the intermediate SPV. Accordingly, each originator-seller would be required to retain credit exposure to the receivables sold by that originator-seller to support issuance of the ABCP.

The eligible horizontal residual interest retained by the originator-seller would be subject to the same terms and conditions as apply under the horizontal risk retention option. Thus, for example, if an originator-seller transfers $100 of receivables to an intermediate SPV, which then issues senior interests and an eligible horizontal residual interest with an aggregate par value of $100, the originator-seller must retain an eligible horizontal residual interest with a par value of $5 or more.

Importantly, the originator-seller also would be prohibited from selling, transferring, and hedging the eligible horizontal residual interest that it is required to retain. This option is designed to accommodate the special structure and features of these types of ABCP programs.

As noted above, this would be the minimum amount of credit risk that must be retained as part of a securitization transaction.

Although the proposal would allow the originator-sellers (rather than the sponsor) to retain the required eligible horizontal residual interest, the proposal also imposes certain obligations directly on the sponsor in recognition of the key role the sponsor plays in organizing and operating an eligible ABCP conduit. Most importantly, the proposal provides that the sponsor of an eligible ABCP conduit that issues ABCP in reliance on this option would be responsible for compliance with the requirements of this risk retention option. The proposal also would require that the sponsor maintain policies and procedures to monitor the originator-sellers' compliance with the requirements of the proposal. In the event that the sponsor determines that an originator-seller no longer complies with the requirements of the rule (for example, because the originator-seller has sold the interest it was required to retain), the sponsor would be required to promptly notify, or cause to be notified, the investors in the securitization transaction of such noncompliance.

In addition, consistent with market practice, the proposal would require that the sponsor:

(i) Establish the eligible ABCP conduit;

(ii) Approve the originator-sellers permitted to sell or transfer assets, indirectly through an intermediate SPV, to the ABCP conduit;

(iii) Establish criteria governing the assets the originator-sellers are permitted to sell or transfer to an intermediate SPV;

(iv) Approve all interests in an intermediate SPV to be purchased by the eligible ABCP conduit;

(v) Administer the ABCP conduit by monitoring the interests acquired by the conduit and the assets collateralizing those interests, arranging for debt placement, compiling monthly reports, and ensuring compliance with the conduit documents and with the conduit's credit and investment policy; and

(vi) Maintain, and adhere to, policies and procedures for ensuring that the requirements of the rule have been met.

The sponsor of an ABCP conduit satisfies the definition of “sponsor” under the proposed rules. If the conduit does not satisfy the conditions for an “eligible ABCP conduit,” the sponsor must retain credit risk in accordance with another risk retention option included in the proposal (unless an exemption for the transaction exists).

The sponsor also would have to provide, or cause to be provided, to potential purchasers a reasonable period of time prior to the sale of any ABCP from the conduit, and to the Commission and its appropriate Federal banking agency, if any, upon request, the name and form of organization of each originator-seller that will retain (or has retained) an interest in the securitization transaction pursuant to § _.9 of the proposed rules (including a description of the form, amount, and nature of such interest), and of each regulated liquidity provider that provides liquidity support to the eligible ABCP conduit (including a description of the form, amount, and nature of such liquidity coverage).

Section 15G permits the Agencies to allow an originator (rather than a sponsor) to retain the required amount and form of credit risk and to reduce the amount of risk retention required of the sponsor by the amount retained by the originator.

In developing the proposed risk retention option for eligible ABCP conduits, the Agencies have considered the factors set forth in section 15G(d)(2) of the Exchange Act.

The terms of the proposed option for eligible ABCP conduits include conditions designed to ensure that the interests in the intermediate SPVs sold to an eligible ABCP conduit have low credit risk, and to ensure that originator-sellers have incentives to monitor the quality of the assets that are sold to an intermediate SPV and collateralize the ABCP issued by the conduit. In addition, the proposal is designed to effectuate the risk retention requirements of section 15G of the Exchange Act in a manner that facilitates reasonable access to credit by consumers and businesses through the issuance of ABCP backed by consumer and business receivables. Finally, as noted above, an originator-seller would be subject to the same restrictions on transferring the retained eligible horizontal residual interest to a third party as would apply to sponsors under the rule.

