CrunchedCredit : Capital Markets Finance and Real Estate Attorneys

Senators Kaye Hagan and Bob Corker’s co-sponsorship of Chuck Schumer and Mike Crappo (who says we all can’t get along) filed “The United States Covered Bond Act of 2011.” I almost think this bill gets support because no one can figure out a compelling reason to be for or against it, so why not show a little whiff of bi-partisanship? The new bill broadly tracks the bill that Congressman Garrett introduced into the House earlier this year, HR-940. We’ve written about this before (it is getting to be quite a list, see here, here, here, here, here, here, here, here, here, here and even as a Golden Turkey), and, I gotta say, my views have not materially changed. This remains an answer to a question no one has. Please, someone, tell me why this is important and useful!? 

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A few weeks ago the Congressional Budget Office (CBO) released a white paper entitled “An Evaluation of Large-Scale Mortgage Refinancing Programs,” analyzing the potential impact of a so-called stylized refinancing program (more on that in a minute) that would promote widespread mortgage refinancing (or so they say..more on that too).

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On August 17, the final rules from the SEC came out (“Rules”) regarding an ABS issuer’s duty to file Exchange Act reports -- specifically, if and when an issuer can suspend reporting.

The Rules specify that, effective September 22, the duty to file periodic reports under the Exchange Act will be suspended if all outstanding ABS are held by affiliates of the depositor or if no ABS are outstanding.

Before the enactment of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Dodd-Frank Act”), the obligation to file certain Exchange Act reports was automatically suspended for any fiscal year after the year in which the issuer’s registration statement became effective or, for offerings of ABS shelf takedowns, the fiscal year after the takedown. Prior to the Dodd-Frank Act, most ABS issuers could and did take advantage of the suspension. Section 942(a) of the Dodd-Frank Act amended Section 15(d) of the Exchange Act by eliminating the automatic suspension of the duty of ABS issuers to file Exchange Act reports for transactions in which the ABS are held by fewer than 300 persons and authorized the SEC to issue rules providing for the suspension or termination of an ABS issuer’s reporting obligations.

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I just can’t schedule enough time in my day to worry about all the things that seem to demand to be worried about. As I write, this week the Dow closed 630+ down one day and bounced 600 points the next. Yikes.  Between that, the debt ceiling and downgrades, Dodd-Frank, the interminable drumbeat of hostility towards Wall Street and business coming out of the White House, the mess in Europe, the falling dollar, insanely low interest rates, high unemployment, the fact that somehow corporate America seems to still be earning bucket loads of money, and, in general the discomfiting disconnect between our still positive every day deal world and the angst, anxiety and drumbeat of awful news in the macro market, what should we think?  It makes my hair hurt.

But, drawing on my deep and boundless reserve of existential anxiety, I’ve now found a few free moments to worry about the SEC’s new re-proposal on shelf eligibility for asset-backed securities. This missive was released (pdf) on July 26, 2011, and comments are due by October 4, 2011. 

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The Chairman of the House Committee on Financial Services (“HFSC”) Spencer Bachus (R-AL) and the Chairman of the HFSC Subcommittee on Capital Markets and GSEs Scott Garrett (R-NJ) submitted a letter on August 2, 2011 to the joint regulators addressing the premium capture cash reserve account (“PCCRA”) as proposed in the risk retention NPR.  Under the proposed risk retention rules, if excess spread in a securitization is monetized, any premium received has to be put into a separate PCCRA that would absorb losses first.  So a securitizer who monetizes an IO or earns a premium on the sale of P&I bonds, has to put that money in a PCCRA to serve as a first loss reserve for any losses on the collateral-- for the life of the transaction-- on top of the 5% risk retention requirement. So, basically, securitizations would be done without profit.  Understandably, the PCCRA has been one of the sore spots of the risk retention NPR.  The Mortgage Bankers Association (“MBA”), among many others, extensively discussed the problems with the PCCRA in its July 11 letter to federal regulators outlining MBA’s views and recommendations from the commercial and multifamily mortgage finance perspective in response to the risk retention NPR.

