Transcript Dodd-Frank Act Implementation:An Overview

Dodd-Frank Act Implementation:
An Overview
NY2 742237
mofo.com
October 30, 2014
Anna Pinedo
Overview
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Dodd-Frank in 2013
• U.S. regulators found themselves under pressure to complete the
required rulemakings to implement the Dodd-Frank Act
• This task did not get accomplished; however, significant
progress was made in 2013
• During 2013, the agencies finalized:
• The capital rules for U.S. banks,
• Addressed further implementation of the OLA framework,
• Proceeded with designations for various nonbank entities (nonbank
SIFIs),
• Finished much of the rulemaking in the mortgage area,
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Dodd-Frank in 2013 (cont’d)
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Completed much of the Title VII (derivatives) rulemaking,
Reproposed the risk retention rules,
Proposed LCR rules, and
Released the final Volcker Rule.
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2014, to date
• The pace of rulemaking has slowed in 2014, although some actions
have been taken, such as
• Final rule implementing Rule 165 (enhanced prudential and
supervisory requirements) for certain US banks and FBOs
• Incremental progress on various Title VII matters
• Final supplementary leverage ratio
• Final liquidity coverage ratio
• Final risk retention rules for securitization
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Anticipated Developments
• Capital
• New regulatory requirements to be proposed
• Long-term debt requirement
• Short-term wholesale funding measure
• NSFR
• Issues deferred by Fed/banking agencies in connection with Sec.
165
• Single counterparty exposures
• Framework applicable to nonbank SIFIs
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Anticipated Developments
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Conflicts rule (Sec. 621)
Fiduciary duty?
Compensation provisions
Amending regulations that incorporate the use of ratings
Additional guidance on various Title VII provisions
• Final margin rules for non-cleared derivatives
• SEC rules for SBSs
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Agenda
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Capital and Liquidity
Enhanced Prudential Supervision
Volcker Rule
Mortgage Market
Other Developments
What to Expect
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Capital and Liquidity
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U.S. Basel III Capital Rules
• Coverage
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All banks and thrifts
All bank holding companies with $500 million+ in assets
All thrift holding companies
Top-tier U.S. holding companies in FBO structure
The Market Risk Proposal – applicable generally to those with aggregate
trading assets and trading liabilities of at least 10% of total assets, or $1
billion
• Excluded are foreign banking organizations and (temporarily) savings
and loan holding companies substantially engaged in insurance
underwriting or commercial activities
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Major Changes
• Establishes capital rules and capital floors generally applicable to all
U.S. banking organizations under Section 171 of Dodd-Frank (the
“Collins Amendment”)
• Higher capital ratios
• Changes in components of capital
• New capital ratio: Common equity Tier 1 (“CET1”) RBC ratio
• Capital Conservation Buffer
• New PCA thresholds
• Substantial changes to credit risk weightings (by adopting material
elements of Basel II standardized approach for risk-weightings)
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Effective Dates and Transition
Date
Institutions not subject to Advanced Approaches
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•
1/1/2015
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Begin compliance with minimum capital ratios
Begin transition for revised definitions of capital (and adjustments and
deductions)
Comply with new risk weights
PCA categories effective
1/1/2016
Begin transition for the capital conservation buffer
Date
Advanced Approaches Institutions ($250BB+ or on-balanchesheet foreign expos of
$100BB+)
•
1/1/2014
•
Begin transition for revised capital ratios, definitions of regulatory capital (and
adjustments and deductions)
Begin compliance with advanced approaches rule for determining risk-weighted
assets
1/1/2015
Begin compliance with standardized approach for risk-weight; PCA categories
effective
1/1/2016
Begin transition for capital conservation and countercyclical buffers
2019
End of phase in for community banks
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Pro Forma Effect (Fed staff)
• 95% of bank holding companies under $10 billion and all with $10
billion or more that meet current regulatory capital requirements
would meet the 4.5% minimum CET1 ratio
• Nearly 90% with less than $10 billion in assets would meet the CET1
plus the capital conservation buffer (7%)
• Nearly 95% of bank holding companies with $10 billion or more
would meet the 7% CET1 threshold
However, this does not address cost and complexity of
application
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Liquidity Coverage Ratio (LCR)
Final Rule adopted September 4, 2014
• Covered organizations must maintain high quality liquid assets
(HQLA) equal to estimated net cash outflows over a 30-day stressed
liquidity period
• Applies to Advanced Approaches organizations, and any subsidiary
bank with $10BB+
• Simpler modified version applies to others (“modified companies”)
with $50BB+ and that do not have significant commercial or
insurance operations
• Effective date: covered companies must calculate their LCRs at
each month-end beginning January 1, 2015 but “modified
companies” begin on January 1, 2016.”
