On October 20th at the Charlotte City Club, Dechert partner David Harris spoke on an ASF Sunset Seminar panel titled “FDIC’s Final Securitization Safe Harbor – Understanding the New Rules.”  I won’t spend too much time on the background of the FDIC’s Old Safe Harbor Rule but will tell you that the Transitional Safe Harbor Rule continues to have a place even though we have a New Safe Harbor Rule (adopted on September 27, 2010), because the New Safe Harbor Rule extends the Transitional Safe Harbor Rule so that transfers of assets into securitizations made on or prior to December 31, 2010 are permanently grandfathered and not subject to the conditions of the New Safe Harbor Rule.  Following?

Translation: The FDIC is using its New Safe Harbor Rule to attempt to reshape the securitization market.  The New Safe Harbor Rule imposes significant new conditions for non-grandfathered bank-sponsored securitizations.  And the FDIC has indirectly implemented its position on securitization reforms before the Office of the Comptroller of the Currency (the “OCC”), the SEC and other regulatory agencies take action on a joint basis.  The New Safe Harbor Rule was issued over the OCC’s dissenting vote and prior to the SEC’s issuance of the final Regulation AB II. The New Safe Harbor Rule regulates substantive terms of transactions, including several additional requirements for RMBS.

Here’s what the landscape is looking like:

Permanently grandfathered are securitizations (whether issued before or after December 31, 2010) issued by existing revolving trusts or master trusts that meet the Transitional Safe Harbor Rule and that had issued securities as of September 27, 2010.

For securitizations that are accounted for as sales under GAAP and otherwise qualify under the
New Safe Harbor Rule, the FDIC will not, as conservator or receiver, exercise its statutory power to repudiate contracts in order to reclaim, recover or recharacterize as property of an Insured Depository Institution (an “IDI”) the assets transferred by the IDI into a securitization. Not so for a financing under GAAP.

Where there’s a true sale, the FDIC should not have the power to repudiate just because the value of the securitized assets may have increased. But even if they don’t prevail, an attempt to do so by the FDIC will cause delays, even if only the first time around. And the FDIC may prevail just because it’s the FDIC.

If a transaction is deemed to be an off-balance sheet transaction, the FDIC has no assets to look to and should not be able to repudiate contracts in order to reclaim property of an IDI.  David Harris pointed out that in an off-balance sheet transaction, the FDIC would have no genesis for such a claim. In the Redwood RMBS transaction done this year, Citi retained the servicing of the Citi whole loans sold into the securitization and David Harris pointed out that the fewer ties to the assets sold, the safer– i.e., don’t retain servicing.

The panelists enumerated potential securitization market impacts of the New Safe Harbor Rule:

The FDIC’s risk retention rules are not in alignment with the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Act”) and do not answer the questions that have been left to joint rulemaking by the Act. Because there will be at least fifteen months during which the FDIC’s risk retention rules are in effect before the Act-mandated risk retention rules are final, large financial institutions may not be able to rationalize securitizing versus other options available to satisfy their funding and capital needs.

To the extent IDIs are required to comply with the conditions and requirements of the New Safe Harbor Rule, IDIs will be placed at a competitive disadvantage vis-à-vis non-IDIs (and IDIs that can securitize without the safe harbor) possibly resulting in damaging market fragmentation.

Regulatory uncertainty and the prospect of undue compliance costs, over and above regulatory capital and accounting issues, continue to threaten the viability of an active and efficient private securitization market.

It is unclear whether the FDIC’s risk retention requirement could preclude an accounting sale, which in turn would affect a sponsor’s capital requirements.  Although the SEC has stated that it does not believe that risk retention in itself will require the consolidation of the securitization entity onto the sponsor’s balance sheet, it also concluded that final determinations are based on facts and circumstances, leaving open the question of whether a sponsor may have increased capital costs as a result of the risk retention requirement (in addition to those resulting from the retained interest itself).

Especially for RMBS, the infrastructure and controls necessary to provide the additional disclosure and to meet the other conditions in the New Safe Harbor Rule could take time and be costly.

The additional disclosure requirement applicable to privately placed deals will significantly impact that market, especially with respect to asset classes that historically have not had a public disclosure scheme (e.g., CLOs).

As Phil Collins has sung, we’ve still got a “Long Long Way To Go.”

By Laurie Nelson.