See

15 U.S.C. 78o-11(1)(c)(G)(iv) and (d) (permitting the Commission and the Federal banking agencies to allow the allocation of risk retention from a sponsor to an originator).

15 U.S.C. 78o-11(d)(2). These factors are whether the assets sold to the securitizer have terms, conditions, and characteristics that reflect low credit risk; whether the form or volume of transactions in securitization markets creates incentives for imprudent origination of the type of loan or asset to be sold to the securitizer; and the potential impact of the risk retention obligations on the access of consumers and businesses to credit on reasonable terms, which may not include the transfer of credit risk to a third party.

Request for Comment

59. Is the proposed risk retention option for eligible ABCP conduits appropriate?

60(a). Have the Agencies appropriately defined the terms (such as an eligible ABCP conduit, intermediate SPV and originator-seller) that govern use of this option? 60(b). Is the foregoing description of ABCP structures accurate? 60(c) Are there additional ABCP structures that are not easily adaptable to the risk retention options proposed? 60(d). If so, should the proposed ABCP option be revised to include these structures and if so, how?

61. Should the proposed option for securitizations structured using ABCP conduits require financial disclosure regarding the liquidity provider?

62(a). Also, should other entities be permitted to be liquidity providers for purposes of the rule? For example, should the rule permit an insurance company to be an eligible liquidity provider if the company is in the business of providing credit protection (such as a bond insurer or re-insurer) and is subject to supervision by a State insurance regulator or is a foreign insurance company subject to comparable regulation to that imposed by U.S. insurance companies?

62(b). Why or why not?

63. In addition, the Agencies seek confirmation that the terms of this option effectively prevent structures such as SIVs and ABCP programs that operate as arbitrage programs from using this option.

64. Should the rule, as proposed, allow the liquidity provider to be a depository institution holding company or a subsidiary of a depository institution instead of just the depository institution?

65. Are the disclosures proposed sufficient to provide investors with all material information concerning the originator-seller that will retain an interest in the securitization transaction and of each regulated liquidity provider that provides liquidity support to the eligible ABCP conduit, as well as enable investors and the Agencies to monitor whether the sponsor has complied with the rule?

66(a). Should additional disclosures be required? 66(b). If so, what should be required and why? 66(c). For example, should a sponsor be required to disclose the material assumptions and methodology used in determining the aggregate dollar amount of interests issued by each intermediate SPV? 66(d). Would such a disclosure be beneficial to investors? 66(e). In light of the broad range of asset classes that underlie ABCP conduits, would such a disclosure pose any operational or other challenges for sponsors of ABCP conduits?

67(a). Should we, as proposed, require that the ABCP be for a term of 270 days or less? 67(b). Should we allow for a longer term, such as up to one year?

7. Commercial Mortgage-Backed Securities

Section 15G(c)(1)(E) of the Exchange Act provides that, with respect to securitizations involving commercial mortgages, the regulations prescribed by the Agencies may provide for “retention of the first-loss position by a third-party purchaser that specifically negotiates for the purchase of such first loss position, holds adequate financial resources to back losses, provides due diligence on all individual assets in the pool before the issuance of the asset-backed securities, and meets the same standards for risk retention as the Federal banking agencies and the Commission require of the securitizer[.]”

In light of this provision, the Agencies are proposing to permit a sponsor of ABS that is collateralized by commercial real estate loans to meet its risk retention requirements if a third-party purchaser acquires an eligible horizontal residual interest in the issuing entity in the same form, amount, and manner as the sponsor would have been required to retain under the horizontal risk retention option and certain additional conditions are met.

15 U.S.C. 78o-11(c)(1)(E)(iv).

The allocation of a first-loss position to a third-party purchaser has been common practice in CMBS transactions for a number of years.

