The SEC and 5 other federal agencies have a new proposed rule that would require sponsors of asset-backed securities (ABS) to retain at least 5% of the credit risk of the assets underlying the securities.  The credit risk may not be transferred or hedged. Comments are requested by 6/10/11.

In selecting 5% as the amount of credit risk retention, the agencies believe they've selected a meaningful amount that will not negatively impact the availability and cost of credit to consumers and businesses. 

    Participating in the Joint Proposal are ...   the Federal Reserve Board, the Office of the Comptroller of the Currency, the FDIC, the SEC, the Federal HFA, and the Department of HUD.   The rule would provide sponsors with various options for meeting the risk-retention requirements of Dodd-Frank - among other things, the options include:

• Retention of risk by holding at least 5% of each class of ABS issued in a securitization transaction - aka "vertical retention."
• Retention of a 1st-loss residual interest in an amount equal to at least 5% of the par value of all ABS interests issued in a securitization transaction - i.e., "horizontal retention."
• An equally-divided combination of vertical and horizontal retention.
• Retention of a representative sample of the assets designated for securitization in an amount equal to at least 5% of the unpaid principal balance of all the designated assets.
• For commercial MBS's, retention of at least a 5% 1st-loss residual interest by a 3rd party that specifically negotiates for the interest, if certain requirements are met.

Further Requirements Under Dodd-Frank Act.    As proposed, the rule includes descriptions of loans that would not be subject to these requirements, including ABS's that are collateralized exclusively by residential mortgages that qualify as “qualified residential mortgages” (QRMs).  "QRMs" would be defined as incorporating such criteria as borrower credit history, payment terms, and loan-to-value ratio - designed to ensure they are of very high credit quality.

The proposed rule also includes investor disclosure requirements regarding material information concerning the sponsor’s retained interests in a securitization transaction.  The disclosures would provide investors and the agencies with an efficient mechanism to monitor compliance with the risk-retention requirements of the proposed rules.

As proposed, there is a 0% risk-retention requirement for ABS collateralized exclusively by commercial loans, commercial mortgages, or automobile loans that meet certain underwriting standards.  As with QRMs, these underwriting standards are designed to be robust and to ensure that the loans backing the ABS are of very low credit risk.

Finally, the proposed rule also would recognize that the 100% guarantee of principal and interest provided by Fannie Mae and Freddie Mac meets their risk-retention requirements as sponsors of MBS's for as long as they are in conservatorship or receivership with capital support from the U.S. government.

For further details, go to:   [SEC Release 11-79, 3/31, "Joint Release.."]