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LCR (cont’d)
• Full LCR applies to: advanced approaches banks ($250b in total
consolidated assets or $10b or greater in on-balance sheet foreign
exposures); other institutions made subject to LCR
• LCR Light (Modified LCR): depository institutions with $50b or less
in total consolidated assets that are not: grandfathered SLHCs
deriving 50% or greater of total assets or revenues from activities
not financial in nature; insurance underwriting companies; or
holding 25% or greater of total assets in insurance underwriting
subsidiaries. Monthly (instead of daily) LCR calculations.
• Final rule does not apply to FBOs.
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LCR (cont’d)
• LCR requires HQLA stock to be at least 100% of its total net cash
outflows over a 30-day standardized liquidity stress scenario, plus a
maturity mismatch add-on that includes only certain inflows/outflows
likely to cause a maturity mismatch
High-Quality Liquid Assets
Total Net Cash Outflows
100%
• HQLAs are categorized as Level 1, Level 2A and Level 2B
• No limit on Level 1 assets
• Level 2 assets are capped at 40% of HQLAs; Level 2B assets are
capped at 15% of total HQLAs
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LCR (cont’d)
• Level 1 assets are not subject to haircuts. These include: excess
reserves held at Fed, US Treasuries, securities issued or guaranteed
by full faith and credit of US government, etc.
• Level 2A assets are subject to a 15% haircut. These include:
Agency securities, claims on or guaranteed by a sovereign entity or
multilateral development bank
• Level 2B assets are subject to a 50% haircut. These include: certain
corporate debt securities issued by non-financial companies; certain
publicly traded equities of non-financial companies included in
Russell 1000 Index or foreign equivalent
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Capital Ratios
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Minimum Capital Ratios (fully phased-in)
• 3 minimum risk-based capital ratios
• Common equity Tier 1 (“CET1”) capital ratio of 4.5 percent (new)
• Tier 1 capital ratio of 6 percent (increase from 4%)
• Total capital ratio of 8 percent (same)
• Leverage ratio
• Tier 1 ratio to average consolidated assets of 4 percent
• Similar to current rule for most U.S. banks
• Current favorable 3 percent requirement for CAMELS 1-rated U.S. banks
and comparably ranked bank holding companies eliminated
• New definition of Tier 1 capital excludes some instruments currently
included
• Unlike Basel leverage ratio of 3 percent, denominator does not include offbalance sheet items
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Supplemental Leverage Ratios
• Additional Tier 1 leverage ratios for 8 largest US banking holding
companies (considered as global systemically important banks by
Basel),
• The supplemental leverage ratios are measured against both onbalance sheet and off-balance sheet assets (proposed rulemaking
for treatment of on- and off-balance sheet exposure published on
May 1, 2014)
• These supplemental leverage ratios are higher than 3 percent capital
ratio proposed by the Basel Committee
• Intended to encourage conservation of capital and to address, in
part, the risk of being “too big to fail”
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Capital Conservation Buffer (“CCB”)
• Ratio of CET1 capital to risk-based assets of 2.5 percent (on top of
each RBC ratio)
• A bank’s actual CCB will equal the lowest of the following three
amounts (but not less than zero):
• Bank’s CET1 ratio minus 4.5%
• Bank’s Tier 1 RBC ratio minus 6%
• Bank’s Total RBC ratio minus 8%
• Failure to meet buffer results in restrictions on payouts of capital
distributions and discretionary bonus payments to executives
• Maximum amount of restricted payout equals eligible retained
income* times a specified payout ratio. Payout ratio is a function of
the amount of the bank’s capital conservation buffer capital
*Most recent 4 quarters of net income, net of cap distributions and certain
discretionary bonus payments
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Countercyclical Capital Buffer
• For Advanced Approaches banking organizations:
• Not a concern for community banks
• A macro-economic countercyclical capital buffer of up to 2.5 percent of
CET1 capital to risk-weighted assets
• Augments the capital conservation buffer
• Applied upon a joint determination by federal banking agencies
• Unrestricted payouts of capital and discretionary bonuses would
require full satisfaction of countercyclical capital buffer as well as
capital conservation buffer
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Capital Ratio Table
Type of ratio
Current
New
N/A
4.5%
4%
6%
8%
8%
N/A
+2.5%
CET1 countercyclical capital buffer (risk-based for
N/A
Advanced Approaches banks)
+2.5%
Minimum risk-based ratios
CET1 risk-based
Tier 1 risk-based*
Total risk-based
CET1 capital conservation buffer (risk-based)
Minimum Leverage ratios
Tier 1 leverage to average assets
3% / 4%
4%
Tier 1 supplement proposal for 8 largest banks
N/A
3% + 2%
*Existing: at least 50% of qualifying total capital must be Tier 1; no such
limit under new rule
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Capital Components
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Capital Components
• Three buckets:
• Common equity Tier 1 (“CET1”)
• Additional Tier 1
• Tier 2
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CET1 Components
• Common stock classified as equity under GAAP. Can include
nonvoting common, but voting common should be the dominant