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Ah, baby is one. I remember when mine was -- complete with an over-the-top celebration for an infant who had no idea what was going on and would remember nothing of it. The food, the drink, the fancy cake, the ridiculous crown… I chalk it up to a rite of passage for a parent to throw at least one of those unnecessary first birthday parties. On this, Dodd-Frank’s first birthday, I’m not so sure those who birthed it are donning hats, eating cake and sipping champagne in celebration.

On July 19, the Government Accountability Office (the “GAO”) published an 83 page report entitled “MORTGAGE REFORM Potential Impacts of Provisions in the Dodd-Frank Act on Homebuyers and the Mortgage Market.” The report addresses the potential impact on the mortgage market of qualified mortgage (“QM”) criteria, the credit risk retention requirement, provisions concerning homeownership counseling and regulation of high-cost loans. By examining mortgage loans made from 2001 through 2010 in CoreLogic, Inc.’s database, the GAO has drawn some practically meaningless conclusions about the mortgage market. For starters, the GAO acknowledges that the data used for its examination was not necessarily a representative sample. Furthermore, on several occasions throughout the report, the GAO hedges its analysis to the point of, well, uselessness.

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Dechert Partners Patrick Dolan, Thomas Vartanian and Robert Ledig recently reviewed the current status of and proposed amendments to Representative Garrett's covered bond legislation in the latest Dechert On Point. As this bill continues to slog through the congressional halls (for now, the bill appears to have stalled in the Senate, as the Senate faces more pressing matters (think debt ceiling and 3 wars)), we question whether the continuing improvement of the CMBS market will obviate any utility this bill promises to deliver if congress finally stops debating the bill and actually passes it. There still seems to be a lot of chatter supporting the legislation. The real question is whether anyone will actually take advantage of it.

By: Stewart McQueen

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Greetings. What ever happened to those REMIC rules regarding property releases that we blogged and wrote about in 2009 (pdf) and 2010 (pdf)? The REMIC rules were revised in September 2009 to add flexibility to facilitate certain types of servicing transactions. However, under the new rules, if a property release occurs, the loan had to be retested to determine whether it continued to be principally secured by real estate (e.g., secured by no more than 125% loan-to-real property value ratio).

Quite a price for a bit more flexibility! This caused enormous consternation as it was promulgated during a massive cyclical downturn in real estate values which resulted in many properties not being able to pass the new “principally secured” test if a release occurred. And many loans contemplated such a release. In a bold recognition of reality, something not entirely common in regulatory circles, the IRS issued Revenue Procedure 2010-30 (pdf) establishing a safe harbor for certain “grandfathered transactions” and “qualified paydown” transactions. Under the Rev Proc, a loan would not lose its status as a REMIC “qualified mortgage” even if the “new” loan-to-real estate value ratio was in excess of 125% (i.e., if the loan was less than 80% secured by real property) so long as the loan was “grandfathered,” meaning that it was closed on or before December 6, 2010 (and not amended after that date).

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The process of transforming 2,000 pages of Dodd-Frank into 25,000 pages of regulations is well under way. Front and center is Risk Retention. I assume you, like me, have been studying the 300 plus pages of the proposed Risk Retention rules (known to the cognoscenti as the Risk Retention “NPR”) for the past several weeks getting ready for the June 10th deadline for comments, right? Oddly, almost a full month passed before the government actually posted the NPR to the Federal Register, something which is usually done in a matter of days. (Tea leaf readers, thoughts?)

We have visited Risk Retention in this Blog before, but today we want to really focus on premium capture as it seems to capture all that is wrong with the NPR. My first reaction to reading the words on the page: Where the hell did this come from? On the fifth read, same reaction. There was nary a hint of the premium capture monstrosity in either Dodd-Frank or in the whispering about the rule-making process before the NPR came out.  

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On May 5, SIFMA hosted a Spotlight Series: Risk Retention and Qualified Residential Mortgages.  It was immediately apparent that unintended consequences of the proposed risk retention rules (pdf) abound.

The panelists acknowledged that the regulators had a very tough mandate, and that the rules are way more complicated than anticipated.  It was estimated that approximately 60% of the proposed rule will make its way to the final rule, and that while feelings of annoyance with respect to the drafting of the proposed rule may linger, it is up to the securitization market participants to help the regulators provide us with a clear, workable final rule.

