U.S. Issuances of ABS by Non- U.S. Issuers

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Stewart Jackson
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3 State of U.S. Private-Label RMBS Our purpose is to provide an update on the state of the U.S. securitization and covered bond markets for prospective issuers who have been out of the U.S. market since the financial crisis. Many issuers have been put off by the uncertainty caused by the large number of reform proposals resulting from the crisis. While there are still many uncertainties, the basic outline of the future U. S. market is finally emerging. We will review the status of a number of reforms, both adopted and still proposed. We will start with an overview of the markets since The following pages show, for 2005 to 2012: U.S. Mortgage-Related Securities Issuance U.S. Asset-Backed Securities Issuance European Securitization Issuance *Source: SIFMA 3

4 U.S. Mortgage-Related Securities Issuance (USD Billions)* Agency Non Agency Total Year MBS CMO CMBS RMBS Total , , , , , , , , , , , , , ,056.1 *Source: SIFMA 4

5 U.S. Asset-Backed Securities Issuance (USD Billions)* Year Auto Credit Cards Equipment Home Equity Manufactured Housing Other Student Loans Total *Source: SIFMA 5

6 European Securitization Issuance (USD Billions)* ABS Year Auto Consumer Credit Cards MBS Leases Other CDO CMBS Mixed RMBS *Source: SIFMA 6

7 State of the U.S. ABS Market Residential MBS Redwood Trust Post-GFC RMBS pioneer Accounts for most of 2010 to 2012 U.S. RMBS Issuance Other issuers JPMorgan J.P. Morgan Mortgage Trust (March 2013): $616.3 million; pool of 752 loans Credit Suisse CSMC Trust 2013-TH1 (February 2013): $425.7 million; pool of 555 loans Post-Crisis Deal Terms Arbitration Time-Limited Representations and Warranties 7

8 State of U.S. Private-Label RMBS Cont d Various governmental policies are impeding the market for private-label securitizations Low guarantee fees for GSE loans encourage GSE securitizations High conforming loan limits of the GSEs limit the number of loans for private-label securitizations Regulatory reform has created uncertainty in the market and, in some cases, favors GSE securitizations At the same time, Congress and GSEs are attempting to develop the secondary market for non-agency securitizations In 2012, the Federal Housing Finance Agency (FHFA) proposed a strategic plan for building infrastructure for a new secondary mortgage market Items in the proposal include building a single securitization platform, standardizing data reporting and developing a standard pooling and servicing agreement In 2012, the FHFA and the Consumer Financial Protection Bureau announced a partnership to create a National Mortgage Database containing loan-level information dating back to 1998 Jumpstart GSE Reform Act introduced in March 2013 to promote reform of the GSEs Private-label securitizations are on the rise An April 2013 report by Standard & Poor s Rating Services projects U.S. RMBS Issuance could reach $20 billion or higher in 2013, up from $6 billion in

10 Dodd-Frank Section 943: Reps and Warranties Rule 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 10

11 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 11

12 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 12

13 Dodd-Frank Section 942(a): Elimination of Automatic Suspension of SEC Reporting - Cont d SEC no-action letter stating it wouldn t recommend enforcement action if an ABS issuer continues to determine its reporting obligations based on the standards of Section 15(d) of the 34 Act if: reporting obligation in respect of outstanding ABS had been suspended by operation of Section 15(d) immediately prior to the date of enactment of Dodd- Frank; the issuer continues to comply with requirements under the ABS transaction agreements to make ongoing information regarding the ABS and the related pool assets available to security holders, directly or through the trustee; and the issuer retains the information for at least five years after ABS are no longer outstanding and, upon request, furnishes a copy of any or all such information to SEC. 13

14 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 14

15 Dodd-Frank Section 942(a): Elimination of Automatic Suspension of SEC Reporting Cont d Rule 15d-22(b) amends Form 15 to add a checkbox for ABS issuers to indicate that they are relying on Exchange Act Rule 15d-22(b) to suspend their reporting obligation and adds two Notes: Note 1 indicates that securities held of record by a broker, dealer, bank or nominee shall be considered as held by the separate accounts for which the securities are held, and Note 2 includes an anti-avoidance provision providing that an issuer may not suspend reporting if securities are acquired and resold by affiliates as part of a plan or scheme to evade the reporting obligations 15

17 Regulation AB Adopted in December 2004 Governs disclosure and reporting requirements for SEC-registered securitization transactions Proposed and adopted on the view that the securitization market had become so significant that additional regulatory attention was warranted 17

