United States: Structured Finance Bulletin - Spring 2019

Last Updated: March 29 2019
Article by Mayer Brown

Securitization – What to Expect in 2019

JAMES ANTONOPOULOS

LINDSAY O'NEIL

SUSANNAH SCHMID

ANGELA ULUM

LANCE WORKMAN

This article summarizes some of the key trends to watch in 2019 in the consumer asset-backed securities (non-mortgage) space, the mortgage and residential securitization space, and with respect to the Customer Due Diligence Requirements for Finance Institutions issued by the Financial Crimes Enforcement Network.

Consumer ABS Space

Unlike in years past, there are no new significant laws or rules in the United States that are taking effect in 2019 and that are targeted at the United States ("US") consumer asset-backed securities ("ABS") space. There are, however, a few items and trends to watch that will have an impact on the consumer ABS markets in the United States including: (i) the recently effective EU Securitization Regulation, (ii) the adoption of contractual provisions for LIBOR successor and replacement benchmark rates and (iii) the SF-3 renewal process.

EU SECURITIZATION REGULATION

The next phase of the European Union's (the "EU") new regulatory regime for securitizations took effect on January 1, 2019, pursuant to Regulation (EU) 2017/2402 (the "EU Securitization Regulation"). The EU Securitization Regulation revises and consolidates the existing rules relating to securitizations, including risk retention, disclosure and credit-granting standards.

Consistent with the old regulatory regime, the EU Securitization Regulation does not directly require compliance by US originators or sponsors (except in certain cases where they are subject to supervision on a consolidated basis under the Capital Requirements Regulation with an EU banking entity). However, the EU Securitization Regulation may indirectly result in US entities providing additional disclosures in order for certain EU investors to be able to invest in US securitizations.

Of particular note are the new transparency requirements on originators, sponsors and securitization special purpose entities, requiring that investors obtain specified information and transaction documents, including the requirement to provide investors with regular reports, including, among other items, loan-level information regarding the underlying assets provided on specified reporting templates.

These transparency requirements raise a key interpretive issue for US originators and sponsors, since the disclosures required under the new transparency rules, specifically with respect to loan-level information, vary from those required under the US Securities and Exchange Commission's ("SEC") Regulation AB disclosure regime. The EU Securitization Regulation does not specify the jurisdictional scope of these detailed transparency requirements. So, the key question for US originators and sponsors is, are they obligated to provide the information required under the transparency rules, including loan-level information, when selling securitization exposures to EU institutional investors. Moreover, will those EU investors be able to satisfy their due diligence obligations under the EU Securitization Regulation in connection with a US-based securitization where loan-level information meeting the new transparency requirements is not provided. Although we are aware of different views in the marketplace, we believe that originators, sponsors and securitization special purpose entities that are not established in an EU member state should not generally be directly subject to the transparency requirements of the EU Securitization Regulation. Ultimately, it will be the individual EU investors that will need to make the determination that the applicable US-sponsored securitization is eligible for investment. The differing views on this interpretative issue could have a marketing and pricing impact on US securitizations offered to EU investors, and we could see the pool of potential EU investors shrink to the extent they are not provided with loan-level information.

See "Q&A: The Impact of the EU Securitization Regulation on US Entities" in this newsletter for a more detailed description of the EU Securitization Regulation and its impact on the US securitization market.

SUCCESSOR AND REPLACEMENT LIBOR BENCHMARK RATES

In 2017, the chief executive of the United Kingdom's Financial Conduct Authority ("FCA"), which regulates LIBOR, indicated that the United Kingdom FCA expects to cease taking steps aimed at ensuring the continuing availability of LIBOR by no later than the end of 2021.

Prior to that announcement, it was common practice in auto and equipment loan and lease, credit card and other non-mortgage ABS transactions that, upon the unavailability of published LIBOR, the relevant interest calculation would first revert to the average of quotes obtained by a number of reference banks and, if such quotes were not made available, a fall back to the last published value of LIBOR. Given the relatively short maturity dates of the LIBOR-based securities that have been issued in these asset classes, this methodology has continued to be used in ABS transactions even after the United Kingdom's FCA announcement. Lack of contractual provisions providing for the selection of a successor or replacement benchmark could have the effect of converting floating rate securities to fixed rate instruments referencing the last published value of LIBOR.

Toward the end of 2018, a few new issuances of credit card ABS transactions built on the historical methodology discussed above, by giving the servicer authority to select a successor or replacement benchmark that the servicer determines is the industry-accepted substitute or successor base rate without the need to obtain securityholder consent or follow the rigid amendment standards under the transaction documents.

In December 2018, the Alternative Reference Rates Committee (or "ARRC") released a consultation for public feedback on US dollar LIBOR fallback contract language for securitizations. ARRC has previously selected the Secured Overnight Financing Rate (or "SOFR") as its recommended alternative reference rate to LIBOR.

In its paper, ARRC proposed an approach to fallback language for new LIBOR-based securities issued in connection with securitizations that is much more detailed and rigid than language that exists in current securitizations. The ARRC proposal sets forth a number of "Benchmark Discontinuance Events," or triggers upon which the benchmark rate would be automatically transitioned from LIBOR to a specified replacement benchmark. Some of these triggers include: (i) a public statement by the administrator of the benchmark or a regulatory supervisor, central bank or other authority announcing that such administrator has ceased or will cease to provide the benchmark permanently or that the benchmark is no longer representative or may no longer be used; (ii) the benchmark rate not being published for five consecutive business days; and (iii) more than 50 percent of the underlying securitized assets being indexed to the replacement benchmark.

