The FDIC’s securitization safe harbor rule, 12 CFR 360.6 (the “Safe Harbor Rule”), is intended – like its predecessor – to provide assurance to insured depository institutions (“IDIs”), rating agencies and investors that the FDIC will not seek to reclaim property transferred as part of a securitization, or participated, by an IDI if the relevant transfer in connection with the securitization or participation meets the criteria specified in the Safe Harbor Rule. It provides a transition period safe harbor for certain transactions issued on or prior to December 31, 2010. Securitizations and participations issued on and after January 1, 2011 must meet conditions set forth in the new rule in order to receive the protection of one of the safe harbors that the Safe Harbor Rule creates: a Safe Harbor for Participations, a Safe Harbor for Sales under generally accepted accounting principles (“GAAP”) and two Safe Harbors for Transfers that are Not Sales under GAAP. Notably, the Safe Harbor Rule does not apply to securitizations issued by certain government-sponsored enterprises, affiliates of such enterprises, or entities that are established or guaranteed by those enterprises, nor does it apply to securitizations by the Government National Mortgage Association.
Transition Period Safe Harbor
The Safe Harbor Rule extended the protection of the 2000 securitization safe harbor rule (the “Prior Safe Harbor Rule”) to (1) securitizations and participations issued on or before December 31, 2010, (2) master trusts or revolving trusts for which one or more obligations were issued on or before September 27, 2010 (the date of adoption of the new Safe Harbor Rule) and (3) any open commitment (up to a maximum amount of the commitment as of September 27, 2010) if one or more obligations under the commitment were issued on or before December 31, 2010, if the transfers met pre-November 2009 GAAP requirements for sale treatment (other than the legal isolation requirement) and the requirements of the Prior Safe Harbor Rule.
Why a New Safe Harbor Rule?
The FDIC established the Prior Safe Harbor rule in 2000 as a “clarification” of the FDIC’s repudiation power, offering assurance that the FDIC, as conservator or receiver for a failed IDI, would not disaffirm or repudiate contracts in order to reclaim, recover or recharacterize as property of the failed IDI financial assets participated or transferred by that IDI, so long as the transfer or participation satisfied the conditions for sale treatment under GAAP and met the Prior Safe Harbor rule’s other criteria. Changes to GAAP that became effective for reporting periods that begin after November 19, 2009 – FASB releases, FAS No. 166, Accounting for Transfers of Financial Assets, an Amendment to FASB Statement No. 140 (now Accounting Standards Codification Topic 860) and FAS No. 167, Consolidation of Variable Interest Entities, an Amendment to FASB Interpretation No. 46(R) (now Accounting Standards Codification Topic 810) – made it unlikely that many transfers and participations that previously had received true sale accounting treatment would continue to receive such accounting treatment. (For more information on FAS 166 and FAS 167, see the June 16, 2009 Alert). In response, the FDIC issued an interim rule, initially in November 2009 and then extended in March 2010, to continue the transition period through September 30, 2010 the protections afforded to transactions that met the criteria for sale treatment under pre-November 2009 GAAP. The Safe Harbor Rule, which became effective September 30, 2010, extended that protection to December 31, 2010. (For a discussion of the May 2010 notice of proposed rulemaking on the safe harbor rule, see the May 18, 2010 Alert.) The Safe Harbor Rule addresses the FDIC’s exercise of its powers, as receiver or conservator, with respect to transfers and participations that do not receive sale treatment under GAAP, as well as those transactions that do.
Safe Harbor for Participations
Under the Safe Harbor Rule, when acting as conservator or receiver, the FDIC will not disaffirm participation contracts or recover assets transferred provided that such participation satisfies the requirements (other than the “legal isolation” requirement) for sale treatment under GAAP. This safe harbor covers a last-in, first-out participation even if such participation fails to meet the criteria of a “participating interest” under GAAP so long as such failure is due solely to such participation being a last-in first-out participation.
Safe Harbor for Securitizations
The Safe Harbor Rule imposes a number of conditions on securitizations to be eligible for safe harbor treatment. These conditions are set forth in paragraphs (b) and (c) of the Safe Harbor Rule (the “Conditions”). Certain Conditions, such as that all securitization agreements be documented in writing, approved by the IDIs board of directors or loan committee and included in the records of the IDI are consistent with requirements for an enforceable agreement against an IDI. Other Conditions must be documented and include the following criteria.