18 Regulation AB II In April 2010, the SEC proposed substantial revisions in the wake of the financial crisis, attempting to provide greater investor protection and restore investor confidence The SEC re-proposed its revisions in July 2011 following Dodd-Frank Act provisions concerning asset-level disclosure, broker and originator compensation and risk retention Adoption of the final rules expected in 2013 and currently lays over the ABS market 18

19 Regulation AB II Proposed Revisions Extensive asset-level data disclosure Reg AB extended to cover Rule 144A and Reg D offerings same disclosure as S-1 offering departure from sophisticated purchaser paradigm for private placements Shelf offerings require: a preliminary prospectus be available 5 days prior to pricing executive officer certification that structure designed to produce cash flow sufficient to pay offered securities Credit risk manager to perform an asset review in certain circumstances (e.g. when credit enhancements not met or at direction of investors) 19

20 Regulation AB II Proposed Revisions Issuers to file a computer program giving effect to waterfall provisions. The SEC is reconsidering this requirement and expected to re-propose separately Reg AB II will apply to any issuer offering MBS and ABS in the U.S. (if private offerings included) 20

21 Dodd-Frank Section 941: Risk Retention Rules Require securitizers to retain not less than 5% of credit risk of assets collateralizing ABS issuance whether vertical, horizontal, L-shaped, cash reserve account, or representative sample Transaction specific risk retention options for revolving master trusts, CMBS, ABCP conduits, and agency ABS Exemptions for govt. guaranteed ABS, certain resecuritizations, QRMs (as defined in the proposed rule), and certain auto loans, commercials loans and commercial real estate Foreign transaction safe harbor for transactions predominantly outside the US Prohibition on hedging or transferring required risk retention 21

22 Dodd-Frank Section 621: Conflicts of Interest Rules Adds section 27B to 33 Act proposed Rule 127B prohibits certain persons involved in structuring, creating and distributing ABS from engaging in transactions within 1 year after date of first closing of sale of such ABS that would involve or result in a material conflict of interest with respect to any investor in such ABS Exceptions Risk-mitigating hedging activities Liquidity commitments Bona fide market-making Conditions: ABS transaction that involves covered persons, covered products, a covered timeframe, a covered conflict, and a material conflict of interest 22

23 Dodd-Frank Section 621: Conflicts of Interest Rules Cont d Covered persons include underwriters, placement agents, initial purchasers, sponsors, and any affiliate or subsidiary of any such entity Covered products is any ABS as defined in section 3 of the 34 Act and covers both private and registered deals, as well as synthetic ABS Covered timeframe is any transaction engaged in prior to the date that is 1 year after the closing of the sale of the ABS 23

24 Dodd-Frank Section 621: Conflicts of Interest Rules Cont d Covered conflict is any material conflict of interest between an entity that is a securitization participant and an investor in such ABS that arises as a result of or in connection with such ABS transaction Expressly excluded are conflicts that arose exclusively between securitization participants, or exclusively between investors, conflicts that did not arise as a result of or in connection with the ABS transaction, and conflicts that did not arise as a result of or engaging in connection with engaging in any transaction, such as issuing investment research by a securitization participant 24

25 Dodd-Frank Section 621: Conflicts of Interest Rules Cont d Material conflict is a two-prong test: (1) securitization participant would benefit directly or indirectly from actual, anticipated, or potential (a) adverse performance of the asset pool, (b) loss of principal, monetary default or early amortization event on the ABS, or (c) decline in markets value of the ABS; or (2) securitization participant who directly or indirectly controls the structure of the ABS or selection of assets in ABS would benefit directly or indirectly from fees or other forms of remuneration as a result of allowing a third party, directly or indirectly, to structure the relevant ABS; and there is a substantial likelihood that a reasonable investor would consider the resulting conflict important to his or her investment decision 25

27 Volcker Rule Volcker Rule prohibits banks from holding more than 3% of a covered fund Meant to keep banks from owning hedge funds Definition of covered fund is broad and includes any entity that is exempt from registration as Investment Company under 40 Act based on exemptions set forth in 3(c)(1) or 3(c)(7) which would apply to most securitizations Would conflict with securitization risk retention requirements 27

28 Establishment of CFPB Consumer Financial Protection Bureau was established under the Dodd-Frank Act and began operation on July 21, 2011 The jurisdiction of the bureau 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 are mortgages, credit cards and student loans. Consolidates responsibilities from various federal regulatory bodies, including the Federal Reserve, the Federal Trade Commission, the Federal Deposit Insurance Corporation, the National Credit Union Administration and the Department of Housing and Urban Development. It writes and enforces bank rules, conducts bank examinations, monitors and reports on markets, as well as collects and tracks consumer complaints. 28