Under the proposed rule, calculation of the amount of required risk retention would be based on a percentage of the par value of the ABS interests in an issuing entity.  The discussion began with a couple questions some of us have already been asking …

What do regulators mean by “par value”?  What is an “ABS interest”?

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Last Thursday evening, Dechert partners in our Finance and Real Estate Group and Bankruptcy, Business Restructuring and Reorganization Group hosted a cocktail party for our clients at our New York office.  The main item on the agenda for the evening was simply to take the opportunity to learn more about what's on the minds of our clients and to discuss the outlook for the remainder of 2011.  Also on the agenda for the night - wine, sushi, taking in the view of the Empire State Building and catching up on the latest activity in the Major Leagues.

With well over 100 people in attendance, we had the chance to hear from a wide variety of clients in commercial and residential loan origination, mortgage servicing and securitization (CMBS, RMBS, ABS and CLOs).  Across the board, I would say the mood was upbeat and optimistic.  Lending is ramping up.  Term sheets are being drafted.  Bankers are talking more about securitization as a viable take out strategy.

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As you may have heard, several federal regulatory agencies recently jointly issued the Notice of Proposed Rulemaking ("NPR") regarding the general credit risk retention requirements for asset-backed securitizations ("ABS") and the proposed requirements for exemptions from the risk retention requirement for certain securitizations as mandated under the Dodd-Frank Wall Street Reform and Consumer Protection Act. Generally, under the NPR, ABS sponsors are required to retain 5% of the credit risk for any securitized asset, subject to hedging, transfer and finance restrictions, in one of the five permissible forms set forth therein. The NPR attempts to articulate comprehensive, asset-class-by-asset-class standards that would qualify an ABS securitization for exemption from the requirement to hold the credit risk of the underlying assets. We encourage interested readers to refer to our examination of the risk retention requirements and exemption standards as applied to CLOs in this Dechert OnPoint (pdf) and as applied to residential mortgage backed securities in this Dechert OnPoint (pdf). (Also available here).

There will be more to come on CrunchedCredit as we examine the implications the NPR. We will keep you posted.

By Stewart McQueen and John Bumgarner.

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Well, we now have our proposed risk retention rule. The regulator class has been incubating this egg for the better part of nine months and we’re all now well behind the, admittedly, magical thinking schedule proposed in the actual FinReg legislation. Now, I’m not complaining. Particularly having read this missive, I’m all into delay.

If you want to read the proposed rule, feel free to take your pick of announcements from the Department of Treasury, the Federal Reserve, the FDIC, the SEC or the FHFA: it’s here—the long-awaited Credit Risk Retention proposed Rule (large pdf). The Rule shows every evidence of having been written by a committee, in fact, by a committee of committees. We all know that the definition of a committee is something with more than two legs and less than one brain. A committee of committees? Need I say more?

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It looks like our recap on covered bonds came not a moment too soon. Representatives Scott Garrett (R-NJ) and Carolyn Maloney (D-NY) teamed up this week to co-sponsor the bipartisan H.R. 940 (pdf), the United States Covered Bond Act of 2011. The new bill is much in keeping with the recently distributed discussion draft (examined in a recent Dechert OnPoint (pdf)). Currently, it is in committee before both the House Committees on Financial Services and on Ways and Means.

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Recently, while visiting my in-laws, I took a break from college basketball and the Daytona 500 and caught up on the latest developments in the quest for covered bond legislation in the United States.  Not surprisingly, I quickly found that the quest for covered bond legislation is, well, still a quest.

We have discussed the possibility of covered bond legislation numerous times on this blog (see here, here, here, here, here, here, here and here).  As you may recall, 2010 ushered in optimism for proponents of covered bond legislation, as both the House and Senate at least entertained the possibility.  Representative Scott Garrett (R-NJ), who has long been a strong proponent, led the charge in the 111th Congress pushing a bill out of the House Financial Services Committee and in front of the full House for consideration.  The Senate Banking, Housing and Urban Affairs Committee even went so far as to hold a hearing on the topic.  Despite the attention, the elections and then other distractions took priority, and a lame-duck session came and went without further movement on the topic.  However, the bells ringing in the new year also rung in a new round of this fight, as all interested parties are gearing up for yet another attempt to pass this legislation.

