New Risk Retention Requirements for Asset Backed Securities

While the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) has been widely identified as having a broad and sweeping impact on the financial markets as a whole, it will most certainly also have a dramatic impact on the structuring and implementation of asset-backed securities. More particularly, the parties involved in structuring and executing collateralized debt obligations (“CDOs”) and collateralized loan obligations (“CLOs”) may be significantly impacted by the risk retention (or “skin-in-the-game”) requirements under Section 941 of the Dodd-Frank Act (the “Risk Retention Requirements”). Important elements establishing the mechanics and implementation of the Risk Retention Requirements will remain unclear, however, until regulators promulgate further required rules.

As set forth in the Dodd-Frank Act, the Risk Retention Requirements direct that distinct regulations be issued by the Federal banking agencies and the Securities and Exchange Commission (the “Commission”) for each category of ABS, including residential mortgages, commercial mortgages, auto loans, and any other applicable categories of Asset-Backed Securities. The risk retention rules must be prescribed within 270 days after enactment (i.e., by April 15, 2011) and must go into effect within two years after the date final rules are published for all asset classes other than residential mortgages (i.e., not later than April 15, 2013).

The Dodd-Frank Act defines “Asset-Backed Securities” as “a fixed-income or other security collateralized by any type of self-liquidating financial asset (including a loan, a lease, a mortgage, or a secured or unsecured receivable) that allows the holder of the security to receive payments that depend primarily on cash flow from the asset, including (i) a collateralized mortgage obligation; (ii) a collateralized debt obligation; (iii) a collateralized bond obligation; (iv) a collateralized debt obligation of asset-backed securities; (v) a collateralized debt obligation of collateralized debt obligations; and (vi) a security that the Commission, by rule, determines to be an asset-backed security for purposes of this section.” While the statutory language makes it clear that the Risk Retention Requirements apply to CDOs, it does not expressly include CLOs. Presumably, CLOs will be included in the regulations either by application of a broad definition of “collateralized debt obligations” or by express inclusion by the Commission as an asset-backed security subject to the Risk Retention Requirements.

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TALF Extended

Not surprisingly, the Federal Reserve announced today that it is extending the TALF program from the December 31, 2009 deadline to March 31, 2010 for newly issued ABS and legacy CMBS and to June 30, 2010 for newly issued CMBS. While the Fed acknowledges that conditions in the financial markets have improved, it still views the markets for asset backed securities and commercial mortgage backed securities as "impaired." The Fed is also leaving the door open to further extensions should conditions warrant. Another outstanding issue is whether to expand the TALF to include other types of eligible collateral. The Fed said in its announcement that it and Treasury will reconsider the issue "if financial or economic developments indicate that providing TALF financing for investors' acquisitions of additional types of securities is warranted."

Federal Reserve Press Release, August 17, 2009


Some surprises were included in today's announcement by the Federal Reserve and the Treasury on new developments with the soon-to-be $1 trillion Term Asset-Backed Securities Loan Facility (TALF). Of particular note is the statement that the two agencies will push for legislation to re-tool the program.

According to the joint release, the TALF is “designed to catalyze the securitization markets by providing financing to investors to support the purchase of certain AAA-rated asset-backed securities” and will at first be limited to newly and recently originated auto, credit card, student, and SBA-guaranteed small business loans. The TALF funds will go out monthly starting in March, and they are already anticipating a program expansion for April that will include “asset backed securities (ABS) backed by rental, commercial, and government vehicle fleet leases and ABS backed by small ticket equipment, heavy equipment, and agricultural equipment.” The Treasury and the Fed are also analyzing how to expand the program in future months to include commercial mortgage backed securities and other AAA-rated, newly issued ABS.

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Federal Reserve Announces Two New Programs to Spur Lending

The Federal Reserve announced two new programs today, committing an additional $800 billion in order to spur lending. U.S. Treasury Secretary Hank Paulson also announced that $20 billion from the Troubled Asset Relief Program (TARP) would be used to support one of the programs. The first, worth $600 billion, is aimed at helping the housing market; and the second Fed program, worth $200 billion, is directed at thawing the frozen consumer credit markets.

The Fed announced this morning that it will "initiate a program to purchase the direct obligations of housing-related government-sponsored enterprises (GSEs)—Fannie Mae, Freddie Mac, and the Federal Home Loan Banks—and mortgage-backed securities (MBS) backed by Fannie Mae, Freddie Mac, and Ginnie Mae." The Fed will work with "primary dealers through a series of competitive auctions" for purchases of up to $100 billion in "GSE direct obligations" beginning next week. For purchases of up to $500 billion in MBS, the Fed will select asset-managers through a competitive process and plans to start these purchases before the end of the year. The Fed said in a release that it will provide operational details after "consultation with market participants," and added that "Purchases of both direct obligations and MBS are expected to take place over several quarters."

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