SEC Proposes Exemption To Risk-Retention Rule

WASHINGTON — The Securities and Exchange Commission voted unanimously Wednesday to approve a proposed rule that would exempt municipal securities from credit-risk retention requirements imposed in the wake of the financial crisis.

The proposal, part of a joint rulemaking with federal banking and housing regulators, implements a provision in the Dodd-Frank Wall Street Reform and Consumer Protection Act that requires securitizers of asset-backed securities to retain a minimum economic interest in a material portion of the credit risk being securitized. According to the SEC, the exemption is appropriate in light of the special treatment Congress gives munis.

Bond lawyers and market participants welcomed the exemption, saying it resolves lingering uncertainty stemming from Dodd-Frank’s definition of asset-backed securities, which struck some as potentially overbroad.

“It’s important because literally read, the definition of asset-backed securities could be read to include certain conduit financings, student loan financings, and single-family housing financings,” said John McNally, the president of the National Association of Bond Lawyers and a partner at Hawkins Delafield & Wood LLP in Washington.

Muni market participants had also harbored concerns about a Dodd-Frank provision creating a “total or partial exemption, as may be appropriate in the public interest and for the protection of investors,” for asset-backed securities issued by state and local governments.

On Wednesday, though, some observers said the SEC’s proposed muni exemption was straightforward and appropriate, given the nature of securitizations in the municipal market, where issuers bear the reputational risk associated with having their names affixed to a project.

“The exemption articulated so far is cause for some relief,” said Roger Davis, the chairman of the public finance department at Orrick, Herrington & Sutcliffe LLP in San Francisco. The SEC’s proposal would require securitizers, entities who buy and bundle assets such as housing and student loans, to retain 5% of the credit risk of the assets collateralizing the ABS and assure that they have “skin in the game.” The Federal Deposit Insurance Corp. and the Federal Reserve released virtually identical risk-retention proposals on Tuesday, including exemptions for municipal securities.

In its proposal, the SEC said it and the banking and housing agencies, including the FDIC, the Fed, the Office of the Comptroller of the Currency, the Federal Housing Finance Agency, and the Department of Housing and Urban Development, proposed to exempt ABS issued by state and local governments and bonds issued by a nonprofit student loan corporations, as defined in section 150(d) of the Internal Revenue Code.

The SEC did so, it said, “in light of the special treatment afforded such securities by Congress,” as well the muni exemption in Dodd-Frank’s risk retention provisions. The SEC said it also considered the role of state and local governments in “issuing, insuring, or guaranteeing the ABS or collateral.”

Last month, an issuer group urged the SEC to carve out an exemption for nonprofit student lenders.

In a Feb. 17, 2011, letter to SEC chairman Mary Schapiro, the Education Finance Council, which represents nonprofit and state-based student loan providers, said, “Additional risk retention would limit the ability to originate new loans, thereby negatively impacting students and families.”

Specifically, the letter, signed by EFC president, Vince Sampson, said that student loan ABS issued by state and nonprofit student lenders do not rely on special-purpose vehicles, the off-the-books loans that figured prominently in the financial crisis. Rather, student loans are more like revenue bonds issued by state and local governments which remain on the issuer’s books.

In an interview, Sampson said without an exemption, student lenders would have had to find another means to come up with cash to satisfy enhanced risk-retention requirements.

“That would have been incredibly difficult,” Sampson said. “At some point, with additional risk retention, the economics don’t work for the agencies.”

The SEC is accepting comments on its proposed rule until June 10.

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