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On January 20th, the SEC finalized its first batch of many rules to come under Dodd-Frank, requiring issuers to perform reviews of the assets underlying their ABS securities and requiring them to disclose fulfilled and unfulfilled repurchase requests for alleged breaches of representations and warranties.  These have effective dates beginning with 2012 issuance so, to a certain extent, we can kick the anxiety can down the road for a while.  Nonetheless, this is a pretty clear window into what may be a bleak regulatory future.  And that’s important now.  More on this later.

Rule 193 (release here (pdf)) requires an issuer to know something about the assets it’s securitizing.  The issuer is supposed to do diligence to understand the assets it securitizes and tell the investor about the nature of its inquiry.  Curiously, and I’m not complaining here, Rule 193 does not purport to define what disclosures need be made, just that there ought to be “robust" and "transparent” diligence behind them. Its inquiry must be “designed and effected to provide reasonable assurances” that the disclosures about the assets are correct.

Hardly shocking.  Call me silly, but that seems to be what we do in structured finance.  I guess more information about exactly what the issuer did to understand the assets it securitizes could be useful, particularly in asset classes in which the asset level data is sketchy and aggregate.  It’s just silly in CMBS when we already deliver vast quantities of granular data in every deal.

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I'm sitting in the Grand Ballroom at the JW Marriot (filled to capacity) and listening to Tucker Carlson give his thoughts on likely GOP challengers to the President. I've seen him before - he did a great bit with Paul Begala a few years ago at the MBA in San Diego; very likable and very, very funny (told a great story about receiving a call from Donald Trump that I don't think I can reprint here). His early pick for the Republican nominee is New Jersey's Chris Christie.

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The industry descended on our Nation's Capital this morning for the 2011 CREFC conference: "Commercial Lending: The New World Order". It was -2 at Logan when my shuttle took to the air - needless to say I'm more than happy for the opportunity to spend a few days with friends, clients and colleagues in a warmer climate. (Current DC temperature is 24 degrees - not quite Stone Crabs at Joe's, but I'll take what I can get.) 

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I have a Leapster Explorer™ on order for my son’s 5th birthday that I seriously hope arrives in the next two days, but in addition to that delivery, there’s a lot of securitization-related rulemaking required or permitted to be delivered under the Dodd-Frank Wall Street Reform and Consumer Protection Act that was enacted on July 21, 2010 (“Dodd-Frank”).

Fewer than half of the rulemaking provisions in Dodd-Frank specify when the required or permitted rule should be issued or go into effect. Some of the Dodd-Frank rulemaking provisions require multiple agencies to issue rules jointly, some provisions require multiple agencies to issue rules separately, several provisions require that rules be issued by one agency in consultation with another agency… Some rulemaking deadlines are based on date of enactment of Dodd-Frank (July 21, 2010), others on the effective date (July 22, 2010, except as otherwise specifically provided in Dodd-Frank).

Below is a discussion about where we are in connection with some of the Dodd-Frank provisions that are of particular interest to the securitization industry.
 

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Another item to add to the growing list of possible unintended consequences of financial reform in connection with ABS: Section 210(a)(11) of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Reform Act”)—Avoidable Transfers.

Here’s the who, what, where, when, why and how ABS are affected.

WHO? A “covered financial company” of which the FDIC becomes the liquidating receiver. Under the Reform Act, a “covered financial company” is a “financial company” as to which a “systemic risk determination” (such financial company is deemed to pose a significant risk to the financial stability of the U.S. upon its failure) has been made by the Secretary of the U.S. Treasury in consultation with the President. Entities most likely to be affected are non-bank “financial companies,” bank holding companies, and non-bank U.S. subsidiaries of either-- if such subsidiary is in a financial business. An insured depository institution cannot be a “covered financial company.”
 

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Somehow, particularly this year, the fact that election eve and All Hallow's Eve arrive but three days apart seems so compellingly appropriate.  Both are scary and both involve an awful lot of people pretending to be something they're not.  But elections are supposed to have consequences while Halloween does not.  So let’s test that.  Does this election matter for CRE finance?  Or, how many treats and tricks did this election cycle have to offer?

As I write, the election is in the history books.   A resounding Republican victory in the House, while the Ds held on to the Senate by a smidge.  We hear the term game changer tossed around a lot, but will this indeed be a game changer for CRE finance?