29 Consumer and Mortgage Lending Reform In January 2013, the Consumer Financial Protection Bureau issued the Ability-to-Repay and Qualified Mortgage rule Amends Reg Z to require lenders to account for a borrower s ability to repay Reg Z applies to all persons extending consumer credit to U.S. residents Final rule takes effect in January 2014 Ability-to-Repay Requirement For residential 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 29

30 Consumer and Mortgage Lending Reform Cont d Eight enumerated underwriting factors for creditors to consider, including: Borrower s income or assets (excludes assets securing the loan) Borrower s employment status Borrower s expected monthly payment for the loan Borrower s debt obligations Borrower s credit history 30

31 Consumer and Mortgage Lending Reform Cont d Qualified Mortgage ( QM ) definition Residential mortgage loan that meets the following criteria: No excess upfront points and fees No negative amortization Term not exceeding 30 years Consumer cannot defer repayment of principal No balloon payment (with a very narrow exception) Income and financial resources must be verified and documented Limits on debt-to-income ratios QMs provide compliance safe harbor or rebuttable presumption that ability-to-repay requirements satisfied 31

32 Consumer and Mortgage Lending Reform Cont d Consequences of the Ability-to-Repay and QM rule Complexity may create compliance challenges and litigation risks Restrictions may tighten access to credit Non-U.S. issuers not subject to these requirements may have an advantage over other market participants 32

33 Consumer and Mortgage Lending Reform Cont d In January 2013, the Consumer Financial Protection Bureau issued new mortgage servicing standards focused on helping troubled borrowers Final rules take effect in January 2014 and apply to all U.S. servicers Among other items, the new standards: Forbid servicers from dual-tracking (i.e. evaluating a consumer for loan modifications at same time as preparing to foreclose) Require servicers to provide delinquent borrowers with direct and continuous access to servicing personnel Prevent servicers from making a first foreclosure notice or filing until a mortgage is at least 120 days delinquent Require servicers to provide written notice of loss mitigation options to borrowers Servicers that service less than 5,000 loans that they or an affiliate either own or originated are exempted 33

34 Credit Ratings Dodd-Frank Act eliminated certain safeguards against strict liability for credit rating agencies rating securities offered and sold pursuant to a US registration statement Issuers must obtain consent from such credit rating agencies in order to include such ratings in the registration statement or prospectus Because credit rating agencies now face strict liability for that portion of any registration statement or prospectus they have in essence expertised, they have routinely declined to provide the necessary consents Applies only to registered deals; not applicable to Rule 144A or Reg S offerings 34

36 Definitional Changes Dodd-Frank s inclusion of swaps as commodity interests means that pooled investment vehicles trading in swaps (and their operators or advisors) must consider whether they may be subject to regulation as a Commodity Pool, a Commodity Pool Operator or a Commodity Trading Advisor 36

37 Commodity Pool Definition As amended by Dodd-Frank, the Commodity Exchange Act ( CEA ) now defines the term commodity pool to include any investment trust, syndicate, or similar form of enterprise operated for the purpose of trading in commodity interests, including any (i) commodity for future delivery, security futures product, or swap; (ii) agreement, contract, or transaction described in section 2(c)(2)(C)(i) of the CEA or section 2(c)(2)(D)(i) of the CEA; (iii) commodity option authorized under section 6c of the CEA; or (iv) leverage transaction authorized under section 23 of the CEA In addition, the CFTC, by rule or regulation, may include within, or exclude from, the term commodity pool any investment trust, syndicate, or similar form of enterprise if the CFTC determines that the rule or regulation will effectuate the purposes of the CEA 37

38 Commodity Pool Operator Definition As amended by Dodd-Frank, the CEA now defines the term commodity pool operator to include any person: (i) engaged in a business that is of the nature of a commodity pool, investment trust, syndicate, or similar form of enterprise, and who, in connection therewith, solicits, accepts, or receives from others, funds, securities, or property, either directly or through capital contributions, the sale of stock or other forms of securities, or otherwise, for the purpose of trading in commodity interests, including any (I) commodity for future delivery, security futures product, or swap; (II) agreement, contract, or transaction described in section 2(c)(2)(C)(i) of the CEA or section 2(c)(2)(D)(i) of the CEA; (III) commodity option authorized under section 6c of the CEA; or (IV) leverage transaction authorized under section 23 of the CEA; or (ii) who is registered with the CFTC as a commodity pool operator In addition, the CFTC has the authority to include within, or exclude from, the CPO definition any person if such inclusion or exclusion will effectuate the purposes of the CEA 38