element within Common Equity Tier 1 capital
• Retained earnings
• “AOCI”—Accumulated other comprehensive income (except
unrealized gains/losses on cash flow hedges relating to items that
aren’t fair valued on the balance sheet). However, community
banks can make a one-time election (at time March 31, 2015 call
report or FR Y-9C is filed) not to include most AOCI
components in CET1 capital. Represents change from proposal
• Qualifying CET1 minority interest (in a subsidiary that is a
depository institution)
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CET1 Deductions
• Goodwill + all other intangibles (other than MSAs), net of associated
deferred tax liabilities (“DTLs”)
• Deferred tax assets (“DTAs”) arising from NOLs and tax credit carry
forwards (net of DTA valuation allowance and net of DTLs)
• Gain-on-sale of securitization exposures
• Defined benefit plan net assets net of DTLs (excluding those of
depository institutions with their own plans)
• Certain investments in the capital instruments of other
unconsolidated financial institutions
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Other CET1 Deductions/Adjustments
• Deductions
• Investments in financial subsidiaries
• Savings association impermissible activities
• Following items >10% individually or >15% aggregate of CET1 capital:
DTAs related to temporary timing differences; MSAs; and “significant”*
investments in capital instruments of other unconsolidated financial
institutions
• For Advanced Approaches banks, expected credit losses exceeding
eligible credit reserves
• Adjustments
• Deduct unrealized gains and add unrealized losses on cash flow
hedges
*If bank owns >10% of other institution’s common stock, all investments are
“significant”
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Additional Tier 1 Capital
• Noncumulative perpetual preferred stock
• Other capital instruments that satisfy specific criteria
• Tier 1 minority interests that are not included in a banking
organization’s CET1 capital
• Qualifying bank-issued TARP and SBLF preferred securities that
previously were included in Tier 1 capital
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Significant exclusions from Tier 1 Capital
• Cumulative preferred stock no longer qualifies as Tier 1 capital of
any kind (subject to phase-out)
• Certain hybrid capital instruments, including trust preferred
securities, no longer qualifies as Tier 1 capital of any kind (subject to
phase-out)
• But such non-qualifying capital instruments issued before May 9,
2010 by banking organizations with less than $15 billion in assets
(as of December 31 2009) are grandfathered, except grandfathered
capital instruments can’t exceed 25% of Tier 1 capital. This is
consistent with Section 171 of DFA and is a change from June 2012
Proposal
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Tier 2 Capital Components
• Cumulative and limited life preferred, subordinated debt and other
qualifying instruments that satisfy specified criteria (including
qualifying TARP and SBLF preferred securities that currently qualify
as Tier 2 capital). No limit on such instruments includible in Tier 2
• Qualifying total capital minority interest not included in Tier 1 capital
• Allowance for loan and lease losses (“ALLL”) up to 1.25% of riskweighted assets excluding ALLL
• No limit on Tier 2 capital includible in total capital
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Deductions from Tier 1/Tier 2 Capital
• Direct and indirect investments in own capital instruments
• Reciprocal cross-holdings in financial institution capital instruments
• Direct, indirect and synthetic investments in unconsolidated financial
institutions. Three basic types:
• “Significant” Tier 1 common stock investments
• “Significant” non-common-stock Tier 1 investments
• Non-significant investments (aggregate 10% ceiling)
• The Basel III “corresponding deduction” approach for reciprocal
cross holdings, non-significant investments in capital of
unconsolidated financial institutions, significant non-common stock
investments and non-significant investments
• Volcker Rule covered fund investments (from Tier 1)
• Insurance underwriting subsidiaries
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Minority Interests
• Limits on type and amount of qualifying minority interests that can be
included in capital
• Minority interests would be classified as a CET1, additional Tier 1, or
total capital minority interest depending on the classification of the
underlying capital instrument and on the type of subsidiary issuing
such instrument
• Qualifying CET1 minority interests are limited to a depository
institution (“DI”) or foreign bank that is a consolidated subsidiary of a
banking organization
• Limits on the amount of includible minority interest would be based
on a computation generally based on the amount and distribution of
capital of the consolidated subsidiary
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Prompt Corrective Action (PCA)*
Category
Total
RBC
Tier 1
RBC
CET1 RBC
Tier 1
Leverage
Well capitalized
10%
8%
6.5%
5%
Adequately capitalized
8%
6%
4.5%
4%
Undercapitalized
<8%
<6%
<4.5%
<4%
Significantly undercapitalized
<6%
<4%
<3%
<3%
Critically undercapitalized
Tangible equity**/total assets </= 2%
*For non-Advance Approaches Institutions
**Tier 1 Capital plus non-Tier 1 perpetual
preferred stock
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Risk-Weighted Assets
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Risk Weights that are the same
• Exposures to cash, CIPC, U.S. Government and its agencies, U.S.
