Alert April 05, 2011

Federal Agencies Seek Comment on Proposed Risk-Retention Rule

Six federal agencies are seeking comment on a proposed rule that would require sponsors of asset-backed securities to retain at least five percent of the credit risk of the assets underlying the securities and would not permit sponsors to transfer or hedge that credit risk.

The rule is proposed by the FRB, OCC, FDIC, SEC, HUD and the Federal Housing Finance Agency. It would provide sponsors with various options for meeting the risk-retention requirements of the Dodd-Frank Wall Street Reform and Consumer Protection Act. Among other things, the options include:

  • retention of risk by holding at least five percent of each class of ABS issued in a securitization transaction (also known as vertical retention);
  • retention of a first-loss residual interest in an amount equal to at least five percent of the par value of all ABS interests issued in a securitization transaction (horizontal retention);
  • an equally-divided combination of vertical and horizontal retention;
  • retention of a representative sample of the assets designated for securitization in an amount equal to at least five percent of the unpaid principal balance of all the designated assets; and
  • for commercial mortgage-backed securities, retention of at least a five percent first-loss residual interest by a third party that specifically negotiates for the interest, if certain requirements are met.

As required by Dodd-Frank, the proposal includes descriptions of loans that would not be subject to these requirements, including asset-backed securities that are collateralized exclusively by residential mortgage loans that qualify as “qualified residential mortgages”. The proposal would establish a definition for QRMs -- incorporating such criteria as borrower credit history, payment terms, and loan-to-value ratio -- designed to ensure they are of very high credit quality. The proposal also includes investor disclosure requirements regarding material information concerning the sponsor's retained interests in a securitization transaction.

The proposal 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, these underwriting standards are designed to be robust and to ensure that the loans backing the ABS are of very low credit risk.

Comments on the proposal must be received by June 10, 2011. Click here for the proposal.