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Last week the FDIC approved its final Safe Harbor Rule regarding securitization. That something that sounds so good could be so bad leaves you thinking: can’t we catch a break in trying to repair this damaged economy? To set the stage a bit, the FDIC has a suite of powers, while acting as conservator or receiver of an insured depository institution (“IDI”), to affirm or repudiate contracts and claim or recover property of the IDI. When a failing IDI securitizes financial assets, these powers allow the FDIC to undo the transaction and re-acquire those assets. The possibility that a securitization would be undone by the FDIC is an existential problem for any proposed securitization. But never fear. So long as a transaction meets all the conditions for sale accounting under GAAP, the transaction is proof against the exercise of those powers. Even better, there is a Safe Harbor! Sounds simple, right?

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As of yet, still, a U.S. covered bond market eludes us. Potentially a new source of funds for lending activity, a covered bond market in the U.S. would compliment the securitization market and the GSE market, enabling institutions to broaden their investor base with the dual recourse nature of covered bonds — recourse to a pool of assets that secures or “covers” the bond if the originator (usually a financial institution) becomes insolvent or otherwise fails to make payments on the covered bonds.

Without legislation to give investors certainty on how the FDIC would treat covered bonds in the event of an issuer’s insolvency, there is little hope of seeing any covered bond deals issued in the United States. Congressman Scott Garrett (R-NJ) is the author of the covered bond bill in the House but a similar bill has yet to be introduced in the Senate. On September 15, 2010, the U.S. Senate Banking, Housing and Urban Affairs Committee held a hearing on covered bonds. Congress may have a “lame duck” session after the election to take up urgent matters but it’s not likely that covered bonds will be deemed an urgent matter. If the bill is not voted on before final recess this session, the bill would need to be introduced anew in the next session of Congress in January.

There is no question that investor demand for covered bonds is there. The panelists at the SIFMA Spotlight Series on Covered Bonds earlier this week discussed the prevalence of “Yankee issuances” — issuances of covered bonds into the U.S. by issuers located in foreign countries such as Canada, France, Germany and the UK. Some serious U.S. investor cash reportedly to the tune of $20 billion has funded these issuances in 2010.

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I know I return to this theme a lot in this column, but the Unintended Consequences Watch needs to be manned day and night. Today let’s talk about 17g-5. This esoteric sounding SEC rule is intended to diminish the perceived failings of the rating agency culture which has been fingered as one of the principal causes of the “Late Unpleasantness”. The notion was that the rating agencies, hired by the issuers, were mired in conflicts of interest and there were few, if any, structural safeguards to protect investors from bad ratings.

17g-5 provides that rating agencies must require a party retaining the agency to rate an asset backed security (including CMBS) to establish and maintain a password-protected website for all other rating agencies. The website must contain all information provided to the rating agency in connection with the rating. This pertains whether information is provided in writing or orally and to information provided by the issuer or by anyone on behalf of the issuer. The information must be loaded into the website simultaneous with its delivery to the retained rating agency. This was purported to provide a structural counterpoint to the pressure for continuously lower levels by issuer procured ratings.

This has some superficial appeal. To the extent that investors were concerned about conflicts of interest, unsolicited ratings seems an antidote to these perceived concerns. Indeed, on first blush, it’s hard to see an argument that unsolicited ratings are bad.

But on first blush I thought the financial crisis that began about three years ago last month, would be over by Thanksgiving. The story of 17g-5 is yet another reminder that financial systems are much more complex than rule makers perceive them and wish them to be. Welcome back, yet again, to the wonderful world of unintended consequences.

In this case, what has flowed from the desire to do good by providing multiple opinions of value to the investors is a system which is likely to degrade the quality of information and analysis available to investors.

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It seems that I use most of my time in this space to rail against an unthoughtful regulatory architecture that will certainly surprise and may ultimately do unintended and substantial harm to our nascent and uncertain recovery. While, from where I sit, it’s still fair to say this market continues to show little real conviction that it’s safe to get back in the water (hardly an irrational mindset) there is, periodically, some good news. So let’s make time for a bit of good news. Ta-da: It was reported recently that average consumer credit card borrowings have dropped below $5,000 per person for the first time since 2002.

