The Board of Directors of the FDIC (the “Board”) has adopted a final rule (the “Final Rule”)1 that will replace its current securitization “safe harbor” rule (the “Securitization Rule”), which remains applicable on a limited basis as described below. This new rule, approved by the Board and released on Monday, September 27, is intended to give investors and rating agencies comfort that the FDIC, as receiver or conservator for a failed bank, will not interfere with securitizations that meet certain requirements. The adoption of the Final Rule culminates a rulemaking process that began with an Advance Notice of Proposed Rulemaking (“ANPR”) in December 2009, and continued with the release of a Notice of Proposed Rulemaking (“NPR”) in May 2010, which sought public comment from securitization industry participants on a proposed set of conditions that the FDIC proposed to impose on banks seeking safe harbor protection.
Most notably, the Final Rule:
The Final Rule appears to grandfather master trusts and revolving trusts under the Securitization Rule, although this change was not addressed in the Monday Board meeting or in the supplementary information accompanying the Final Rule.
Background: The Securitization Rule and FAS 166/167
Before adoption of the Securitization Rule in 2000, banks (including savings institutions) structured securitization transactions by relying on a legal true sale of the underlying financial assets or a grant of a security interest in the financial assets that could under existing law be liquidated notwithstanding the appointment of the FDIC as receiver or conservator. In response to securitization industry concerns that its power, as receiver or conservator, to repudiate contracts of failed banks could promote uncertainty both as to the rights of investors in bank-sponsored securitizations and as to the accounting treatment of the transfers by banks when there had not been a legal true sale of the financial assets, the FDIC adopted the Securitization Rule.3
The Securitization Rule provides that the FDIC will not “disaffirm or repudiate contracts..., [to] reclaim, recover or recharacterize as property of the institution or the receivership” any securitized assets transferred by a bank in connection with a securitization transaction as long as the transfer achieves sale accounting (“off-balance sheet”) treatment under generally accepted accounting principles (“GAAP”), other than the “legal isolation” criterion of GAAP.4 From 2000 to 2009, most bank-sponsored securitization transactions met sale accounting treatment under Statement of Financial Accounting Standards No. 140 (“FAS 140”)5 and were therefore afforded protection from repudiation under the Securitization Rule, even if the transaction was not a legal true sale from the bank. FAS 140 introduced a concept of “qualifying special-purpose entities” (“QSPEs”), which were considered isolated from sponsors of securitizations.
In June 2009, the Financial Accounting Standards Board released Statements of Financial Accounting Standards Nos. 166 and 167 (“FAS 166 and 167”), which substantially changed the accounting treatment of securitization transactions for accounting periods beginning on or after November 15, 2009.6 FAS 166 and 167 abolished the QSPE concept contained in FAS 140 and focused on control of special-purpose entities rather than on permissible activities. As a result, many standard securitization structures that would have achieved sale accounting treatment under FAS 140 failed to do so under FAS 166 and 167 and were consolidated for financial statement reporting purposes (“on-balance sheet”).
Because the Securitization Rule relies on GAAP standards that, after the implementation of FAS 166 and 167, permit fewer securitizations to achieve sale accounting treatment, the securitization industry asked the FDIC to consider the circumstances under which it might continue to afford these bank-sponsored securitizations protection from its repudiation powers.
Transitional Relief
The Final Rule provides permanent relief for securitization transactions for which the related transfers of financial assets are made on or before the Transition Date. These transactions will continue to be afforded protection from repudiation under the Securitization Rule if they meet the requirements of the Securitization Rule as they existed before the implementation of FAS 166 and 167. In other words, for transactions for which the related transfer of financial assets occurs on or before the Transition Date, sale accounting treatment under FAS 140 will be sufficient for coverage under the transitional safe harbor even though FAS 140 no longer applies to financial statement presentation.