The third-party purchaser has been commonly referred to in the CMBS marketplace as a “B-piece buyer”

because the CMBS tranche or tranches purchased by this investor were either unrated by the credit rating agencies or assigned a below-investment grade credit rating. Typically a B-piece buyer purchases at a discount to face value the most subordinate tranche in the cash flow waterfall of the CMBS transaction. In order to manage its risk, the B-piece buyer often is involved early in the securitization process and has significant influence over the selection of pool assets. For example, the B-piece buyer often performs “due diligence” on the pool assets, which often means a review of the loans in the pool at the property and loan level. As a result of this review, a B-piece buyer may request that specific loans be removed from the pool prior to securitization.

See,

e.g., Board Report.

We note that under the proposal there is no requirement that the tranche or tranches purchased by the third-party purchaser be assigned any particular credit rating.

Additionally, a B-piece buyer is often designated as the “controlling class” under the terms of the pooling and servicing agreement governing the CMBS transaction, and in accordance with its rights as the controlling class, a B-piece buyer often names itself, or an affiliated company, as the “special servicer” in the transaction. Such servicer typically is the servicer authorized to service loans in default or having other non-payment issues. The control of special servicing rights by the B-piece buyer has the potential to create conflicts of interest with the senior certificate holders to the securitization. For example, the control of special servicing rights would allow the B-piece buyer to directly or indirectly manage any loan modifications. While some CMBS transactions required an “operating advisor” to oversee the servicing activities of the special servicer, in many instances this operating advisor works on behalf of the controlling class (i.e., the B-piece buyer unless and until losses reduced its junior tranche to zero). To help better address the potential conflict created by special servicer arrangements involving B-piece buyers, newly issued CMBS for which investors received financing through the Term-Asset Backed Securities Lending Facility (“TALF”) were required to have an independent operating advisor that acted on behalf of the investors as a collective whole, had consultative rights over major decisions of the special servicer, and had the ability to recommend replacement of the special servicer.

These operating advisor requirements also were coupled with enhanced disclosures to investors regarding major decisions by the B-piece buyer and special servicer. Aspects of these TALF requirements have been incorporated into recent CMBS transactions undertaken after the closing of the TALF to new financings.

The TALF was a special lending facility established by the Federal Reserve and the Treasury Department in response to the financial crisis to assist the financial markets in accommodating the credit needs of consumers and businesses of all sizes by facilitating the issuance of ABS collateralized by a variety of consumer and business loans. The TALF also was intended to improve the market conditions for ABS more generally. Additional information concerning the TALF is available on the public Web sites of the Board (

see http://www.federalreserve.gov/monetarypolicy/bst_lendingother.htm

) and the Federal Reserve Bank of New York (see

http://www.newyorkfed.org/markets/talf.html

In light of the specific provisions of Section 15G(c)(1)(E) and the historical market practice of third-party purchasers acquiring first-loss positions in CMBS transactions, the Agencies' proposal would allow a sponsor to meet its risk retention requirements under the rule if a third-party purchaser retains the necessary exposure to the credit risk of the underlying assets provided six conditions are met. These conditions are designed to help ensure that the form, amount, and manner of the third-party purchaser's risk retention are consistent with the purposes of section 15G of the Exchange Act. This option would be available only for securitization transactions where commercial real estate loans constitute at least 95 percent of the unpaid principal balance of the assets being securitized.

See

proposed rules at § _.10(a). “Commercial real estate loan” is defined in § _.16 of the proposed rules to mean a loan secured by a property with five or more single family units, or by nonfarm nonresidential real property, the primary source (fifty (50) percent or more) of repayment for which is expected to be derived from the proceeds of the sale, refinancing, or permanent financing of the property; or rental income associated with the property other than rental income derived from any affiliate of the borrower. A commercial real estate loan does not include a land development and construction loan (including 1- to 4-family residential or commercial construction loans); any other land loan; a loan to a real estate investment trust (REIT); or an unsecured loan to a developer.