This is terrific news. Perhaps not the stuff of rational giddiness, but combine that with the fact that corporate earnings are up, private cash savings rates are at recent highs, the de-leveraging is going great guns (everywhere, that is, outside of our government), house prices seem to be stabilizing in most markets even if sales continue to lag, interest rates are at ridiculously low levels and the reality of the re-set of the valuations of both the commercial and residential property stock has been internalized. A bit of optimism is not wildly inappropriate.

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Covered bond legislation is once again a hot topic on Capitol Hill. Representative Scott Garrett (R-NJ) co-sponsored the latest iteration of his proposed legislation (United States Covered Bond Act of 2010 or H.R. 5823 (pdf)) along with Representatives Kanjorski (D-NJ) and Bachus (R-AL). The House Financial Services Committee recently voted in favor of reporting H.R. 5823 to the full House of Representatives for consideration, which hopefully will be taken up for a vote this fall shortly after the August recess.

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It’s August 6 as I write this, and the finance industry is taking a deep breath after hustling for weeks to get their comments delivered to the SEC on the SEC’s massive restructuring (pdf) of Reg AB and offering reform.  We here at Dechert had been very busy writing the CREFC comments (pdf) and I’m delighted to see that effort coming to a close (it only took 24 drafts to get to our submission).

To be clear, this is merely the opening act of what will be a protracted insect dance between business and government to settle on rules that deliver on the SEC’s goals of transparency and alignment between issuers and investors while not imperiling the restoration of a healthy CMBS market.  This process will consume the time of many of us for the indefinite future.

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Today the American Bankers Association will publish its Summary and Analysis of the Regulatory Reform Conference Report. The project will provide detailed summaries of each title of the Dodd-Frank Wall Street Reform and Consumer Protection Act conference report, as well as analysis of which entities will be affected and how. The conference report has been approved by the House on June 30 and is now awaiting Senate action.

Thomas Vartanian, who recently joined Dechert LLP, and a team of twenty-two Dechert LLP attorneys led the American Bankers Association effort, preparing the summary and providing the analysis of the proposed supervisory structure for the United States financial system, including the role of the new Financial Stability Oversight Council and the expanded role of the Federal Reserve.
 

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Back from vacation … The sheer joy of re-engagement cannot be captured in words.  But, can there be a better way of restarting than perusing FinReg?  Being the parochial structured finance lawyer that I am, I start with Subtitle D with the Potemkin village-like name of  "Improvements to the Asset Backed Securitization Process" and Section 13, which is the Proprietary Trading or so-called Volcker Rule provisions.  I’ve got some thoughts.

Let's start with the improvements to the securitization process.  The good news, as I’m sure everyone knows by now, is that some sensible asset class-specific provisions for commercial mortgages were included in the risk retention language.  More flexibility in sorting out what alignment of interests ought to look like.  Included was the notion that a B piece buyer could meet the retention requirement as could really good reps or underwriting.

The bad news is, just as in almost every other corner of this massive regulatory exercise in political self-indulgence, all the tough and important issues have been kicked down the road to the “Regulators”.  The scope of that delegation is breathtaking.  The regulators have been invited to sort out what is and what is not risk retention (vertical strip, horizontal strip, L strip), what is the “credit risk” for which 5% must be retained, what are good hedges and bad, what is the minimum hold period for risk, what is high quality underwriting, and what appropriate risk management practices of securitizers ought to be.  Wow!  They can do all that?  We won’t have to think at all.

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The push for covered bond legislation – left on the cutting room floor when Fin Reg. was finalized during a marathon session last week (or should I say finalized subject to Senator Scott Brown’s continuing review) – is coming under renewed discussion by Congress (led by Representative Scott Garret) and the FDIC.

The FDIC balked at the proposal that was to be included in the Dodd-Frank bill because of concerns about the effect of certain collateralization requirements on failed banks' balance-sheets. Covered bond terms can require issuers to replace weakening collateral upon the occurrence of certain triggers; in a receivership scenario, this re-collateralization requirement would force the FDIC to re-deploy quality assets to serve as bond collateral and shift the risk of loss of declining collateral from bondholders to the government. The FDIC hates when that happens.

