Editor’s Letter

Christopher Culp and Paul Forrester note concerns expressed by the Office of the Comptroller of the Currency (OCC), other regulators, market participants, and financial journalists about the rapid growth and apparent deterioration in underwriting standards for subprime auto loans and “leveraged loans”—commercial and industrial loans to highly leveraged or below-investment-grade borrowers, many of which wind up in collateralized loan obligations (CLOs). In this article, they explain the analysis behind their conclusion that recent increases of risks in underlying collateral—such as subprime auto loans and leveraged loans—has translated into commensurate increases in the risks auto asset-backed securities (ABS) and CLOs. They believe that the post-crisis changes in the design and documentation of structured securities, together with heightened investor awareness and better access to information, suggest that increased interest in such securities is not merely irrational yield chasing. They further observe that recent regulations such as the Volcker rule and the credit risk retention rule, ostensibly intended to preserve market integrity and protect ABS investors, are instead likely to stifle market activity and depress legitimate transactions intended to facilitate economically legitimate risk transfer. In their opinion, significant ongoing regulatory uncertainties pose real threats to the future of the U.S. structured finance market. Unless considerable efforts are made by regulators to address the significant costs imposed on structured products—without any obvious benefits—the authors continue to fear for the prospects of these markets.

John Levonick explains the increasingly visible and well-defined role that third-party due diligence service providers will play in the issuance of ABS as a result of a mandate in the Dodd–Frank Act and subsequent SEC rule making. The rules are intended 1) to require third-party due diligence providers to describe the scope and manner of the due diligence they have conducted and to clearly explain their findings and conclusions and 2) to require issuers and underwriters of a registered or unregistered ABS offering publicly disclose all findings and conclusions from third-party due diligence providers. The author expects that the third-party due diligence services that will be conducted in anticipation of a rated Exchange Act-ABS will now be more transparent to the public and available for detailed analysis.

With today’s advanced information-processing and communications technology and highly developed financial markets, it is surprising to hear Dave Jefferds explain why a corporate CFO and treasurer do not have easy access to the names of all their stockholders and bondholders. The author describes an unwieldy Wall Street operating system known as the “street name” system, designed to solve paperwork processing problems in the late 1960s, which does a good job settling and matching $2 quadrillion trades every year but does not allow easy communication between corporations and their stakeholders because of the way all trades are settled through the Depository Trust Company’s intermediary custodians. He sees encouraging possibilities in internet-based, peer-to-peer networks.

Mark Adelson provides 18 summaries of ABS Vegas 2015 panel discussions prefaced by some of his own overall observations, including an upbeat spirit among more than 5,000 attendees, steadily increasing issuance of non-mortgage ABS, gradual progress toward reviving residential ABS (RMBS), significant time and energy devoted to regulation, lack of conference content related to RMBS and rating agency litigation, the need for the industry to develop a viable private-label RMBS market, and the underlying need to return to the basics in proper loan underwriting, appraisals, and due diligence.

Jason Kravitt, Sairah Burki, Calvin Wong, and Deborah Toennies discuss several current aspects of securitization regulatory reform including the proposed “high-quality securitization” standards; the asset-level disclosure and dispute-resolution provisions in Regulation AB II; and the due diligence reporting requirements in the new NRSRO rules. Among the overriding themes that stand out in this ABS Vegas 2015 panel discussion are the complexity of the rules, a rule-making process far from finished seven years after the financial crisis, differing points of view among various parties, such as the U.S. versus Europe and issuers versus rating agencies, and the need for regulations to be reasonably consistent on a global basis. For example, the high-quality securitization initiative originated in Europe, where there is concern about the sheer complexity of structured finance transactions. In the U.S., there is greater concern that awarding the high-quality securitization label to some deals and not others will tarnish the ones that are not so designated. The more-detailed disclosures required by Reg AB II and risk retention rules are an increased burden for originators but are welcomed by the rating agencies.

With a focus on commercial mortgage-backed securities (CMBS), Paul Kurzeja summarizes an ABS Vegas 2015 panel discussion on three provisions of the Reg AB II shelf registration process that create complex issues: The CEO certification prior to each take-down creates significant personal liability for the CEO that did not exist before Reg AB II was enacted; if investors invoke the asset-review provisions, they and the issuer may have different opinions in interpreting the level of representations and warranties that is considered material; and dispute resolution provisions are difficult to determine because CMBS have not experienced any significant level of put-back claims and therefore may be best guided by the Commercial Real Estate Finance Council’s model remediation language.

Following Jeff Chen’s presentation at the ABS Vegas 2015 conference, Jeff and Say Goo describe recent progress toward development of a cross-border securitization market in China, including schemes developed by the China Bank Regulatory Commission (CBRC) and the China Securities Regulatory Commission (CSRC) and approaches taken in domestic securitizations done to date to such legal issues as legal isolation, commingling, and bankruptcy remoteness. Some of the legal concepts underpinning securitization are new to China and untested in its courts. The authors call for the National People’s Congress to enact a comprehensive securitization statute.

Summarizing his ABS Vegas 2015 panel discussion on the Aussie securitization market, Chris Dalton describes recognition of securitization as an important form of funding for the Australian financial system, robust recovery of the market since the financial crisis, an active year in terms of new primary issuance in 2014, a strong Australian dollar component to the market, good RMBS performance supported by a stable local mortgage market, regulatory efforts to expand the investor base and bring global investors back into the market, and a regulatory leaning toward simplifying securitization, limiting structures to just two tranches, and avoiding resecuritizations and synthetic securitizations.

In a panel discussion on solar securitization at the ABS Vegas 2015 conference in February, Nate Gabig, Benjamin Cohen, and Manish Kapoor addressed a myriad of issues impacting the market and presented various reasons why they feel that solar securitization may be poised to emerge as well as potential risks that need to be addressed. Both project and financing costs for rooftop photovoltaic systems continue to decline, and the actual price of solar has become competitive with, and in certain markets has become cheaper than, traditional “grid-based” sources of electricity. The maturing solar development companies that finance these systems are only now starting to tap into the capital markets to fuel their next wave of growth (with transactions that include both YieldCos and securitizations), and the future of the solar ABS market looks positive.

TOPICS: CLOs, CDOs, and other structured credit, asset-backed securities (ABS)

Henry A. Davis

Editor

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