The first condition requires that the third-party purchaser retain an eligible

horizontal residual interest in the securitization in the same form, amount, and manner as would be required of the sponsor under the horizontal risk retention option (proposed § _.5).

Accordingly, the interest acquired by the third-party purchaser must be the most junior interest in the issuing entity, and must be subject to the same limits on payments as would apply if the eligible horizontal residual interest were held by the sponsor pursuant to the horizontal risk retention option.

See

proposed rules at § _.10.

The second condition would require that the third-party purchaser pay for the first-loss subordinated interest in cash at the closing of the securitization without financing being provided, directly or indirectly, from any other person that is a party to the securitization transaction (including, but not limited to, the sponsor, depositor, or an unaffiliated servicer), other than a person that is a party solely by reason of being an investor.

This would prohibit the third-party purchaser or an affiliate of the third-party purchase from obtaining financing from any such person as well as from any affiliate of any such person. These requirements should help ensure that the third-party purchaser has sufficient financial resources to fund the acquisition of the first-loss subordinated interest and absorb losses on the underlying assets to which it would be exposed through this interest.

See

proposed rules at § _.10.

This requirement is consistent with section 15G(b)(1)(E)(ii) of the Exchange Act, which provides that the Agencies may consider whether a third-party purchaser of CMBS “holds adequate financial resources to back losses.”

The third condition relates to the third-party purchaser's review of the assets collateralizing the ABS. This proposed condition would require that the third-party purchaser perform a review of the credit risk of each asset in the pool prior to the sale of the asset-backed securities. This review must include, at a minimum, a review of the underwriting standards, collateral, and expected cash flows of each commercial loan in the pool.

The fourth condition is intended to address the potential conflicts of interest that can arise when a third-party purchaser serves as the “controlling class” of a CMBS transaction. This condition would prohibit a third-party purchaser from (i) being affiliated with any other party to the securitization transaction (other than investors); or (ii) having control rights in the securitization (including, but not limited to acting as servicer or special servicer) that are not collectively shared by all other investors in the securitization. The proposed prohibition of control rights related to servicing, would be subject to an exception, however, if the underlying securitization transaction documents provide for the appointment of an independent operating advisor (Operating Advisor) with certain powers and responsibilities.

Under the proposal, an “Operating Advisor” would be defined as a party that (i) is not affiliated with any other party to the securitization, (ii) does not directly or indirectly have any financial interest in the securitization other than in fees from its role as Operating Advisor, and (iii) is required to act in the best interest of, and for the benefit of, investors as a collective whole.

See

proposed rules at § _.10(a)(4)(i). The proposal also includes a

de minimis

exception to the general prohibition on affiliation with other parties to the securitization transaction. Under this

de minimis

exception, the third-party purchaser would be permitted to be affiliated with one or more originators of the securitized assets so long as the assets contributed by such originator(s) collectively comprise less than 10 percent of the assets in the pool (as measured by dollar volume).

See

proposed rules at § _.10(a)(4)(ii).

The Agencies believe that the introduction of an independent Operating Advisor would minimize the ability of third-party purchasers to manipulate cash flows through special servicing. In approving loans for inclusion in the securitization, the third-party purchaser will be mindful of the limits on its ability to offset the consequences of poor underwriting through servicing tactics if a loan becomes troubled, thereby providing stronger incentive for the third-party purchaser to be diligent in assessing credit quality of the pool assets at the time of securitization. For these types of securitization transactions, the third-party purchaser's review of each loan can serve as an effective check on the underwriting quality and credit risk of the underlying loans and the reliability of key information utilized.

Further, in order for a third-party purchaser to have servicing rights in connection with the securitization transaction, the securitization transaction documents must require that the Operating Advisor have certain powers and responsibilities in order to ensure that the Operating Advisor can effectively fulfill its advisory role in the transaction.