GSEs, U.S. banks, US PSEs, non-structured corporate investment
securities, fixed assets
• The following credit exposures:
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1-4 family residential mortgages
Consumer loans and credit cards
Owner-occupied CRE loans
1-4 family acquisition, construction and development (“ADC”) loans
Income property real estate loans (that are not ADC loans)
Statutory multifamily loans
Pre-sold construction loans
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New: Eleven Broad Asset Classes
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Residential mortgages
Commercial real estate lending
Corporate exposures
Off-balance sheet exposures
OTC derivatives
Cleared transactions
Unsettled transactions
Securitization exposures
Equity exposures
Sovereign, public sector entities (“PSEs”) and foreign bank
exposures
• Other assets
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Enhanced Prudential Standards
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Enhanced Prudential Standards
• February 2014: Fed adopted Final Rule for Enhanced Prudential
Standards under Sections 165 and 166 of Dodd-Frank
• Designed to prevent/mitigate risks to U.S. financial stability that
could arise from the material financial distress or failure, or ongoing
activities of, large, interconnected financial institutions
• Enhanced Prudential Standards increase in stringency based on the
systemic footprint and risk characteristics of the financial institution:
(1) capital, (2) risk management, (3) liquidity, (4) stress testing, and
(5) debt-to-equity limits
• Although aimed at U.S financial stability, significant implications for
community banks
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Enhanced Prudential Standards (cont’d)
• Final Rule incorporates previously issued capital plan and stress test
requirements
• Capital Plan Rule (2011) imposes enhanced, risk-based and leverage
capital requirements on $50BB BHCs and requires submission of
annual capital plan that demonstrates ability to maintain capital above
minimum ratios under baseline and stressed conditions
• DFA Rules (2012) require $50BB BHCs to conduct periodic supervisory
and company-run stress tests
• DFA Rules (2012) require $10BB BHCs, SHLCs and banks to conduct
annual company-run stress tests
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Enhanced Prudential Standards (cont’d)
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OCC: “Heightened Expectations”
• In February 2014, the OCC proposed minimum standards for the design and
implementation of a risk governance framework for large insured national
banks, insured federal savings associations, and insured federal branches
of foreign banks with average total consolidated assets of $50 BB +
• Rules and responsibilities for organizational units that are fundamental
to design and implementation of the framework
• Front line units, independent risk management, and internal audit
• Establish an appropriate system to control risk taking and risk appetite
statement
• Highly prescriptive
• The proposal also would establish minimum standards for an
institution’s board of directors in overseeing the framework’s design
and implementation
• Not intended for community banks, but instructive as to key design
elements of a risk governance framework
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EPS: Community Bank Take-aways
• Company-run stress testing even for banks with less than $10BB as
part of capital planning process. “Every bank, regardless of size, or
risk profile, [will need] to have an effective internal process to (1)
assess its capital adequacy in relation to its overall risks, and (2) to
plan for maintaining appropriate capital levels.” OCC-Bulletin 201233, Community Bank Stress Testing Supervisory Guidance
• Capital planning will be required for every bank
• Already key feature of formal and informal enforcement actions
• Boards will require this from management
• Increasing emphasis on risk management and governance
• Chief risk officers
• Risk committees
• Board oversight of process
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Volcker Rule
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Volcker Rule
The Volcker Rule prohibits banking entities (without regard to asset
size) from engaging in:
•
Proprietary Trading: a banking entity may not engage in proprietary
trading – “engaging as principal for” its own “trading account” in a
“purchase or sale of one or more financial instruments,” including
derivatives
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Covered Fund Activities: a banking entity, as principal, may not directly or
indirectly acquire or retain an ownership interest in, or sponsor, a covered
fund
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Banking entity: includes insured depository institutions, BHC, and affiliates
Covered Funds: reliance on 3(c)(1) or 3(c)(7) of Investment Company Act
Conformance period ends July 21, 2015; possible extension(s) upon
application or Fed order
Overly complex. See www.mofo.com for resource materials
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Volcker Rule
• Banking entities include
• US banks and thrifts
• Bank and thrift holding companies
• Foreign banking organizations (FBOs) that operate a branch/agency or
commercial lending company in the US
• Affiliates of these entities (US and foreign)
• Banking entities do not include
• A covered fund (unless it is a banking entity included in one of the first
three categories above)
• A portfolio company held by a financial holding company under the
merchant banking or insurance company authority or held by a SBIC
(unless it is a banking entity included in one of the first three categories
above)
• Non-banking entities, such as broker-dealers not affiliated with
banks, are not subject to the rule
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Application to Community Banks
• Community banks and their holding companies were not the intended
target of the Volcker Rule, but are nonetheless subject to almost all of
its provisions
• Many provisions will not apply to smaller banks without complex
trading and derivatives activities, but all banks will have to determine
what applies to their particular situation, and take steps to ensure
ongoing compliance
• Most community bank problems identified so far relate to securities
investments that may need to be divested, especially CDOs, CLOs
and auction rate preferred securities (ARPS)
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Volcker Rule
• Certain proprietary trading activities are permitted, including:
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Trading in U.S. gov’t and municipal bonds; repos and reverse repos
Loan purchases and sales
Trading in foreign and domestic currencies
As agent on behalf of customers or as principal in fiduciary capacity
Risk-mitigating hedging
Underwriting and market-making
Foreign banking organizations solely outside the US
• Super 23A and 23B
• No extension of credit to, or purchase of assets from, a covered fund
that the banking entity sponsors or advises
• Conflict of interest rules apply for permitted proprietary trading and
covered fund activities
• Compliance programs
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Volcker Rule: Community Banks
• Proprietary Trading Prohibition
• Purchases and sales out of investment securities portfolio should be
OK if not for short-term profit—but need to understand the Rule and
analyze activity
• Trades for “liquidity management” are not covered, but bank needs to
have a liquidity management plan to qualify for the exclusion
• Bank needs to analyze derivatives activities: entering into derivatives
and terminating them before maturity are considered “purchases and
sales” of “financial instruments. Interest-rate swaps likely not “shortterm” trading. F/X swaps?
