The Securities and Exchange Commission on Wednesday adopted final rules for the asset-backed securities market that will require securitizers to keep “skin in the game.” By a 3-2 vote the Commission, in joint-rulemaking with other regulators, will require them to retain no less than five percent of the credit risk of the assets they securitize.
Asset-backed securities (ABS) are created by buying and bundling loans to create investment products backed by those assets for sale to investors. Loan bundles are typically divided into separate securities with different levels of risk and returns.
In a statement prior to the vote, SEC Chairman Mary Jo White lamented that, prior to the financial crisis, many lenders loosened underwriting standards and extended low-quality loans, knowing they would be sold through a securitization by a sponsor. The new rule, she said, will build upon efforts needed to address those issues and, hopefully, avert another crisis in the marketplace.
The new risk retention requirement was split off from other asset-backed securities regulations approved by the Commission in August. Four years in the making, the SEC at that time revised rules governing the disclosure, reporting, and offering process for asset-backed securities. It now requires loan-level disclosure for certain assets, such as residential and commercial mortgages and automobile loans. The rules also provide more time for investors to review and consider a securitization offering. ABS issuers using a shelf registration statement must file a preliminary prospectus containing transaction-specific information at least three business days in advance of the first sale of securities in the offering.
The SEC’s new risk retention rule was approved one day after the Federal Deposit Insurance Corporation, the Federal Housing Finance Agency, and the Office of the Comptroller of the Currency adopted similar requirements. Along with the SEC, the Federal Reserve Board, and the Department of Housing and Urban Development were also expected to vote on Wednesday.
A client advisory by the law firm Morrison & Foerster notes that the rulemaking exempts certain types of securitizations from risk retention requirements, including government-guaranteed securitizations and qualifying “pass-through” resecuritizations. Securitizations backed by auto loans, commercial loans, and commercial real estate loans that meet specified underwriting standards, as well as qualified residential mortgage loans (QRMs), are also exempt, although risk retention needs cannot be met by commingling QRM and non-QRM loans in a single securitization. Of particular note to mortgage providers and home buyers: banking regulators scratched out earlier requirements that QRM status is contingent upon a 20 percent minimum down payment. The Final Rule’s definition of QRM, for now, will the same as the definition of “qualified mortgage” under the Consumer Financial Protection Bureau’s “ability-to-repay” rules. The QM definition will be revisited by regulators four years from the effective date of the Final Rule, every five years thereafter, or at any time upon request by one of the regulators.
SEC Commissioner Daniel Gallagher, along with fellow republican Michael Piwowar, dissented. “Today’s rulemaking takes the untenable housing policy that injected irrational exuberance into mortgage lending and, as a result, caused a catastrophic financial crisis and chisels that failed policy into the stone tablets of the Code of Federal Regulations,” he said. “In other words, it manages to take the policies that lost the last war and adopt them as the government’s preparation to win the next.” Among Piwowar’s objections were that other regulators involved in the process failed to prepare an economic analysis of those proposals.
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