For example, as proposed, the transaction documents must require that, if the third-party purchaser or an affiliate acts as servicer, the servicer consult with the Operating Advisor in connection with, and prior to, any major decision in connection with the servicing of the securitized assets. Major decisions would include, without limitation, any material modification of, or waiver with respect to, any provision of a loan agreement, any foreclosure upon or comparable conversion of the ownership of a property, and any acquisition of a property.

See

proposed rules at § _.10(a)(4)(B)-(E).

The securitization transaction documents must also provide that the Operating Advisor is responsible for reviewing the actions of any servicer that is, or is, affiliated with the third-party purchaser and for issuing a report to investors and the issuing entity, on a periodic basis, concerning whether the Operating Advisor believes, in its sole discretion exercised in good faith, the servicer is in compliance with any standards required of the servicer as provided in the applicable transaction documents, and if not, the standard(s) with which the servicer is out of compliance. In addition, the securitization transaction documents must also provide that the Operating Advisor has the authority to recommend that a servicer that is, or is affiliated with, the third-party purchaser be replaced by a successor servicer if the Operating Advisor determines, in its sole discretion exercised in good faith, that the servicer has failed to comply with any standard required of the servicer as provided in the applicable transaction documents and that such replacement would be in the best interest of the investors as a collective whole. The relevant transaction documents must provide that, if such a recommendation is made, the servicer that is, or affiliated with, the third-party purchaser must be replaced unless a majority of each class of certificate holders eligible to vote on the matter votes to retain the servicer.

Consistent with other disclosure requirements under the proposed rules, the fifth proposed condition requires that the sponsor provide, or cause to be provided, potential purchasers certain information concerning the third-party purchaser and other information concerning the transaction. Specifically, the proposal would require that a sponsor disclose to potential investors a reasonable time before the sale of asset-backed securities and, upon request, to the Commission and its appropriate Federal banking agency (if any) the name and form of organization of the third-party purchaser, a description of the third-party purchaser's experience in investing in CMBS, and any other information regarding the third-party purchaser or the third-party purchaser's retention of the eligible horizontal residual interest that is material to

investors in light of the circumstances of the particular securitization transaction.

Additionally, a sponsor would be required to disclose the amount of the eligible horizontal residual interest that the third-party purchaser will retain (or has retained) in the transaction (expressed as a percentage of ABS interests in the issuing entity and as a dollar amount); the purchase price paid for such interest; the material terms of such interest; and the amount of the interest that the sponsor would have been required to retain if the sponsor had retained an interest in the transaction pursuant to the horizontal menu option. The material assumptions and methodology used in determining the aggregate amount of ABS interests of the issuing entity, including any estimated cash flows and the discount rate used, also must be included in the disclosure. The proposed rules would require that the sponsor provide, or cause to be provided, to potential investors the representations and warranties concerning the securitized assets, the schedule of any securitized assets that are determined not to comply with such representations and warranties, and what factors were used to make the determination that a securitized asset should be included in the pool notwithstanding that it did not comply with such representations and warranties, such as compensating factors or a determination that the exceptions(s) were not material.

Finally, the sixth condition would require that any third-party purchaser acquiring an eligible horizontal residual interest under this option comply with the hedging, transfer and other restrictions applicable to such interest under the proposed rules if the third-party purchaser was a sponsor who had acquired the interest under the horizontal risk retention option.

Although the third-party purchaser may retain the credit risk required under § _.3 of the proposed rules, the proposal provides that the sponsor remains responsible for compliance with the requirements described above. Therefore, consistent with the menu option available to eligible ABCP conduits, the proposal would require that the sponsor maintain and adhere to policies and procedures to monitor the third-party purchaser's compliance with these requirements. In the event that the sponsor determines that the third-party purchaser no longer complies with the requirements of the rule (for example, because the third-party purchaser has sold the interest it was required to retain), the sponsor must promptly notify the investors in the securitization transaction of such noncompliance.