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Dechert has assembled a team to cover the latest legislative and regulatory developments affecting the CMBS, RMBS, and ABS markets. Each Dechert Securitization Update provides timely information on these developments. For a discussion of several recent legislative and regulatory developments that will shape the future of the securitization markets, please see the latest Securitization Update Dechert has prepared. This Securitization Update includes a discussion of the Dodd-Frank Wall Street Reform and Consumer Protection Act, the SEC's proposal to amend Regulation AB, the FDIC's proposed changes to the "safe harbor" rule, and the SEC's new rating agency rules. To be added to our regular Securitization Update mailing list, please follow this link, fill out all required fields, and check the box entitled "Real Estate and Structured Finance", along with any other subject areas that might be of interest.

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Notwithstanding our optimism, it appears that there was not enough support from the Senate side of the reconciliation committee to include the proposed covered bond amendment in the final financial reform bill approved by the reconciliation committee.  However, the support received by the House and some members of the Senate committee indicates that covered bond legislation may, nonetheless, find passage in the near future.

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Earlier this week, Representative Scott Garrett (R-NJ) introduced an amendment to the proposed financial reform legislation that will establish a regulatory framework for a covered bond market in the United States.  The House side of the reconciliation committee quickly passed the measure - the Senate side is now considering it.  This development is welcomed news to a banking industry that has craved a covered bond market for some time now.  For our part, we've been examining covered bond structures since the advent of the credit crises as our clients continued to try to devise a workable structure, so we're very excited by this development. 

Covered bonds, which have been part of the European financing vernacular for over 200 years, function as a cross between an unsecured corporate bond and an asset-backed security.  Typically, a financial institution will issue a direct-recourse bond which is also secured by a specified pool of assets that remain on the financial institution's balance sheet.  These are attractive to investors for many reasons, most important of which is that the investor has recourse to a specified pool of assets in the event the financial institution becomes insolvent, unlike typical unsecured corporate bonds that depend solely on the issuer's credit.

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The Senate reconvened reconciliation hearings at noon today with a deal brokered yesterday to place the new financial watchdog agency within the auspices of the Federal Reserve, rather than establishing an independent agency.  This compromise by Congressional Democrats - which is engendering strong opposition from some important constituencies - could indicate a growing desperation to get something (anything, anything at all) in front of the President before his appearance at the G-20 this weekend.  As someone who spends a good piece of my week (and some weekends) reading and writing documents that are intended to build a legal framework around unforeseeable real-word events, I can appreciate the utter impossibility of crafting legislation that will simply get it right the first time.  I’ve learned this too many times:  As complexities increase, the better can become the enemy of the good. 

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Do you have any idea how often each of the House and Senate reform bills proposes to solve an intractably complex problem by simply asking the regulators to come up with rules?  I don’t, but I found at least 20.  Now it all goes to reconciliation, and my suspicion is that that number will not go down and may, indeed, go up when our duly elected representatives throw up their hands, declare victory and make someone else figure it out.  Now, Congress asking our regulators to create rules to implement policy is nothing new, and there’s nothing wrong with it, if used sparingly.  But this is wholesale delegation of hugely important stuff.

Without clarity around the rules of the game, business will not thrive.  I keep coming back to this notion.  I run a business, and I need to figure out how financial markets will function coming out of the late unpleasantness.  It’s hard enough, but when the rules keep changing, it’s worse.

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We’ve been promised that the House and Senate financial reform bills will be reconciled in a highly transparent and thoughtful way and be wrapped up and ready for the President’s signature by Independence Day.

I’m trying to be upbeat about this.  There are, after all, substantial benefits to be obtained from certainty, and once this is done, we’ll at least have rules.  We may not like them, but at least we’ll have rules. (OK, the final Bill will probably include dozens of referrals to the regulatory community to make the actual rules, but nothing’s perfect.).  God only knows what to expect when our duly elected representatives, awash in populist outrage and with the clock ticking loudly down to election day, try their hands at making sense of these two ridiculously complicated 1,400 page bills.  Barney Frank will manage the reconciliation process.  Imagine, he has now been imbued with the hopes of the financial services community for a sensical and balanced Bill.  Man bites dog.  You can’t make this stuff up. 

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