The ARRC proposal sets forth a detailed "waterfall menu" for designating the replacement benchmark, beginning with SOFR and, if SOFR is not available, moving to a substitute rate recommended by a relevant governmental body, among other specified options.

It is unlikely that ABS transactions closing in 2019, or at least early in 2019 prior to the issuance of ARRC's final paper, will adopt ARRC's rigid and structured methodology. In fact, given the relatively short maturity dates of consumer ABS, it is likely that many of these issuances will either (i) continue to follow the existing practice of locking in the last available LIBOR rate should the benchmark cease to be published or (ii) adopt the flexible methodology implemented by the credit cards ABS issuers as maturity dates on issued securities extend closer to the end of 2021.

SF-3 RENEWAL PROCESS

SEC registrants are required to renew Form SF-3 registration statements three years from the effectiveness of the existing SF-3 registration statement. Many issuers filed SF-3 registration statements in late 2015 and early 2016 following the implementation of the Regulation AB II rules, and thus many renewal filings began in 2018 and will continue through 2019. Thus far, many issuers whose registration statements were previously reviewed by the SEC staff have received either a limited or no review and generally only new SEC-registered issuers are receiving a more thorough review.

Mortgage and ResidentialSecuritization Space

In the mortgage and residential securitization space, there are a few trends to watch in 2019 including: (i) an increased push to use technology, (ii) continued regulatory relief and (iii) continued growth of nontraditional mortgage products.

INCREASED PUSH TO USE TECHNOLOGY

With the growing space of financing technology and the government advocating for modernization of the industry, we expect that an increasing number of originators will look to digitize their mortgage loan documentation and collateral.

CONTINUED REGULATORY RELIEF

A trend to watch in 2019 is additional reglatory relief from the Consumer Financial Protection Bureau ("CFPB"). As acting director, Mick Mulvaney took a lighter touch to regulation as compared to his predecessor, decreasing the size of the staff and budget within which the CFPB operates, and notably during his tenure only one enforcement action was issued. The newly appointed Kathy Kraninger is largely expected to follow this path. This will leave state-level enforcement action to continue to take greater prominence, but state resources are often more constrained than the federal government and are unlikely to be able to entirely fill the regulatory void left by the CFPB.

CONTINUED GROWTH OF NONTRADITIONAL MORTGAGE PRODUCTS

In 2019, we expect to continue to see a rise in Non-Qualified Mortgage securitizations (which have more than doubled since 2016). In addition, while the demand for reverse mortgage loans will continue to exist and likely grow in 2019, we expect to see an increase in private label originations in this space and changes to the Home Equity Conversion Mortgage Program. Further, we have seen, and expect to continue to see, increased interest in "fix and flip" mortgage loans in 2019. We also expect to see a continued appetite for single family rental properties. Lastly, the origination of closed-end second lien home equity loans may pick up along with home price appreciation.

The CDD Rule

The Customer Due Diligence Requirements for Finance Institutions (the "CDD Rule") was issued by the Financial Crimes Enforcement Network ("FinCEN") and requires covered financial institutions (including banks, US branches and agencies of foreign banks, federally insured credit unions, mutual funds and broker dealers) to identify and verify the identity of beneficial owners of its legal entity customers with respect to "accounts" that are opened on or after May 11, 2018. The definition of "account" is broad and includes many securitization transactions, subject to certain exceptions. FinCEN has clarified that the extension of a loan or warehouse facility will be considered the opening of a new account for purposes of the CDD Rule.

While not required under the CDD Rule, we have seen some financial institutions elect to collect information on beneficial owners at a level lower than 25 percent, as well as more than one individual with managerial control. We expect this trend to continue throughout 2019. Most financial institutions have elected to satisfy their due diligence requirement by obtaining a form certification from their customers that identifies their beneficial owners. Certain customers are excluded from the CDD Rule—however, notwithstanding such exclusion, we see some financial instutitions requesting a separate certification from customers that specifies the exemption that the customer is relying on under the CDD Rule. We expect the new CDD Rule to continue to influence the industry in 2019 and that additional clarity will develop as to certain open questions.

Q&A: The Impact of the EU Securitization Regulation on US Entities

MERRYN CRASKE

JULIE GILLESPIE

KEVIN HAWKEN

CAROL HITSELBERGER

CODY LAWRENCE

JAN STEWART

What is the SecuritizationRegulation, and does it apply to the US entities?

The next phase of the European Union's (the "EU") new regulatory regime for securitizations became applicable from January 1, 2019, pursuant to Regulation (EU) 2017/2402 (the "Securitization Regulation"). The Securitization Regulation revises and consolidates the existing rules relating to securitizations,1 including with respect to risk retention, disclosure and credit-granting, and introduces a ban on resecuritization. It also specifies criteria that a securitization will need to satisfy if the parties want the transaction to be designated as a simple, transparent and standardized ("STS") securitization. Like past phases of EU regulation regarding securitizations, such as the Capital Requirements Regulation (the "CRR"), the Securitization Regulation does not directly require compliance by United States ("US") entities participating in securitization transactions (except in certain cases where they are subject to supervision on a consolidated basis with an EU regulated institution). However, the Securitization Regulation may indirectly result in US securitization originators, sponsors and securitization special purpose entities ("SSPEs") being required to provide additional disclosure in order for EU institutional investors to be able to invest in US securitization transactions.

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This Mayer Brown article provides information and comments on legal issues and developments of interest. The foregoing is not a comprehensive treatment of the subject matter covered and is not intended to provide legal advice. Readers should seek specific legal advice before taking any action with respect to the matters discussed herein.

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