Request for Comment

68(a). Should the rules allow a third-party purchaser to retain the required amount of risk in a CMBS transaction as described above?

68(b). Why or why not?

69(a). Should a third-party purchaser option be available to other asset classes besides CMBS? Would expanding this option to other asset classes fulfill the purposes of section 15G? 69(b). If so, would any adjustments or requirements be necessary?

70. Should the use of this option be conditioned, as proposed, on a requirement that the third-party purchaser separately examine the assets in the pool and/or not sell or hedge the interest it is required to retain?

71(a). Should the use of this option be conditioned, as proposed, on the requirement that the sponsor disclose the actual purchase price paid by the third-party purchaser for the eligible horizontal residual interest? 71(b). Why or why not?

72. Is any disclosure concerning the financial resources of the third-party purchaser necessary in light of the requirement that the third-party purchaser fund the acquisition of the eligible horizontal residual interest in cash without direct or indirect financing from a party to the transaction?

73(a). Should the rule specify the particular types of information about a third-party purchaser that should be disclosed, rather than requiring disclosure of any other information regarding the third-party purchaser that is material to investors in light of the circumstances of the particular securitization transaction? 73(b). Should the specific types of information about a third-party purchaser be in addition to any other information regarding the third-party purchaser that is material to investors in light of the circumstances of the particular securitization transaction?

74. Are the conditions relating to servicing, including those related to an Operating Advisor, appropriate or should they be modified or supplemented?

75(a). Should the Agencies require any other disclosure relating to representations and warranties concerning the assets for CMBS?

76(a). We are aware of at least one industry group developing model representations and warranties for CMBS.

Should the rule require that a blackline of the representations and warranties for the securitization transaction against an industry-accepted standard for model representations and warranties be provided to investors at a reasonable time prior to sale? 76(b). Would this provide more information regarding the adequacy of the representation and warranties being provided? 76(c). Would this be a costly requirement? 76(d). Could investors easily create their own blacklines if needed?

See,

e.g., comment letter to the Commission from CRE Finance Council dated January 19, 2011, available at

http://www.sec.gov/comments/df-title-ix/asset-backed-securities/assetbackedsecurities-37.pdf.

77. Are the disclosures proposed sufficient to provide investors with all material information concerning the third-party purchaser's retained interest in the securitization transaction, as well as to enable investors and the Agencies to monitor whether the sponsor has complied with the rule?

78(a). Should additional disclosures be required? 78(b). If so, what should be required and why?

8. Treatment of Government-Sponsored Enterprises

Section _.11 of the proposed rules would govern the credit risk retention requirements for the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac) (jointly, the “Enterprises”) while operating under the conservatorship or receivership of FHFA, as well as for any limited-life regulated entity succeeding to the charter of either Fannie Mae or Freddie Mac pursuant to section 1367 of the Federal Housing Enterprises Financial Safety and Soundness Act of 1992 (Safety and Soundness Act).

The primary business of the Enterprises under their respective charter acts is to pool conventional mortgage loans and to issue securities backed by these mortgages that are fully guaranteed as to the timely payment of principal and interest by the issuing Enterprise.

Because of these activities, Fannie Mae or Freddie Mac (or a successor limited-life regulated entity) would be the sponsor of the asset-backed securities that it issues for purposes of section 15G.

12 U.S.C. 4617.

See

12 U.S.C. 1451,

et seq.

(Freddie Mac); 12 U.S.C. 1716,

et seq.

(Fannie Mae).

In considering how to address in the proposal the risk retention requirements of section 15G with respect to the mortgage-backed securities issued, and fully guaranteed as to timely payment of principal and interest, by the Enterprises or a successor limited-life regulated entity, the Agencies considered several factors. Because Fannie Mae and Freddie Mac fully guarantee the timely payment of

principal and interest on the mortgage-backed securities they issue, the Enterprises are exposed to the entire credit risk of the mortgages that collateralize those securities.