39 Why should you avoid CPO status? A CPO: Is de facto a financial entity and not able to avail itself of the end-user exemption Must register itself, and register its principals and associated persons, as members of the NFA Requires filing of a Form 7-R for the entity, and an 8-R for each AP/principal A principal will be understood to include a director, officer, or anyone with decision-making authority A holder of 10% or more of the equity of the entity also is considered a principal An AP must take a Series 3 exam, required ethics training, and subject itself to fingerprinting and other registration obligations Is subject to ongoing compliance obligations 39

40 Compliance obligations of CPOs A CPO will be subject to oversight and examinations by the NFA A CPO must be prepared to comply with various initial and ongoing reporting, recordkeeping and other requirements, including: The requirement to appoint a CCO The obligation to file with, and have approved by, the NFA a disclosure document, and comply with regulations relating to information disclosures A requirement to maintain compliance policies and procedures to provide for appropriate custody of client assets; secure privacy of client information; comply with anti-money laundering requirements; prevent manipulative or disruptive trading practices, ensure business continuity, maintain accurate records, etc. File certain annual and other reports, such as Forms CPO-PQR and CTA-PR 40

41 Exclusions from Definition of Commodity Pool No-Action Relief The CFTC has issued no-action relief to the effect that certain vehicles that trade in swaps need not be considered as a commodity pool In no-action letters relating to securitization vehicles (each, an SV ) and equity real estate investment trusts (each, an equity REIT ), the CFTC has applied a fact-intensive analysis to determine whether or not an SV or equity REIT constitutes a commodity pool A primary inquiry is the extent to which such a vehicle s entering into swaps actually drives (or could actually drive) the investment returns of investors in the vehicles, as opposed to being used for certain limited permitted uses (e.g. credit enhancement and altering rates or currency flows from underlying assets) 41

42 Securitizations No-Action Relief CFTC No-Action Letter (October 11, 2012) provides that a securitization vehicle will not constitute a commodity pool if it conforms to the following criteria: the issuer of the asset-backed securities is operated consistent with the conditions set forth in Regulation AB, or Rule 3a-7, whether or not the issuer s security offerings are in fact regulated pursuant to either regulation; the entity s activities are limited to passively owning or holding a pool of receivables or other financial assets (either fixed or revolving) that by their terms convert to cash within a finite time period plus any rights or other assets designed to assure the servicing or timely distributions of proceeds to security holders; the entity s use of derivatives is limited to the uses of derivatives permitted under the terms of Regulation AB, which include credit enhancement and the use of derivatives such as interest rate and currency swap agreements to alter the payment characteristics of the cash flows from the issuing entity; the issuer makes payments to securities holders only from cash flow generated by its pool assets and other permitted rights and assets, and not from or otherwise based upon changes in the value of the entity s assets; and the issuer is not permitted to acquire additional assets or dispose of assets for the primary purpose of realizing gain or minimizing loss due to changes in market value of the vehicle s assets. 42

43 Securitizations More No-Action Relief CFTC No-Action Letter (December 7, 2012) provides further detail with regard to securitization vehicles that may or may not constitute commodity pools: certain securitization vehicles that do not satisfy the operating or trading limitations contained in Regulation AB or Rule 3a-7 may be properly excluded from the definition of commodity pool, provided that the criterion with respect to the ownership of financial assets continues to be satisfied and the use of swaps is no greater than that contemplated by Regulation AB and Rule 3a-7, and such swaps are not used in any way to create an investment exposure Examples: A standard asset-backed commercial paper conduit Even if not falling within the letter of the letter, an investment in this securitization is not unlike an investment in a traditional securitization that satisfies Regulation AB or Rule 3a-7 in that the investment is essentially in the financial assets in the vehicle and not in the swaps A CDO using swaps to convert fixed rate assets into floating rate assets and FX swaps to convert a foreign currency into dollars Similarly, such an investment is not unlike an investment in a traditional securitization that satisfies Regulation AB or Rule 3a-7 in that the investment is essentially in the financial assets in the vehicle and not in the swaps A covered bond transaction The collateral pool (and any special purpose vehicle) would not be a commodity pool if it contains no commodity interests other than any swaps which are used only for purposes permitted by Regulation AB, and covered bond holders are only entitled to receive payments of accrued interest and repayment of principal of their covered bonds, without any condition to payment based upon any derivative exposure 43