In addition, the Final Rule provides a transitional safe harbor to “any obligations of revolving trusts or master trusts, for which one or more obligations were issued as of” adoption of the Final Rule, as well as to “any obligations issued under open commitments up to the maximum amount of such commitments as of the date of adoption of [the Final Rule] if one or more obligations were issued under such commitments on or before December 31, 2010.” Other securitizations can be afforded safe harbor protection only under the revised safe harbor of the Final Rule, as described below.
Under the transitional Securitization Rule, the FDIC will not interfere with transfers of securitized assets by use of its power to repudiate contracts of failed banks if (a) the most senior class of the securitization is rated investment-grade by a nationally recognized statistical rating organization or the securities are sold in transactions exempt from registration, (b) the failed bank received adequate consideration for the transfer, (c) the documents effecting the transfer reflect the intent of the parties to treat the transaction as a sale, and (d) the transfer meets all conditions for sale accounting treatment under GAAP, in accordance with FAS 140, other than legal isolation. Securitizations that fall under the transitional safe harbor described above will continue to receive this treatment just as if GAAP sale accounting determination still followed FAS 140.
Mechanics of the New Safe Harbor
The Final Rule provides two different safe harbors, one for securitizations that achieve off-balance sheet treatment and one for those that do not. For securitizations that achieve off-balance sheet treatment under FAS 166 and 167, the FDIC will not interfere with the transfers of securitized assets through its power to repudiate contracts of failed banks. In effect, this safe harbor will function similarly to that of the existing Securitization Rule. However, under the Final Rule, securitizations will have to comply with many additional conditions (discussed below) in order to be protected by the safe harbor.
For securitization transactions that fail to achieve sale accounting treatment, the Final Rule provides a new safe harbor, partly in response to a change in the powers granted to the FDIC. In 2006, Congress amended the Federal Deposit Insurance Act (the "FDI Act") to provide for a 90-day stay7 against enforcement of any contractual rights against a failed bank, including self-help remedies for secured parties. Recognizing that, for securitizations that would no longer qualify under the Securitization Rule, the stay could delay payments to investors for up to 90 days, with interest and principal unpaid in the meantime, the major rating agencies warned that significant downgrades in ratings of existing securities could result from the threat of repudiation of securitization agreements.
For securitizations that do not achieve sale accounting treatment, the Final Rule provides two new protections. First, if the FDIC fails to “pay or apply collections from the financial assets received by it in accordance with the securitization documents” on behalf of a failed bank for 10 business days after receipt of a written notice, then the FDIC consents to the exercise of contractual rights under the securitization agreements, including self-help remedies to foreclose on the securitized assets, provided that no involvement of the FDIC is required (other than consents, waivers or execution of transfer documents as may be reasonably requested in the ordinary course of business).
Second, the Final Rule provides that if the FDIC repudiates a securitization agreement, it must pay damages equal to the par value of the obligations of the securitization outstanding at the date of its appointment as conservator or receiver (less any payments of principal paid to investors to the date of repudiation), plus any unpaid accrued interest actually received through the date of repudiation, within 10 business days, or else it consents to the same exercise of contractual rights. The Final Rule expressly states that the FDIC will not seek to reclaim any interest payments made to investors in accordance with transaction documents. The Final Rule also provides that the FDIC will consent to (or perform itself) any servicing activity required in furtherance of the securitization, including the making of payments to investors to the extent actually received through payments on the securitized assets.
Summary of Additional Conditions to Safe Harbor
In a significant departure from the Securitization Rule, the Final Rule (like the NPR and ANPR) contains many requirements and conditions that are intended to promote higher quality securitizations. Some of these conditions will apply only to RMBS securitizations, while the remaining provisions will apply to securitizations of all asset classes. Failure to satisfy any of the conditions will result in loss of the safe harbor protections, which could result in negative rating agency actions with respect to a securitization depending on the credit rating of its sponsor. The Final Rule organizes these proposed conditions in five categories: capital structure and financial assets, disclosures, documentation and recordkeeping, compensation, and origination and retention.