The charters of Fannie Mae and Freddie Mac also place limitations on the types of mortgages that the Enterprises may guarantee and securitize.

Both Fannie Mae and Freddie Mac have been operating under the conservatorship of FHFA since September 6, 2008. As conservator, FHFA has assumed all powers formerly held by each Enterprise's officers, directors, and shareholders. In addition, FHFA, as conservator, is authorized to take such actions as may be necessary to restore each Enterprise to a sound and solvent condition and that are appropriate to preserve and conserve the assets and property of each Enterprise.

The primary goals of the conservatorships are to help restore confidence in the Enterprises, enhance their capacity to fulfill their mission, mitigate the systemic risk that contributed directly to instability in financial markets, and maintain the Enterprises' secondary mortgage market role until their future is determined through legislation. To these ends, FHFA's conservatorship of the Enterprises is directed toward minimizing losses, limiting risk exposure, and ensuring that the Enterprises price their services to adequately address their costs and risk. Any limited-life regulated entity established by FHFA to succeed to the charter of an Enterprise also would operate under the direction and control of FHFA, acting as receiver of the related Enterprise.

100

See

12 U.S.C. 4617(b)(2)(D).

100

See

12 U.S.C. 4617(i). The affairs of a limited-life regulated entity must be wound up not later than two years after its establishment, subject to the potential for a maximum of three one-year extensions at the discretion of the Director of FHFA.

Concurrently with being placed in conservatorship under section 1367 of the Safety and Soundness Act, each Enterprise entered into a Senior Preferred Stock Purchase Agreement (PSPA) with the United States Department of the Treasury (Treasury). Under each PSPA, Treasury purchased senior preferred stock of each Enterprise. In addition, if FHFA determines that the Enterprise's liabilities have exceeded its assets under generally accepted accounting principles (GAAP), Treasury will contribute cash capital to that Enterprise in an amount equal to the difference between its liabilities and assets. In exchange for this cash contribution, the liquidation preference of the senior preferred stock purchased from each Enterprise under the respective PSPA increases in an equivalent amount. The senior preferred stock of each Enterprise purchased by Treasury is senior to all other preferred stock, common stock or other capital stock issued by the Enterprise, and dividends on the aggregate liquidation preference of the senior preferred stock purchased by Treasury are payable at a rate of 10 percent per annum.

101

Under each PSPA, Treasury's commitment to each Enterprise is the greater of (1) $200 billion, or (2) $200 billion plus the cumulative amount of the Enterprise's net worth deficit as of the end of any calendar quarter in 2010, 2011 and 2012, less any positive net worth as of December 31, 2012.

102

Accordingly, the PSPAs provide support to the relevant Enterprise should the Enterprise have a net worth deficit as a result of the Enterprise's guaranty of timely payment on the asset-backed securities it issues. By their terms, the PSPA with an Enterprise may not be assigned or transferred, or inure to the benefit of, any limited-life regulated entity established with respect to the Enterprise without the prior written consent of Treasury.

101

Under the PSPAs, the rate rises to 12 percent per annum if the dividends are not paid in cash.

102

The PSPAs also provide for the retained portfolios of each Enterprise to be reduced over time.

In light of the foregoing, § _.11 of the proposed rules provides that the guaranty provided by an Enterprise while operating under the conservatorship or receivership of FHFA with capital support from the United States will satisfy the risk retention requirements of the Enterprise under section 15G of the Exchange Act with respect to the mortgage-backed securities issued by the Enterprise. Similarly, an equivalent guaranty provided by a limited-life regulated entity that has succeeded to the charter of an Enterprise, and that is operating under the direction and control of FHFA under section 1367(i) of the Safety and Soundness Act, will satisfy the risk retention requirements, provided that the entity is operating with capital support from the United States. If either Enterprise or a successor limited-life regulated entity were to begin to operate other than as provided in the proposed rules, that Enterprise or entity would no longer be able to avail itself of the credit risk retention option set forth in § _.11.

For similar reasons, the proposed r

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