residential mortgage securitizations. These provisions require CLO
sponsors to retain risk until the latest of: (1) The date on which the
principal balance of the securitized assets reduces to 33 percent of
the original unpaid principal balance as of the cut-off date or similar
date for establishing the composition of the securitized assets
collateralizing the asset-backed securities issued pursuant to the
securitization transaction, (2) the date on which the unpaid principal
obligations of securities has been reduced to 33 percent of the
original unpaid principal obligations at the closing of the
securitization transaction, or (3) two years after the date of the
closing of the securitization transaction.
    The loans backing CLOs typically have maturities that can extend
beyond the term of the CLOs, particularly when the loans are added to
the pool after issuance, which could mean that loan balances of loans
held by a CLO may not necessarily decrease prior to the maturity or
redemption of the CLO. Hence, the final rule may effectively require
the CLO manager (as the sponsor of the CLO) to retain risk beyond the
minimum sunset period. This should lessen the incentive for managers to
alter the composition of the loan portfolio in a way that could harm
investors relative to what may be present with a shorter sunset period.
    A key difference between this lead arranger option and those
related to, for example, commercial mortgage backed securities is that
the CLO manager must rely on the lead arranger's continuing 5 percent
retention of risk in the CLO-eligible loans, in order for the CLO
manager to satisfy its risk retention obligations. Thus, unlike a
portfolio of commercial mortgages, the CLO requirement extends beyond
the initiation date of the securitization so that the status of the
lead arrangers' continuing participation may affect the CLO manager.
    The agencies received many comments about the lead arranger option,
and the impact of risk retention on the market for open market CLOs.
These comments can be categorized into four main areas: (1) The impact
of the lead arranger option on the availability and cost of leveraged
loans; (2) the unwillingness or inability of arrangers to create CLO-
eligible tranches; (3) alternative options for sponsors of open market
CLOs to retain risk; and (4) general concerns about the impact of risk
retention on the CLO industry and the syndicated loan market.
    Regarding the impact of the lead arranger option on borrowing
costs, commenters asserted that the proposed option would be unworkable
with existing CLO practices and therefore the risk retention
requirements would result in a significant reduction in CLO issuances
and a corresponding reduction in credit to commercial borrowers.
Commenters further asserted that the requirement that the lead arranger
retain at least 5 percent of an eligible tranche would increase the
required capital and FDIC assessment charges, thereby increasing the
pricing of CLO-eligible tranches, and adversely impacting borrowing
costs. Moreover, some commenters noted that only a very small number of
arrangers can meet the definition of ``lead arranger'' as proposed,
because the syndication of leveraged loans is concentrated among a
small number of banks.\448\ According to these commenters, requiring
lead arrangers to hold a relatively large piece of these syndicated
loans on their balance sheets would cause a substantial increase in
their risk-based capital requirement.\449\ Further, commenters noted
that the requirement to retain 5 percent of the eligible tranche,
combined with the hedging and transfer restrictions, is inconsistent
with sound risk management practices, overly burdensome in light of
regulatory and lending limits and would reduce the lead arranger's
ability to extend credit. Commenters also stated that these additional
costs, imposed on the lead arranger, would be passed on to the
corporate borrowers, restricting access to and cost of capital.
---------------------------------------------------------------------------

    \448\ Based on Bloomberg L.P. data, the largest five banks
arranged 47 percent of the syndicated leveraged loans in 2013.
    \449\ One commenter pointed out that banks and other highly
regulated financial entities represent almost the entire market of
originators of the loans that comprise the assets collateralizing
CLOs. This commenter stated that the requirement for lead arrangers
to hold additional exposure to a borrower that is unhedged until
maturity of the loan is generally inconsistent with prudent lending
practices and internal lending policies. Such a requirement also,
impacts the amount of other banking products that such lead
arrangers can extend to other borrowers.
---------------------------------------------------------------------------

    One commenter observed that only a handful of non-regulated
entities have a sufficient amount of available capital to arrange and
syndicate leveraged loans and satisfy the proposed risk retention
requirements under the lead arranger option. According to this
commenter, adopting the lead arranger option, as