• Covered Fund Prohibition
• Securitized investment securities are covered funds (unless underlying
assets are entirely loans); may need to divest current holdings
• Compliance function to determine whether or not covered and, if
activities are covered but permitted, compliance with conditions
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Compliance Programs
• Important focus of the Rule
• All except the “less active” banking entities must implement six-point
compliance program:
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Written policies and procedures reasonably designed to document, describe,
monitor and limit proprietary trading activities, and activities and investments with
respect to covered fund activities, to ensure compliance with the Rule
A system of internal controls reasonably designed to monitor compliance with the
Volcker Rule, and to prevent the occurrence of activities or investments that are
prohibited by the Rule
A management framework that delineates responsibility and accountability for
compliance with the Volcker Rule and includes management review of trading
limits, strategies, etc.
Independent testing and audit of the effectiveness of the compliance program;
Training for trading personnel and managers, as well as other “appropriate”
personnel, to appropriately implement and enforce the compliance program; and
Records sufficient to demonstrate compliance with the Volcker Rule
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Compliance Programs (cont’d)
• “Less active” banking entities
• Those with no covered activities have no obligation to establish a
compliance program until they begin to engage in those activities;
• banking entities with “modest activities,” (those with total assets of $10
billion or less) need only refer to the requirements of the Volcker Rule in
its compliance policies and procedures and make “adjustments as
appropriate given the activities, size, scope and complexity of the
[banking entity]”
• many community banks will fall into this category
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Enhanced Compliance Programs
• Enhanced Minimum Standards for Compliance Programs
• Provided in Appendix B
• Required of banking entities that:
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•
•
Engage in permitted proprietary trading and are required to comply with the
reporting requirements under Appendix A (that is, have a certain minimum
level of trading assets and liabilities, initially $50 billion);
As of the previous calendar year-end, had total consolidated assets of $50
billion or more or, in the case of an FBO, had total U.S. assets of $50 billion
or more; or
Are notified by the relevant Agency that it must satisfy the standards of
Appendix B
• For obvious reasons, the “enhanced” standards will not apply to most
community banks
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Mortgages
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Changed Landscape for Mortgages
• A very different world from the housing finance world of 2006
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Basel III
CFPB
CFTC
FDIC
SEC
Volcker Rule
GSE legislation
Risk retention – QM/QRM
Conflicts of interest
Cross border conflicts of regulation
• Still changing – unfinished regulation and unresolved GSE role
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Basel III
• Increased capital requirements
• Residential mortgage loans – unchanged
• 50% risk weighted if in accord with prudential underwriting standards; else
100%
• Securitization exposures
• Up to 1250%; I/O strips
• Non-cash gain on sale (e.g., I/O strips) deducted from Tier 1 equity capital
• Servicing
• Deduct from Tier 1 capital if exceed 10%
• 250% risk weight
• Liquidity Coverage Ratio requirement
• HQLA equal to total net cash outflow
• Securitizations do not qualify as HQLA
• Net Stable Funding Ratio
• Excludes short-term funding (except for deposits)
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Servicing
• The industry is restructuring
• Financial institutions are selling large amounts of servicing to nonfinancial institutions
• Partly for capital reason
• Partly due to increased costs and legal exposure
• Due to the rapid growth of these servicing organizations,
investigations have been started to review their capacity to service a
major increase in the number loans they service
• Regulation is growing
• CFPB servicing regulations
• Costs are increasing
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Consumer Mortgage Lending Reform
• Consumer Financial Protection Bureau was established under the
Dodd-Frank Act and began operation on July 21, 2011
• Jurisdiction of CFPB includes banks, credit unions, securities firms,
payday lenders, mortgage-servicing operations, foreclosure relief
services, debt collectors and other financial companies, and its most
pressing concerns include mortgage origination & servicing
• Consolidated responsibilities from various federal regulatory bodies,
including the Federal Reserve, the Federal Trade Commission, the
Department of Housing and Urban Development & banking agencies
• It writes and enforces rules on consumer financial products &
services, conducts examinations & monitors and reports on markets
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CFPB at the Ready
• CFPB Ability-to-Repay (ATR) rule
• Amends Regulation Z to require lenders to account for a borrower’s
ability to repay
• Applies to all closed-end consumer-purpose mortgage loans secured by
real estate
• Final rule took effect on January 10, 2014