44 Securitizations (further cont.) However, if investors in an SV have exposure to swaps which are used to create investment exposure (e.g., the payment to investors is affected by swaps in a way other than to enhance credit (within reason) or to swap interest rates or currencies, each as permitted by Regulation AB), then the securitization vehicle may be a commodity pool Examples: CDO holding a 5% bucket for synthetic assets consisting of swaps rather than having 100% of its holdings in financial assets Repackaging vehicle that issues credit-linked or equity-linked notes where the repackaging vehicle owns high quality financial assets, but sells credit protection on a broad based index or obtains exposure to a broad based stock index through a swap (SV may be a commodity pool because investors in the SV are obtaining a significant component of their investment upside or downside from the related swaps) Repackaging vehicle that acquires a three-year bond, issues a tranche of notes, and uses swaps to extend investment experience of the bond (and notes) to four years Commercially unreasonable use of swaps as credit support in a securitization (e.g., to raise CCC rated underlying assets to AA rating level, thereby making the swap a significant aspect of the investment ) 44

45 Legacy Securitizations CFTC No-Action Letter also contains no-action relief for certain legacy securitization issuers of fixed-income securities The relief applies if: the issuer issued fixed income securities before October 12, 2012 that are backed by and structured to be paid from payments on or proceeds received in respect of, and whose creditworthiness primarily depends upon, cash or synthetic assets owned by the issuer; the issuer has not issued and will not issue new securities on or after October 12, 2012; and issuer agrees, upon request, to provide disclosure documents and other information 45

46 Exemptions from CPO Registration CFTC Regulation 4.13(a)(1) closely held pool not required to register as CPO if does not receive any form of compensation; operates only one pool at a time; not otherwise required to register with the CFTC; and does not advertise CFTC Regulation 4.13(a)(2) small pool not required to register if no pools have more than 15 participants (not including pool s operator, CTA and certain other related persons); and total gross capital contributions in all pools do not exceed $400,000 CFTC Regulation 4.13(a)(3) de minimis exemption exclusion from CPO registration for entities that engage in a de minimis amount of derivatives trading activity 46

47 The 4.13(a)(3) Exemption CFTC Regulation 4.13(a)(3) exempts pools with investors that are either non-us persons or that meet an accredited investor - like standard provided that the pools trades only a de minimis amount of commodity interests, whether or not for bona fide hedging purposes Limitations are similar to those in new Rule 4.5: aggregate initial margin, premiums and required security deposit for commodity positions cannot exceed 5% of the liquidation value of the fund s portfolio (after taking into account unrealized profits and losses), OR the aggregate net notional value of commodity positions will not exceed 100% of the liquidation value of the fund s portfolio (after taking into account unrealized profits and losses) Commodity positions include commodity options, certain swaps, certain forex transactions and futures (including security futures) 47

48 Regulation 4.5 Exclusion CTFC Regulation 4.5 excludes from the definition of a CPO qualifying entities that operate pools regulated by some other regulatory authority Qualifying entities include Registered investment companies (that comply with restrictions) Insurance companies with respect to separate account Bank, trust company or financial depository institution with respect to trust or custodial assets while acting in fiduciary capacity Trustee or named fiduciary of, or employer maintaining an ERISA pension plan February 9, 2012 CFTC amended Rule 4.5 to sharply limit the ability of advisers to registered investment companies that use derivatives to rely on the exclusion 48

49 Swaps - Clearing Dodd-Frank Act provides that the CFTC or the SEC in consultation with the US Treasury Secretary may prohibit an entity domiciled in a non-us jurisdiction from participating in any swaps activities in the US if it determines that the regulation of swaps markets in that country undermines the stability of the US financial system Dodd-Frank Act s provisions apply only to swaps activities in the United States, except where activities outside the United States have a direct and significant connection to activities in, or effect on, US commerce, or contravene any rules designed to prevent the evasion of US derivatives laws. If issuer is not a dealer or major participant and enter into swaps in the US for purposes of hedging or mitigating commercial risk, issuer may be eligible to utilize the end-user exemption from mandatory clearing 49

50 Swaps End User Exemption Mandatory centralized clearing of swaps unless one of the counterparties: is (i) not a dealer, major participant, commodity pool, private fund, employee benefit plan, or entity that predominantly engages in financial or banking activities, (ii) using the swap to hedge or mitigate commercial risks, and (iii) notifies the CFTC or the SEC how it generally meets its financial obligations associated with non-cleared swaps This exemption is also available to an affiliate of an entity that meets the criteria above (a Qualifying Entity ) so long as such affiliate: is (i) not a dealer, major participant, commodity pool, private fund or bank holding company with over US$50 billion in consolidated assets, (ii) acts on behalf of the Qualifying Entity and as an agent, and (iii) uses the swap to hedge or mitigate the commercial risks of the Qualifying Entity or other affiliate of the Qualifying Entity Swaps entered into in the US for purposes of speculation, trading, or investing are not eligible for the end-user exemption. 50