proposed, would cause a severe contraction in CLO-related activities by
regulated institutions and a significant reduction in liquidity to a
critical sector of the U.S. economy. The Commission notes, however,
that this conclusion assumes that other lenders will not enter the
market with sufficient capital to compensate for the loss of bank
capital in the event that large banks curtail their involvement in the
CLO sector. For example, other commenters asserted that if the risk
retention requirement caused a reduction in participation by open
market CLOs in the leveraged loan market, other institutions would
enter the market to fill the unmet credit needs. Ultimately, if this
were to occur, the commenters asserted that non-CLO credit providers
likely would incur higher costs than the CLO credit providers that have
operated in the past, and these costs would be passed along to the
ultimate borrowers, raising their cost of funding.
    Commenters' second main area of concern was the practical ability
and willingness of originators to create and retain CLO-eligible
tranches. One commenter stated that the lead arranger option is not
workable because the implementation difficulties associated with
creating CLO-eligible tranches are substantial and observed that
surveyed banks have indicated they would not be willing to take on this
endeavor. In particular, to qualify for the option, CLO-eligible
tranches would be required to carry separate voting rights, which the
same commenter asserted would be administratively unworkable and
commercially unacceptable to the other parties to the loan transaction.
Commenters also expressed concern that it was unclear how a CLO would
be able to monitor whether the CLO-eligible loan tranche continues to
meet the necessary criteria. Commenters stated that the requirement
that a lead arranger represent that the loans continue to meet the
rule's criteria exposes the lead arranger to potential liability that
the lead arranger cannot realistically bear. While the Commission
acknowledges these concerns, the Commission also notes that, because
CLOs are a major source of funding for leveraged loan originators,
there is significant economic incentive for arrangers to use the lead
arranger option to ensure the continued participation of CLO managers.
    Other commenters argued that open-market CLOs should be exempted
from the risk retention requirements altogether because the
organizational structure of open market CLOs provides investors with
sufficient safeguards. These commenters indicated that open market CLOs
operate independently of originators and are not part of, and do not
pose the same risks as, the originate-to-distribute model. They also
asserted that CLO managers' interests are fully aligned with the
interests of CLO investors because CLO managers bear significant risk
through their deferred, contingent compensation structure, which they
noted is based heavily on performance of the underlying assets.
Commenters also noted that most CLO managers are registered investment
advisers, with associated fiduciary duties to their clients. Commenters
also noted that many CLO managers are subject to existing regulations
that provide meaningful protections against imprudent or inferior
underwriting, including the leveraged lending guidance released by the
Federal banking agencies in 2013.\450\ Commenters further asserted that
existing industry best practices mitigate risks, and that CLO assets
are actively managed and often include select senior secured commercial
loans with investor protection features. More generally, commenters
asserted that: (1) unlike many other securitizations, CLOs are
securitizations of liquid assets and are structurally transparent, (2)
CLOs have historically performed well even during the financial crisis,
and (3) this strong performance is evidence that risk retention is
unnecessary.
---------------------------------------------------------------------------

    \450\ See Leveraged Lending Guidance. However, as discussed
above in Part III.B.7 of the Supplementary Information, the Federal
banking agencies noted that there is evidence that increased
activity in the leveraged loan market has coincided with widespread
loosening of underwriting standards and that many banks have not
fully implemented standards set forth in the guidance, see
Semiannual Risk Perspective: Spring 2014, Office of the Comptroller
of the Currency, at 5 (June 2014), available at http://www.occ.gov/publications/publications-by-type/other-publications-reports/semiannual-risk-perspective/semiannual-risk-perspective-spring-2014.pdf, Shared National Credits Program: 2013 Review, Board of
Governors of the Federal Reserve System, Federal Deposit Insurance
Corporation, Office of the Comptroller of the Currency (September
2013), available at http://www.federalreserve.gov/newsevents/press/bcreg/bcreg20131010a1.pdf and ``Fed Scrutiny of Leveraged Loans
Grows Along With Bubble Concern'', Bloomberg News, October 1, 2014,
available at http://www.bloomberg.com/news/2014-10-01/fed-scrutiny-of-leveraged-loans-grows-along-with-bubble-concern.html.
---------------------------------------------------------------------------

    Some commenters proposed a new option for ``qualified CLOs'' that
would codify many of the existing practices of open-market CLOs and
require CLO managers to hold 5 percent of the equity tranche of at
least 8 percent of the value of the CLO. As discussed below, the
Commission does not believe this option would provide sufficient
incentive alignment for open-market CLOs. Although some commenters
stated their belief that CLO managers select and manage CLO assets free
from the potential conflicts and misaligned incentives related to the
originate-to-distribute model, the Commission notes that, without a
risk retention requirement, there is little economic incentive to
discourage practices associated with an originate-to-distribute model
from developing.
    The fourth category of comments reflected a general concern about
the lead arranger option and the impact of risk retention on the market
for open market CLOs. One commenter expressed concern that designating
one tranche of a syndicated facility the CLO-eligible loan tranche
would significantly affect the pricing of other tranches due to the
decreased liquidity of such tranches, as such tranches would not be
available for securitization in the CLO market. The same commenter
noted that the universe of CLO-eligible loan tranches would be very
limited and restrict the CLO manager's ability to invest in a diverse
number of loans. Further, several commenters asserted that the costs of
imposing risk retention on CLO managers exceeds the benefits and that
the agencies have not performed an adequate economic analysis in
connection with the lead arranger option.
    One study by Oliver Wyman\451\ claimed that as a result of the
proposed requirements, credit spreads will increase from 117 to 292
basis points and costs to borrowers will increase between $2.5 billion
and $3.8 billion per year because non-CLO lenders will charge a higher
interest rate to leveraged loan borrowers than CLOs. To arrive at these
estimates, the study assumed that CLO managers unaffiliated with a
large financial institution or market participant will no longer be
able to provide capital to the leveraged loan market and that credit
would not be provided to borrowers through other channels.
---------------------------------------------------------------------------