Risk Retention. Until the effective date of risk retention rules under the Dodd‑Frank Act, which is required to be within 270 days of enactment under Section 941 of the Dodd-Frank Act and which rules will then replace the Safe Harbor Rule’s specific requirements, the securitization documents must require that the sponsor of the securitization retain an interest of at least 5% of the credit risk of the financial assets, which interest cannot be pledged, sold or hedged (except for interest rate or currency risk hedging) during the life of the transaction. (See below for a discussion of the Financial Stability Oversight Council study on the Macroeconomic Effects of Risk Retention Requirements.)
Disclosure. The documents governing the securitization must contain reporting and other disclosure obligations at issuance and periodically in connection with distributions, at least quarterly. Disclosure contractual obligations must require, at a minimum, compliance with Regulation AB (17 C.F.R. §§ 229.1100-1123) requirements for public offerings even if the securitization is issued in a private placement. They also must require disclosure of the credit performance of the securities and the underlying assets (including data regarding any modifications) and compensation paid to the originator, sponsor, rating agency or third-party advisor, any mortgage or other broker, and the servicer(s), and the extent to which any risk of loss on the underlying assets is retained by any of them.
Capital Structure Requirements. The documents governing the securitization must require that payments of principal and interest depend mainly on the performance of the securitized assets (as opposed to extraneous market or credit events). Synthetic and “unfunded” securitizations are not eligible for safe harbor protection.
In addition to the requirements generally applicable to securitizations, the Safe Harbor Rule imposes additional conditions on residential mortgage-backed securitizations (“RMBS”). These heightened requirements include: (1) loan-level information such as loan type, loan structure (e.g., fixed rate, balloon, etc.), maturity, interest rate, and location of property must be disclosed to investors; (2) the transferring IDI must confirm, prior to issuance, that the loans that will be securitized comply with all applicable statutory and regulatory standards with respect to mortgage loan origination; (3) a reserve fund of 5% of the cash proceeds of the securitization payable to the sponsor to cover the repurchase of any financial assets required for breach of representations and warranties must be established and set aside for one year; and (4) sponsors must affirm compliance with all applicable legal origination standards for mortgage loans and supervisory guidance governing the underwriting of residential mortgages including that the mortgages are based on documented income.
Securitizations Receiving Sale Treatment under GAAP. Under the Safe Harbor Rule, when acting as conservator or receiver, the FDIC will not disaffirm contracts or recover assets transferred in securitizations (and other transactions that do not qualify for the transition period safe harbor) that meet the requirements for sale treatment under GAAP as long as they satisfy the Conditions.
Securitizations Not Receiving Sale Treatment under GAAP. Unlike its predecessor, the Safe Harbor Rule applies to securitizations that do not meet sale criteria under GAAP. When acting as conservator or receiver, where the relevant transfer does not meet sale criteria under GAAP, the FDIC retains the ability to repudiate a securitization agreement or decline to make payments of collections from a securitization’s underlying assets. The two situations – repudiation and monetary default – are treated separately.
Repudiation. In the event of a repudiation, under the Safe Harbor Rule the FDIC consents to the exercise of contractual rights under the securitization documents (e.g., to take possession of the underlying assets and to exercise self-help remedies), if the FDIC has not paid damages within 10 business days of the effective date of notice of such repudiation, provided that the FDIC is not required to take any action other than to provide typical consents and waivers. Damages, under the Safe Harbor Rule, are measured as par on the date of appointment of the FDIC as conservator or receiver, less payments of principal received by investors, plus accrued and unpaid interest through the date of repudiation. All liens on the relevant assets will be deemed released upon payment of damages. In addition, the Safe Harbor Rule clarifies that the FDIC will not assert that any interest payments made to investors before the repudiation remain the property of the receivership or conservatorship.
Monetary Default. In the event of a monetary default (defined under the Safe Harbor Rule as the failure to pay principal or interest when due after the expiry of any cure periods) resulting from the FDIC’s failure to pay or apply collections received by it (as servicer or otherwise) that continues for 10 business days after actual delivery of written notice to the FDIC requesting exercise of contractual rights, the FDIC consents, under the Safe Harbor Rule, to the investors’ exercise of their contractual rights (e.g., to take possession of the underlying assets and to exercise self-help remedies), provided that the FDIC is not required to take any action other than to provide typical consents and waivers.