52 Foreign Bank Issuance into U.S. Some tranches of European offerings were sold into the U.S. prior to 2008 Post-crisis issuance resumed in 2010 with $25 billion of offerings 2011 followed with more than $35 billion of issuance and 2012 provided almost $50 billion of issuance 2013 has started somewhat slowly at a time when European issuance is at historic lows Currently we have more than $110 billion of covered bonds outstanding 52

53 Foreign Bank Issuances Foreign banks issuing into the US market have been relying on their domestic covered bond framework and have been using cover pool assets that are foreign (not in the United States). Issuances into the United States have been structured as program issuances (or syndicated takedowns) conducted on an exempt basis; that means that the foreign issuer is relying on exemptions from the U.S. securities laws requiring registration of public offerings of securities. As a result, offerings have been targeted at U.S. institutional investors and generally conducted in reliance on Rule 144A. On May 18, 2012, Royal Bank of Canada obtained a no-action letter from the SEC that permitted RBC to register its covered bond program on Form F-3. On July 30, 2012, RBC obtained SEC approval for a registration statement for its covered bond program ( ): On September 19, 2012, RBC issued $2.5 B of 5 year covered bonds under this registration statement. On December 6, 2012, RBC issued $1.5 B of 3 year covered bonds. 53

54 Issuance Alternatives In a private placement in reliance on U.S. private placement exemptions (generally Section 4(a)(2)). In an offering structured as a private placement, with resales under Rule 144A (to qualified institutional buyers, or QIBs). In an offering by a bank that is excepted from registration under Section 3(a)(2) (a 3(a)(2) offering). In an SEC registered offering, public offering without restrictions. 54

56 Covered bonds in the United States Historically, housing finance in the United States has depended on other sources (instead of covered bonds). For example, the GSEs. The GSEs were essential to the growth of the securitization market in the United States. Securitization. U.S. banks became dependent on securitization. There was a significant market for securitization and securitization provided off-balance sheet treatment for regulatory capital and GAAP accounting purposes. FHLB funding. U.S. banks had access to funding from the Federal Home Loan Bank system. 56

57 Covered bonds in the United States Given a mix of the financial crisis, GSE financial circumstances, market forces, accounting developments and regulatory changes, new housing finance alternatives are becoming more important. Covered bonds have been in the news in the United States since In September 2006, Washington Mutual became the first North American financial institution to offer covered bonds in an offering in Europe. In 2007, Bank of America followed with its own covered bond offering in Europe. 57

58 The Emergence of US Domestic CB Supply is Anticipated Subject to the Establishment of US Covered Bond Legislation In 2011, Covered Bond legislation was introduced in the House as H.R. 940 and passed the Financial Services Committee by a strong bi-partisan vote of 44-7 Covered Bonds legislation was introduced in the Senate on November 9, 2011 as S No hearings were held. A new Congress begins in 2013, so the legislation must be reintroduced. Upon passage, it is our expectation that a number of the US money center / super-regional banks will begin issuing covered bonds into the USD market following a brief rule-making period. The passage of US covered bond legislation will resolve existing uncertainty around the ability of covered bonds to survive an FDIC receivership and will allow US issuers to begin accessing this cost efficient funding source soon thereafter. Key steps for US legislation are as follows: The United States Covered Bond Act of 2013 must be introduced in and passed by the House; A companion bill must be introduced in the Senate and passed by the Senate; and The House and Senate must then agree on a final bill, to be signed by the President WaMu issues first North American covered bond into Euro market 2007 Bank of America issues first USD covered bond by a US bank 2007 RBC launches the first Canadian covered bond program January 2010 CIBC issues the first USD 144A covered bond since 2007 March 2011 US Covered Bond Act introduced by Rep. Scott Garrett November 2011 US Covered Bond Act introduced by Senators Hagan and Corker /13 No significant legislative developments RBC first SEC registered covered bond Anticipated completion of US covered bond legislation The Development of US Domestic Covered Bonds in the USD Market 58

59 Proposed Legislation in the U.S. mofo.com

60 Essential legal elements Federal legislation. Creation of a separate insolvency estate Necessary to protect the maturity of the bond We have a unitary insolvency system Only a single estate to meet the claims of creditors Priority claim for bondholders. Covered bond regulator Regulatory oversight of the quality of covered bonds Regulatory approval of issuance Regulatory oversight of the administration of the separate estate No tax on separate estate or its activities. 60