    \451\ http://www.sec.gov/comments/s7-14-11/s71411-535.pdf.
---------------------------------------------------------------------------

    In reaching these conclusions, the study makes several assumptions
that are questionable. For instance, the study assumes that CLO
managers cannot or will not be able to hold 5 percent risk retention.
However, the Commission believes that there may be economically
feasible means for CLO managers to meet the risk retention
requirements, particularly if there is economic incentive of the
magnitude described in the study (i.e., predicted spread increases
ranging from 100 to 200 basis points). Another assumption is that not
enough lead arrangers will use the lead arranger option which will mean
there

will not be enough CLO-eligible tranches for CLOs to be formed using
the lead arranger option. Given that CLOs currently account for a
significant portion of the leveraged loan market, there are significant
economic incentives for loan arrangers to create CLO-eligible tranches
particularly because, by not doing so, originators may not have enough
demand for their issuances. Hence, lead arrangers may make CLO-eligible
tranches available, which would create enough diversification and
supply for CLOs to rely on the lead arranger option.
    The study's third assumption relies on an estimate of elasticity of
supply of credit in the leveraged loan market (i.e., the change in the
availability of credit associated with a given change in the loan
interest rate). The study proxied for the elasticity of supply of
credit with an estimate of elasticity of demand for credit in the
leveraged loan market (i.e., the change in the borrowers' demand for
credit associated with a given change in the loan interest rate)
published in another (academic) study.\452\ However, the commenter's
study does not justify its assumption that the elasticity of supply
should be equal to the elasticity of demand. Indeed, the commenter's
study implicitly assumes that demand is inelastic and would not change
in response to the change in interest rate (i.e., that borrowers would
demand the same amount of credit regardless of the level of interest
rates). The commenter's study also assumes that the credit supply curve
would not shift in response to the change in interest rate (i.e., as a
result of entrance of new lenders).\453\ Taken together, the Commission
believes the assumptions in the commenter's study contribute to an
estimate of the cost to the leveraged loan and the CLO industry that is
likely to be significantly inflated.
---------------------------------------------------------------------------

    \452\ Greg Nini, ``Institutional Investors in Corporate Loans'',
University of Pennsylvania working paper, 2013, available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2349840.
    \453\ The study asks the question ``How much ``extra'' yield
would be needed to induce these non-CLO loan buyers to increase the
amount of credit they are willing to supply?'' and proceeds to
estimate ``the increase in credit quantity that non-CLO leveraged
loan credit providers would have to supply to fully replace lost CLO
capacity.''
---------------------------------------------------------------------------

    More generally, there are several considerations that could affect
the extent of the rule's impact on the leveraged loan market, as
described in the commenter's study. One consideration is that non-CLO
investors might invest more capital given the right incentives (higher
yields or less risk). These investors include hedge funds, loan mutual
funds, and insurance companies. Another possibility is that these
investors, instead of purchasing leveraged loans on the secondary
market, would join in as part of the syndication. Finally, CLO managers
with lower cost of funds and capability to satisfy the risk retention
requirements may replace some of the supply of credit lost due to exit
from the market of CLO managers with higher cost of funds. Any of these
possibilities would mitigate the loss of CLO capital as other investors
invested more capital into the leveraged loan market.
    Although the Commission acknowledges commenters' concerns about the
lead arranger option, the Commission does not believe there is an
economic justification for an exemption from the standard 5 percent
risk retention requirement for CLOs. The Commission believes that the
amount of risk retention included in the alternative approach suggested
by commenters of a CLO option retaining 5 percent of the equity tranche
of at least 8 percent of the value of the CLO transaction (effectively
amounting to as low as 0.4 percent risk retention in the entire
securitization) would not sufficiently address the originate-to-
distribute risks in the leveraged loan market. In particular, a CLO
market absent of meaningful risk retention may not have the protections
against future moral hazard problems that the final rule is designed to
provide. The Commission acknowledges that risk retention may generate
significant upfront costs to the CLO and the leveraged loan market
relative to current practices or the proposed alternatives provided by
commenters. However, the Commission believes that these current
practices and the proposed alternatives would not do enough to align
incentives between sponsors and investors which, in the long term,
could impose larger costs on the market than the risk retention
requirements of the final rule.
    The Commission is also sensitive to the claim by commenters that
the CLO market performed well during the financial crisis in comparison
to other asset classes and, in particular, to RMBS. However, the
Commission believes that this claim has the benefit of hindsight, and
that during the financial crisis, there were considerable concerns with
the ability of borrowers to meet their financial obligations through
their collateralized loans.\454\ Ultimately, aggressive monetary policy
resulted in sharp declines in the interest rates payable on floating-
rate leveraged loans, making it easier for borrowers to meet their loan
obligations. The Commission believes that it is this extraordinary
influence on borrowing costs, and not the underlying market practices
of CLO managers, which largely explains CLO performance during the
financial crisis. Hence, CLO performance during the financial crisis
does not provide a sound basis for an exemption from the rule's
requirements.
---------------------------------------------------------------------------