• Ability-to-Repay Requirement
• For covered mortgages, creditors must make a “reasonable and good
faith determination at or before consummation that the consumer will
have a reasonable ability to repay the loan according to its terms”
• Liability for violation of the foregoing standard is limited for “qualified
mortgages” (QMs), which today consist of Fannie Mae & Freddie Mac
eligible loans & loans eligible for insurance/guaranty by FHA & VA
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ATR Underwriting
• For the general ATR determination, eight enumerated underwriting
factors for creditors to consider, including:
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Borrower’s
Borrower’s
Borrower’s
Borrower’s
Borrower’s
income or assets (excludes assets securing the loan)
employment status
expected monthly payment for the loan
debt obligations
credit history
• For each factor, creditor must VERIFY and CONSIDER the
information
• Inherently fact-specific and subjective, so creditor concerns over
liability loom large
• Special liability for violating ATR rule: life-of-loan defense to
foreclosure (including attorneys’ fees), the ultimate in assignee
liability
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“Qualified Mortgages”
• Qualified Mortgage (“QM”) definition = residential mortgage loan that meets
the following criteria:
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No excess upfront points and fees (3% cap)
No negative amortization
Term not exceeding 30 years
Consumer cannot defer repayment of principal (no neg am)
No balloon payment (with a very narrow exception)
Income and financial resources must be verified and documented
Limits on debt-to-income ratios (43% back-end)
• QM underwriting (verification of DTI) may be conducted under Appendix Q
• QMs provide compliance safe harbor or rebuttable presumption that abilityto-repay requirements satisfied, based on APR of loan
• Safe harbor for loans that are not “higher priced” based on APR formula
• Rebuttable presumption for “higher priced” loans
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FDIC
• 12 CFR 360.6 – FDIC Sale rule
• No more than six credit tranches
• Allows senior tranche sequential pay or planned amortization classes
• No unfunded or synthetic transactions
• Minimum 5% retained interest, except if the risk retention rule is finalized
• 5% reserve fund for one year for reps and warranties
• Reg AB disclosure for public OR private offerings
• Disclosure of compensation to originator, sponsor, rating agency or third party
advisor, any mortgage or other broker and the servicer(s)
• Compensation to rating agencies spread over 5 years
• Must meet GAAP sales accounting treatment other than “legal isolation”
• Failure to comply subjects transaction to repudiation by FDIC in the
event of the failure of the transferring bank
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SEC
• Dodd-Frank rulemaking
• Reg AB II
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Single prospectuses
Delays in offering
Review for breach of reps and warranties
Remedy for breach of reps and warranties
CEO certification
• Rating agencies
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Dodd-Frank Section 943: Reps and Warranties Rule
• Reason for Section 943:
• High percentage of rep and warranty breaches claimed in post-financial crisis
securitization litigation (including related disclosure claims made in securities litigation
• Party enforcing repurchase requirement often same entity or affiliate of sponsor and/or
loan originator who made the reps and warranties
• 34 Act Rule 15Ga-1 – Replacement and repurchase history
• Form ABS-15G – ongoing disclosure requirement on a quarterly basis of certain
repurchase activity
• Items 1104 and 1121 of Reg AB – requires similar information required under Rule
15Ga-1 to be disclosed in the prospectus
• 34 Act Rule 17g-7 – Rating agency disclosure of reps, warranties and enforcement
mechanisms
• Applies to both registered and unregistered ABS
• The Final Rule was issued on January 20, 2011 and became effective on March 28,
2011. There is a series of compliance dates listed in the final rules, including February
14, 2012 for the initial Form 15Ga-1 filing and Reg AB prospectus disclosure.
• NRSROs were required to become compliant with the requirements of Rule 17g-7 by
September 26, 2011.
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Dodd-Frank Section 945: Issuer Diligence Rule
Rule 193 – requires issuers to perform a review of the assets that is
designed and effected to provide reasonable assurance that the disclosure
regarding pool assets in prospectus is accurate in all material respects
•
•
•
•
No specific type of review required
Sampling may be used when appropriate
Third-party may be hired to perform review
If hired for review, third party either has to be named in prospectus and consent to be deemed
an “expert” under Section 7 of the ’33 Act and Rule 436 and subjected to Section 11 liability, or
the issuer has to attribute to itself the findings and conclusions of the independent third party
review
Item 1111 of Reg AB – prospectus disclosure of Rule 193 review
• Identity of party that performed review; whether sampling was used, and if so, what sampling
technique was employed; findings and conclusions of review; whether any assets in pool
deviate from underwriting criteria; and provide data on assets for which compensating or other
factors were used
Final Rule was issued on January 20, 2011, and became effective on
March 28, 2011 for issuances after December 31, 2011.