61 Proposed U.S. Structure Legislation enables direct issuance from the bank to investors while ensuring the assets are segregated in the event of an issuer insolvency The statute generally enables cash flow from the collateral to continue to pay covered bonds as scheduled notwithstanding the insolvency of the issuer. Covered Bond Security Trustee Security Covered Bond Proceeds Cover Pool Issuer Covered Bonds Covered Bondholders 61

62 Key Elements of the Legislation Cover Pool Assets Eligible Asset complying first-lien residential mortgage loan complying commercial mortgage loan loans or securities of States or municipalities complying auto loans or leases complying student loans complying revolving credit receivable any loan made or guaranteed under a Small Business Administration program any other asset designated by the covered bond regulator in consultation with the primary financial regulatory agency of the issuer substitute asset cash, overnight Federal funds, US Government obligations and GSE obligations 20% of pool 62

63 Key Elements of the Legislation (cont d) Legal Attributes of Statutory U.S. Covered Bonds Only one asset type permitted in a cover pool. The Issuer s primary Federal financial regulator to be the covered bond regulator. The regulator is required to set a limit for each issuer on the amount of covered bonds an issuer may have outstanding based on total assets Cease and desist authority if program does not comply with legislation Upon insolvency of a bank issuer, 180 days for the FDIC to transfer the covered bonds to another bank. The cover pool becomes a separate estate if the covered bonds are not transferred or if the FDIC is not the receiver. Upon default prior to insolvency, the cover pool becomes a separate estate immediately. 63

64 Key Elements of the Legislation (cont d) Legal Attributes of Statutory U.S. Covered Bonds The covered bond regulator as the trustee of the pool. Appoints one or more servicers or administrators. Administers the estate for the benefit of the bondholders and other secured parties (e.g., swap counterparties). Authority for the cover pool to borrow for liquidity purposes. FDIC granted a residual interest in the cover pool. Covered bonds issued by a bank are deemed to be issued under Section 3(a)(2) of the Securities Act Covered bonds are not an asset-backed security and therefore should not be subject to SEC Regulation AB 64

65 Prospects for Legislation Several factors favor U.S. Covered Bonds legislation in 2013 Prices in the housing market are recovering Fannie Mae and Freddie Mac are being wound down Have been 95% of financing for new mortgage loans FDIC unlimited deposit account guarantee has terminated Presidential election behind us Ways and Means Committee cleared bill Steadily growing issuance by foreign banks into U.S. Currently there are more than $110 billion of covered bonds outstanding SEC approval of RBC registration statement RMBS market still has little traction Possible solution to FDIC concerns 65

67 SEC Registered Covered Bonds RBC obtained a no action letter from the SEC SEC link RBC filed its registration statement of Form F-3 ( ). A shelf registration statement. SEC link There are eligibility requirements for Form F-3, including at least 12 months of SEC reporting history. Form F-9 or Form F-10 issuers generally would be eligible for Form F-3. 67

68 SEC Registered Covered Bonds Cont d The covered bonds were not deemed to be ABS, although disclosure consistent with Regulation AB was required. Disclosure about the cover pool assets is similar to a credit card or UK RMBS master trust. No loan level disclosure for loans in the cover pool. No financial statements required for the Guarantor. 68

69 Canadian Covered Bond Architecture The structure first launched by RBC has been established as the market standard for Canadian issuers with CIBC, BMO, BNS, TD and NBC utilizing the same basic structure. The Canadian covered bond architecture below closely resembles the UK covered bond architecture: Covered bonds are issued to investors with full recourse to the Issuer and the cover pool. The issuer, as Seller, sells mortgage loan assets to the Guarantor, which uses proceeds from the Intercompany Loan to purchase the mortgage loans from the Issuer and provide a guarantee to the covered bond investors. Canadian Bank Seller Mortgage Loans and Related Security Consideration Covered Bond Guarantor Guarantor Interest Rate Swap Provider CB Swap Provider Intercompany Loan Repayment of Intercompany Loan Canadian Bank Issuer Trust Deed (incl Covered Bond Guarantee) and Security Agreement Covered Bond Proceeds Covered Bonds Bond Trustee Covered Bondholders 69

70 Why a No Action Letter? Required by Canadian/U.K. structure Separate Guarantor deemed to be issuing a separate security, the guarantee The guarantee needs to be registered with the SEC The Guarantor is not an SEC reporting company Nor is it a 100% owned subsidiary under Rule 3-10 of Regulation S-X Not a full and unconditional guarantee under Rule 3-10 of Regulation S-X So Guarantor does not qualify for a shelf registration statement No action letter from SEC permits both Bank and Guarantor to register on a shelf registration statement This would not be a requirement for a Pfandbrief-type structure 70