Conditions Applicable Only to RMBS Securitizations
Capital Structure and Financial Assets:
Disclosures:
Documentation:
Compensation:
Origination Standards, Repurchase Reserve:
Conditions Applicable to All Asset Classes
Capital Structure and Financial Assets:
Disclosures:
Documentation and Recordkeeping:
Retention of Risk:
Other Conditions:
Uncertain Application of the Safe Harbor
Although several of the changes made in the Final Rule were designed to reduce the risk that a securitization believed to have the benefit of safe harbor protection at closing will later fail to qualify, some uncertainties remain in the final text. Under the Final Rule, securitizations may still lose the benefits of the safe harbor at a later date as a result of, among other things:
For assistance, please contact any of the following lawyers:
John Arnholz, Partner, Structured Transactions
john.arnholz@bingham.com, 202.373.6538
Reed D. Auerbach, Practice Group Leader, Structured Transactions
reed.auerbach@bingham.com, 212.705.7400
Jeffrey R. Johnson, Partner, Structured Transactions
jeffrey.johnson@bingham.com, 212.373.6626
Matthew P. Joseph, Partner, Structured Transactions
matthew.joseph@bingham.com, 212.705.7333
Steve Levitan, Partner, Structured Transactions
steve.levitan@bingham.com, 212.705.7325
Edmond Seferi, Partner, Structured Transactions
edmond.seferi@bingham.com, 212.705.7329
Charles A. Sweet, Partner, Corporate, M&A and Securities
charles.sweet@bingham.com, 202.373.6777
Roger P. Joseph, Practice Group Leader, Investment Management; Co-chair, Financial Services Area
roger.joseph@bingham.com, 617.951.8247
Edwin E. Smith, Partner, Financial Restructuring, Co-chair, Financial Services Area
edwin.smith@bingham.com, 617.951.8615
Contacts
If you have any questions or would like more information on the issues discussed in this LawFlash, please contact any of the following Morgan Lewis lawyers:
Sweet-Charles1 Available at http://fdic.gov/news/board/10Sept27no4.pdf.
2 The interagency risk retention regulations required by the Dodd-Frank Act will take effect one year, for securitizations of residential mortgages, or two years, for securitizations of other assets, after publication in the Federal Register.
3 12 C.F.R. § 360.6.
4 In order to receive the benefit of the Securitization Rule, a securitization transaction is required to meet all conditions for GAAP sale accounting treatment other than the “legal isolation” condition, as well as certain additional requirements described in this alert; the legal isolation condition under GAAP was intended to be satisfied by the Securitization Rule.
5 Statement of Financial Accounting Standards No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities.
6 Statement of Financial Accounting Standards No. 166, Accounting for Transfers of Financial Assets, an amendment of FASB Statement No. 140 and Statement of Financial Accounting Standards No. 167, Amendments to FASB Interpretation No. 46(R).
7 The duration of the stay is 90 days for receiverships and 45 days for conservatorships. See Section 11(e)(13)(C) of the FDI Act, 12 U.S.C. § 1821(e)(13)(C), added by Section 718(a) of the Financial Services Regulatory Relief Act of 2006, Public Law 109-351, 120 Stat. 1966, 1977 (2006) (effective October 13, 2006).
8 This includes the Interagency Guidance on Non-Traditional Mortgage Products, October 5, 2006, and the Interagency Statement on Subprime Mortgage Lending, July 10, 2007.
9 The FDIC does not define “unfunded” or “synthetic” securitizations, but the FDIC does state in the supplementary information accompanying the release of the Final Rule that it “does not view the inclusion of existing credit lines that are not fully drawn in a securitization as causing such securitization to be an ‘unfunded securitization.’” The FDIC further states that “[t]he provision is intended to emphasize that the Rule applies only where there is an actual transfer of financial assets.”
This article was originally published by Bingham McCutchen LLP.