A Guide to the Credit Risk Retention Rules for Securitizations

This Report was originally published November 3, 2014.

On October 21 and 22, 2014, pursuant to the requirements of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Dodd-Frank Act”), the Securities and Exchange Commission (the “SEC”) and various federal banking and housing agencies adopted credit risk retention rules for securitizations. These rules, which were first proposed on March 29, 2011, and re-proposed on August 28, 2013, provide several methods of retaining the required 5 percent risk exposure, as well as limited exceptions for pools of assets that satisfy specified credit criteria.

The credit risk retention rules apply to sponsors of virtually all securitizations (other than synthetic structures), whether the asset-backed securities (“ABS,” as more fully defined below) are publicly or privately offered, and permit only limited circumstances in which the required risk retention may be held by an originator or other party rather than the sponsor (or a majority-owned affiliate of the sponsor). The required risk may be retained in one of several forms, including vertical, horizontal, and a combined method; no representative sample method was adopted. The rules provide other methods of risk retention that apply only to specific types of assets or transactions, including revolving pool securitizations,  such as asset-backed commercial paper conduits, commercial mortgage-backed securities, securitizations sponsored by government-sponsored enterprises like Fannie Mae and Freddie Mac, and tender option bond transactions.

The regulations set standards for a category of “qualified residential mortgages” (“QRMs”) that are exempt from the risk retention requirements. The definition of QRM is consistent with the definition of “qualified mortgage” (“QM”) as adopted from time to time by the Consumer Financial Protection Bureau (the “CFPB”). The rule also completely exempts any securitization with an asset pool containing a single class of qualified assets (i.e., commercial loans, commercial real estate loans and consumer auto loans that meet stringent requirements), and imposes a zero percent risk retention requirement on qualified assets in blended pools with overall risk retention of at least 2.5 percent. Other exemptions include two narrow exemptions for resecuritizations, as well as exemptions for seasoned loans and for certain federally guaranteed student loans.

Horizontal risk retention must be calculated under a “fair value” approach, while vertical risk retention is calculated based on a percentage of outstanding ABS interests. Retained credit risk exposure generally may not be transferred (other than to a sponsor’s majority-owned affiliate), hedged, or financed by nonrecourse debt, though there are sunset timeframes after which most of these restrictions will expire.

The credit risk retention rules became effective December 24, 2015, for ABS backed by residential mortgage loans, and December 24, 2016, for all other securitizations.