71 Advantages of Registration No offering restrictions; no transfer restrictions. No investment restrictions; the bonds are not restricted securities. No requirement for the issuing bank to have a U.S. branch or agency; no capital impact on a U.S. branch or agency. No discussion required with U.S. banking regulators. No private placement restrictions on communications. No limits on repatriation of proceeds. 71

72 Advantages of Registration Wider investor base State retirement funds ~ 200 investors compared to 75 in a typical 144A Attractive pricing basis points savings compared to 144A RBC $2.5 billion 5 year Better secondary market Eligible for major bond indices e.g., Barclays Aggregate Bond Index TRACE Reporting System Pricing transparency 72

73 Advantages of Registration - TRACE

74 Disclosure Bank disclosure Typical bank disclosure for MTN, plus Mortgage origination program. Mortgage servicing program. Statistical disclosure of servicing portfolio. Covered bonds Summary of fees and expenses of Guarantor. Characteristics of the Loans. Statistical disclosure of cover pool. Static pool disclosure of cover pool (by vintage year of origination). SEC filing of monthly investor report, including delinquency information. Rule 193 disclosure of cover pool audit. 74

75 Ongoing Reporting Requirements The bank would file annual and interim reports and current reports. Form 40-F, Form 6-K and Form 8-K. The guarantor would file annual and interim reports. Annual reports on Form 10-K, including: Servicer s assessment of compliance with servicing criteria in Item 1122 Auditor s attestation report on servicer assessment of compliance Monthly reports on Form 10-D related to distributions of proceeds from the cover pool. Monthly investor report attached as an exhibit Current reports on Form 8-K. 75

77 Variations between U.S. and European Union Rules In contrast to the U.S., to date no EU-wide or EU member regulatory reforms have specifically targeted residential mortgage products Residential mortgage products exist in the EU, but have not proliferated to the extent they have in the U.S. However, the EU is now considering the implementation of rules to force lenders to check the creditworthiness of potential customers and their ability to repay The proposed rules are a reaction to the housing bubble that contributed to the Eurozone crisis Unlikely to go into effect until at least mid-2015 U.S. issuers of RMBS into Europe are impacted by EU securitization reforms of more general application relating to transparency, risk retention, due diligence and financial institution prudential standards 77

78 Variations between U.S. and European Union Rules U.S. Mortgage Loan Quality: Targeted U.S. residential mortgage industry reforms for originators, products, servicers European Union No widespread targeted mortgage loan reforms until this year s housing bubble proposals Credit Risk Retention: Obligation on securitizers and originators 5 methods of retention L-shaped retention Limited sharing of retained interest permitted Many asset class exemptions Limited foreign safe harbor Various proposals in process Obligation on EU financial institution investors to monitor compliance by securitization sponsors, originators and original lenders 4 methods of retention No L-shaped retention No sharing of the retention Limited exemptions Applies to foreign issuers Implemented law ABS Registration and Offering Disclosure Requirements Proposed revised shelf offering process and eligibility criteria Proposed asset-level data Proposed waterfall computer program Reps and Warranties Rule filings Rating agency comparison of reps and Warranties No ABS changes under Prospectus Directive ECB loan-level data Member State loan-level data Different fields of information, such as no FICO score Due Diligence Obligation on issuer Issuer Review Rule Obligation on investor (if an EU financial institution) No Issuer Review Rule Credit Rating Agencies Expert liability for rating agency Rule 17g-5 rating agency Issuer Website Rule No statutory expert liability for rating agency Proposed Article 8 CRA Regulation Issuer Website rule voted down Exemption of non-u.s. ABS from U.S. Issuer Website rule expires 2 December

79 Conclusion An issuer s strategy for participating in the U.S. markets will depend on a number of factors Legal status of the Issuer Bank or bank affiliate Non-bank finance company or aggregator Targeted asset types Mortgage assets more heavily regulated than non-mortgage Deal structure Traditional term securitization Covered bond Other (warehouse, ABCP, etc.) Registered vs. non-registered (144A/Reg. S) Offering only in the U.S. or concurrently in U.S. and non-u.s. jurisdictions. 79

Landscape for U.S. Asset-Backed Securities

The Emerging Regulatory la - 1254740 Landscape for U.S. Asset-Backed Securities June 24, 2014 Presented By Ken Kohler and Jerry Marlatt 2014 Morrison & Foerster LLP All Rights Reserved mofo.com State of