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Dodd-Frank Section 942(a): Elimination of Automatic
Suspension of SEC Reporting
• Section 15(d) of ’34 Act suspends reporting requirements for issuers
of registered offerings for any fiscal year, other than the fiscal year
within which the registration statement became effective, if, at the
beginning of such fiscal year, there were less than 300 holders of the
class that were sold in a registered transaction.
• Section 942(a) eliminated automatic suspension for ABS issuers
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Dodd-Frank Section 942(a): Elimination of Automatic
Suspension of SEC Reporting (cont’d)
• Rule 15d-22(b) – suspends or terminates ABS reporting for registered
deals (i) as to any semi-annual fiscal period, if, at the beginning of the
semi-annual fiscal period, other than a period in the fiscal year within
which the registration statement became effective or, for shelf
offerings, the takedown occurred, there are no ABS of such class that
were sold in a registered transaction held by non-affiliates of the
depositor and a certification on Form 15 has been filed, or (ii) when
there are no ABS of such class that were sold in a registered
transaction still outstanding, immediately upon the filing with the
Commission of a certification on Form 15 if the issuer has filed all
required reports for the most recent three fiscal years
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Regulation AB II – Significant Provisions
• The most significant changes adopted by the SEC are:
• A requirement to file a complete preliminary prospectus at least three days prior to
sales of any securities (this is referred to as the “speed bump” provision)
• Any material change requires the filing of a prospectus supplement at least 48
hours before the first sale of securities
• A requirement to appoint an “asset representations reviewer” to review assets for
compliance with representations and warranties
• A requirement to provide in machine readable form asset-level information for
securitizations involving residential mortgage loans, commercial mortgage loans,
auto loans and leases, debt securities and resecuritizations of these assets
• Report periodically demands by the trustee to repurchase assets for breach of
representations and warranties and any such assets not repurchased
• Dispute resolution – the transaction documents must contain provisions for
repurchase claims unsatisfied after 180 days to be referred to mediation or
arbitration
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Regulation AB II – Significant Provisions
(cont’d)
• The most significant changes (cont.):
• Investor communications – the transaction documents must include a
provision requiring the party responsible for distribution date Form 10-D
filings to include a request from any investor with any other investor
• For each offering, a certification by the CEO
• That the securitization as described in the prospectus is designed to produce
cash flows from the assets in amounts sufficient to service expected
payments on the securities, and
• That the prospectus does not contain an untrue statement of material fact or
omit to state a material fact necessary to make the statements made, in light
of the circumstances under which they are made, not misleading
• New Forms SF-1 and SF-3 for the registration of asset-backed securities
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Regulation AB II – Significant Provisions
(cont’d)
• The following significant items from the 2010 proposal were not
adopted by the SEC:
• A requirement to file a computer program for the cash flow waterfall – in the 2011
re-proposal, the Commission stated that it would address the requirement
separately
• A requirement for the sponsor or an affiliate to retain an interest is the assets
securitized – this is the subject of a separate multi-agency rulemaking as required
by the Dodd-Frank Act
• The extension of the disclosure requirements of Forms SF-1 to private placements
under Rule 506 or Rule 144A
• Filing of transaction agreements in substantially final form with the preliminary
prospectus
• Asset-level information for other assets, including student loans and equipment
leases and loans.
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Risk Retention
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Risk Retention
• Key provisions of the final rule:
• Generally permits risk retention to be accomplished through one or a combination
of methods: a vertical interest, a horizontal interest, or some combination of both
(an “L-shaped interest”). The percentage of the vertical, horizontal, or L-shaped
interest to be retained by the sponsor must be determined as of the closing date
of the transaction. Horizontal risk retention may be accomplished by holding ABS
issued in the transaction or by establishing a cash reserve account for the
transaction.
• Transaction-specific risk retention options for revolving securitization pools, assetbacked commercial paper conduits, commercial MBS (“CMBS”), and Fannie Mae
and Freddie Mac MBS.
• Exempts certain types of securitizations from risk retention requirements, including
government-guaranteed securitizations and qualifying “pass-through”
resecuritizations.
• Exempts securitizations backed by auto loans, commercial loans, and commercial
real estate loans that meet specified underwriting standards, as well as qualified
residential mortgage loans, or “QRMs.”
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Risk Retention (cont’d)
• No minimum down payment requirement for QRMs. The Final Rule’s definition of
QRM is the same as the definition of “qualified mortgage,” or “QM,” under the
Consumer Financial Protection Bureau’s (the “CFPB”) “ability-to-repay” rules. The
Joint Regulators must review the QM definition four years from the effective date
of the Final Rule and every five years thereafter, or at any time upon request by
one of the Joint Regulators, and determine if the QM definition at such time is still
the appropriate definition to use to define QRM.
