On Aug. 27, the Securities and Exchange Commission adopted revisions to its rules concerning asset backed securities, changes inspired by the losses suffered by holders of ABS in 2008.
As the SEC said in the press release that accompanied the new rules, the 2008 losses “revealed that many investors in the securitization market were not fully aware of the risks underlying the securitized assets and over-relied on ratings assigned by credit rating agencies….”
These rules have been in the oven for a long time: proposed four years ago, several rounds of comments have come and gone since then. There are two key features to the changes: enhanced disclosure one the one hand and new requirements for shelf offerings of ASB on the other.
Enhanced Disclosure
On the first of those points, the new rules adopt standardized asset-level (as distinct from pool level) disclosure, to be offered both at the time of offering and later, on an ongoing basis. The disclosures, required to appear in a standardized XML format, include:
- Data about the payment stream related to a particular asset [contractual terms, scheduled payment amounts; the basis for interest-rate calculations; whether and how payment terms will change over time];
- Data about the collateral related to the asset, such as the geographical location of the property and its loan-to-value ratio;
- Data about the performance of each asset over time, such as whether an obligor is making payments as scheduled; and
- Data about loss mitigation efforts by the servicer.
All this may allow investors to do what many of the burned former investors in the area would no doubt claim, the credit rating agencies should have been doing in the opening years of this century but conspicuously weren’t.
Some of the commenters in the various above mentioned rounds raised an issue about the privacy of the obligors. Should the SEC really require so much disclosure as to allow inquiring minds to figure out (to “re-identify”) who the obligors are? The SEC on reconsideration decided not. It omitted or modified “certain asset-level disclosures for RMBS and securities backed by auto loans and leases … to reduce the potential risk that the obligors could be re-identified.”
One example of this conflict arises from the desire of investors to have data about the geographical location of collateral. That is a natural desire; legend has it real estate is all about “location, location, and location.” Still: wouldn’t a rule supplying the public in general with the five digit zip code of such a property prove too granular, allowing re-identification?
The final rule requires the disclosure only of a 2-digit zip code.
Shelf Registration
The SEC agrees with the industry that shelf registration is a good thing, worth preserving, given its “significant flexibility and timing benefits.”
BUT … the SEC also says that this value must be balanced against “investors’ need for adequate information and time to make informed investment decisions.” Accordingly, much of the new rule creates new eligibility standards for the shelf. I’ll mention just two key points here: there must be independent third-party review of representations and warranties; and the chief executive officer of the depositor at an offering must sign a new certification.
Considering Consequences
In a discussion of the likely consequences of its new rule, the SEC observed that it doesn’t know “who will ultimately bear [the] direct compliance costs” imposed by the rule changes. They will be borne in the first instance by the sponsors of ABS, but there are various ways in which sponsors may be able to pass those costs to other market participants, depending on market conditions, the competitiveness of the different links in the securitization chain, and the availability of alternative forms of credit.
What might the issuers do if they prove unable to pass along costs to borrowers or investors? They could issue unregistered offerings of course, or register through Form SF-1. Either such decision could “have the effect of reducing efficiency and [impeding] capital formation,” that is, of undermining the reasons why shelf registration exists as an option.
On the other hand, the SEC observed that some of the investor commenters on this proposal (notably MetLife II) have argued that sponsors are over-stating the costs and burdens of the newly-required disclosures.