Tuesday, April 12, 2011

Feds Issue Proposed Rule re: Dodd-Frank "Risk Retention" Requirements

The federal financial regulators issued the widely anticipated proposed rule regarding the risk-retention requirements of the Dodd-Frank Wall Street Reform and Consumer Protection Act.

A copy of the proposed rule is available at:


As you may recall, section 15G of Dodd-Frank generally requires the securitizer of asset-backed securities to retain not less than 5% 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" ("QRM"), a term to be defined by rule.


The proposed rule would define QRMs as those loans meeting certain underwriting standards, such as: (1) maximum front-end and back-end debt-to-income ratios of 28 percent and 36 percent, respectively; (2) 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); (3) a 20 percent down payment requirement in the case of a purchase transaction; and (4) credit history restrictions.

The proposed rule also includes investor disclosure requirements regarding material information concerning the sponsor's retained interests in a securitization transaction. According to the federal agencies, the disclosures would provide investors and the agencies with an efficient mechanism to monitor compliance with the risk-retention requirements of the proposed rules.

Certain Commercial, Auto ABS:

The proposed rule also has a zero percent risk-retention requirement for ABS collateralized exclusively by commercial loans, commercial mortgages, or automobile loans that meet certain underwriting standards. As with QRMs, the federal agencies state that the underwriting standards for such ABS were "designed to be robust and to ensure that the loans backing the ABS are of very low credit risk."

GSE Exclusion:

The proposed rule would also exempt Fannie Mae (the Federal National Mortgage Association) and Freddie Mac (the Federal Home Mortgage Loan

Corporation) as sponsors of mortgage-backed securities for as long as they are in conservatorship or receivership with capital support from the U.S. government.

Options for Meeting the 5% Risk Retention:

The proposed rule provides several ways in which a securitizer might meet the 5% risk retention requirement, including:

(1) "Vertical risk retention": whereby the sponsor or other entity retains a specified pro rata piece of every class of interests issued in the transaction;

(2) "Horizontal risk retention": whereby the sponsor or other entity retains a subordinate interest in the issuing entity that bears the first losses on the assets, before any other classes of interests;

(3) "L-shaped risk retention": whereby the sponsor essentially uses 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;

(4) "Revolving asset master trusts" or "seller's interest": 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

(5) "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.

The rule is proposed by the Federal Reserve Board, the Office of the Comptroller of the Currency, the Federal Deposit Insurance Corporation, the U.S. Securities and Exchange Commission, the Federal Housing Finance Agency, and the Department of Housing and Urban Development.

The agencies request comments on the proposed rule by June 10, 2011.