The general theme of the American Securitization Forum Sunset Seminar held on Wednesday at Dechert's NY office was the unintended consequences of the Dodd-Frank Act. Our largest conference room was packed with over a hundred securitization industry players all searching for the best predictions on the shape of the massive amount of regulations coming our way over the next few months. First on the agenda was a discussion of the repeal of Rule 436(g) and the resulting Securities Act liability for rating agencies. Dodd-Frank's intent was to improve the value of ratings by making rating agencies more accountable to investors. Unfortunately, the rating agencies would not consent to their ratings being disclosed and the entire public securitization market was stopped cold. Not helpful for a market struggling to return to "normal.” We have the temporary fix issued July 22 of this year in the form of an SEC No-action letter green lighting the omission of ratings in registration statements, but what happens next? Most likely-- the SEC will amend Reg AB Items 1103 and 1120 to not require ratings in registration statements. However, the SEC is considering requiring ratings in non-ABS registration statements, so how likely is this most likely solution really? Other ideas—in no particular order of likelihood: Congress will reinstate 436(g). Doubtful. The SEC will extend the No-action letter indefinitely. Perhaps. Ratings agencies assume the liability or are indemnified by issuers. Maybe. One panelist predicted that in the short run, we'll have uncertainty; and in the long run, more uncertainty. Consensus is that there's a long road ahead and harmonization amongst the regulators and applicable agencies is key. Also keep in mind as this unfolds that rating agency accountability is also to be achieved under Dodd-Frank by new private rights of action against ratings agencies (and other parties) leading perhaps to nationally certified class actions. As a result, the rating agencies will be seeking comfort and indemnity from issuers on the accuracy of data given to them in the course of their diligence.
The discussion turned to conflicts of interest and the prohibition against engaging in any transaction that would result in a material conflict of interest with respect to any investor for one year following closing (other than hedging activity or market-making/sales to provide liquidity for the ABS). An example of this conflict would be underwriting ABS then shorting the synthetic ABS that references the first ABS. One issue raised with respect to compliance is the problem of information barriers between departments at investment banking institutions.
No seminar can be complete without a discussion of "skin in the game" and the goal of improved underwriting. Only time will tell on whether we will see a horizontal or vertical slice requirement or a variety of alternatives. There was also talk about the residential mortgage reform provisions in Dodd-Frank. In a nutshell, no loan can be made unless, in a reasonable and good faith determination, the borrower has the ability to pay. At first glace it makes pretty darn good sense. In practice, however, it’s difficult for a lender to predict whether a borrower can in fact repay a loan. Will a lender be penalized for failing to accurately assess a borrower’s earning potential? Applicable Dodd-Frank criteria includes the borrower's credit history, current income, financial obligations, DTI, LTV and other factors including expected income. A lender needs to focus on regularity of income but can consider irregularity…. It was noted that no member of Congress could get a loan today when, even though the above-mentioned criteria aren't weighted, expected future income needs to be taken into account.
The safe harbor for qualified mortgages basically means non-traditional mortgages are out. Thirty year fixed is the new black. If a loan doesn't meet the definition of a qualified mortgage and it's in foreclosure, a claim can be asserted against the assignee (for any claim the borrower could have made against the original lender). The likely result is that lenders will originate only qualified mortgages.
Of course, if you originate a "qualified residential mortgage" under Dodd-Frank you can be exempted from the related risk retention requirements. Since historical performance data is required for any “qualified residential mortgage,” no new loan product type will ever be exempt from Dodd-Frank risk retention requirements. Expect more thirty year fixed. Consumers will certainly have more protection but they will also have access to much less credit as the markets struggle to reconcile competing regulations and deal with unintended consequences.
The usual themes were reiterated – disclosure, transparency, skin-in-the-game — as was the likely consequence — that there won’t be as many loans to securitize. There’s a lot of rulemaking going on in the District and will be for the next 6 months to a year. We can expect changes— and pain.
By Ralph Mazzeo and Laurie Nelson.