• Consistent with the CFPB’s “ability-to-repay” rules, there are also exemptions from
risk retention for certain community-focused residential mortgage loans and
certain 3-to-4 unit residential mortgage loans.
• Securitizers of RMBS will not be allowed to reduce their risk retention
requirements by commingling QRM and non-QRM loans in a single securitization.
However, securitizers of commercial, commercial real estate, or auto loans will be
able to reduce their risk retention requirement by up to 50% (that is, to 2.5%)
using such “blended pools.”
• Includes a transaction-specific risk retention option for certain open-market
collateralized loan obligations (“CLOs”) that would permit lead arrangers of loans
held by the CLO to retain the 5% risk, rather than the CLO manager.
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Risk Retention (cont’d)
• As in the Re-Proposal, CMBS issuers will have the option of satisfying risk
retention requirements by transferring up to two pari passu subordinated
horizontal interests, or “B-pieces,” to third-party purchasers.
• Restrictions on securitizers hedging or transferring retained interests for specified
periods after the securitization remain unchanged from the Re-Proposal:
• For RMBS transactions, the restrictions would expire on or after the date that
is (1) the later of (a) five years after the closing date or (b) the date on which
the total unpaid principal balance of the securitized assets is reduced to 25
percent of the original unpaid principal balance as of the closing date, but (2)
in any event no later than seven years after the closing date.
• For all other ABS transactions, the restrictions would expire on or after the
date that is the latest of (1) the date on which the total unpaid principal
balance of the securitized assets that collateralize the securitization are
reduced to 33 percent of the original unpaid principal balance as of the
closing date, (2) the date on which the total unpaid principal obligations under
the ABS interests issued in the securitization is reduced to 33 percent of the
original unpaid principal obligations as of the closing date, or (3) two years
after the closing date.
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Risk Retention (cont’d)
• Includes a limited safe harbor excluding from the risk retention
requirements certain predominantly foreign securitizations. The safe
harbor requires, among other conditions, that no more than 10% of the
value of all classes of ABS be sold or transferred to or for the account of
U.S. persons.
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Other Developments
76
Derivatives
•
CFTC Title VII rulemakings are largely complete, although several key rulemakings
remain to be addressed, including:
• Margin for uncleared swaps
• Capital requirements for non-bank swap dealers and MSPs
• Position limits (again)
• Possible relief for end-users
• In addition, the application of Title VII to transactions between a non-U.S. swap dealer
and a non-U.S. person that are “arranged, negotiated or executed” by personnel or
agents of the non-U.S. swap dealer in the U.S. remains somewhat unsettled
• Various other cross-border issues also remain to be addressed, such as issues
relating to SEFs, substituted compliance and mutual recognition
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Derivatives
•
SEC has taken a different approach to Title VII rulemaking
• It appears that no registration requirements will be imposed until all substantive
Title VII rulemaking by SEC is complete
• SEC’s substantive rulemaking has lagged significantly behind the CFTC’s
• SEC has finalized relatively few rules
• In some cases, the SEC is yet to publish a proposed rule on matters that
the CFTC has long since published proposed rules on or even proceeded to
adopt final rules
• Even where SEC has published proposed rules, the timeline for finalizing
these rules is unclear, although SEC Chair Mary Jo White has indicated that
finishing Title VII rulemaking is a high priority for the agency going forward
• The SEC proposed recordkeeping and reporting rules for SBSDs and
finalized certain cross border rules
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2015
79
Anticipated U.S. Developments in 2015
• Items that were deferred (like single-counterparty credit limits,
remediation standards) to be addressed
• New regulatory requirements to be proposed
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Additional U.S. Requirements
• Long-term debt requirement:
• A requirement for large internationally active financial institutions to
have minimum amounts of long-term unsecured debt outstanding to
absorb losses
• Expectation is that this will help counteract moral hazard by providing
sufficient equity/debt to absorb losses in an insolvency—sufficient to
capitalize a bridge bank and sufficient to avoid taxpayer losses
• Tarullo has discussed that this requirement might be met by debt
convertible by its terms to equity (contingent capital)
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Additional U.S. Requirements (cont’d)
• Measures to address reliance on short-term wholesale funding:
• Regulators have noted that risks may arise in connection with shortterm financing transactions, such as repo, reverse repo, securities
borrowing and hedging transactions, and margin loans
• Reliance on short-term funding may lead to fire sales/runs
• Alternatives that have been discussed include:
• Requiring a liquidity linked capital surcharge or tax
• Modifying liquidity regulation
• Imposing a universal margining requirement
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Interaction of Various Requirements
• Banks are still assessing the various interactions resulting from the
requirements that have been finalized
• The “cumulative” effect of these requirements will not be felt for some
time; however, it is apparent that at least in certain respects, the
requirements may create somewhat inconsistent incentives or
disincentives for banks.
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