    \454\ See, e.g., Ng, S., and K. Haywood, 2009, ``Rates Low,
Firms Race to Refinance Their Debts,'' The Wall Street Journal, June
26, 2009, http://online.wsj.com/articles/SB124597520948957427. They
observe: ``Bankers and borrowers alike worry that the overhang could
create serious problems in the years ahead if financial markets
don't heal enough to allow hundreds of non-investment-grade
companies to refinance their debt.''
---------------------------------------------------------------------------

    The Commission believes that commenters' alternative suggestions do
not create sufficient incentive alignment, or ``skin in the game,'' for
sponsors to ensure that originators maintain high underwriting
standards in accordance with the purposes of Section 15G. While the
Oliver Wyman study claims that risk retention will have a large
negative impact on the leverage loan market and the CLO industry, the
Commission believes that the assumptions underlying that assessment are
questionable. In particular, the study assumes that CLO managers, who
currently hold 53 percent \455\ of the leveraged loans sold by
originators, will no longer be able to purchase leveraged loans and
that a significant proportion would otherwise go unfunded. The
Commission acknowledges that this may increase cost to leveraged loans
borrowers, but, for the reasons explained above, the Commission
believes these are likely to be at a much lower level than the study
suggests. Originators may sell leveraged loans to other purchasers, in
which case, as discussed below, smaller CLO managers may be affected
but there would not be a significant impact on the CLO market.
---------------------------------------------------------------------------

    \455\ See Bloomberg Business Week, January 1, 2014, available at
http://www.businessweek.com/news/2014-01-31/leveraged-loan-trades-in-u-dot-s-dot-rise-to-most-since-07-lsta-says.
---------------------------------------------------------------------------

    Under current practices in the leveraged loan market, syndicates
hold the revolving piece of the origination, which is a line of credit
that allows the borrower to drawdown additional capital from the
arranger. Hence, the revolving piece of a leveraged loan represents a
potential future liability to the lead arranger that could ultimately
increase the amount of risk retained. The agencies did not create an
option for treating this future liability as retained risk. In this
way, the final rule may result in the lead arranger holding more
exposure to the borrower of the leveraged loan than what would be
required to satisfy the risk retention

requirement. Therefore, allowing the lead arranger to hold risk
retention in place of the CLO manager should not diminish, and may
increase, the alignment of incentives between loan arrangers and
ultimate investors in the CLO, by providing strong incentives for the
loan arranger to create loans with high underwriting standards.
    The impact of the lead arranger option on the leveraged loan market
will be determined by the likelihood that lead arrangers are willing to
retain risk in the manner required and CLO managers are willing to rely
on this commitment. As commenters stated, there are frictions in the
market that may prevent CLO managers from purchasing CLO-eligible loans
or originators from creating CLO-eligible tranches. CLO managers may
not be able to ensure that the bank will meet the CLO-eligible tranche
requirements for the length of the loan. In addition, the special
voting rights attached to the CLO-eligible tranche may prevent other
parties from wanting to create a CLO-eligible tranche.
    Large commercial banks are the primary source for leveraged loan
origination and may be reluctant to retain ongoing exposure to
leveraged loans because the loans are typically longer term and riskier
than the other assets banks usually hold on their balance sheet. As
such, they may not be willing to serve as a lead arranger for the
purpose of creating a CLO-eligible tranche. Should these banks choose
to create CLO-eligible tranches to facilitate additional demand for
their originations, it is possible that they would charge borrowers
higher rates to compensate for the additional capital charge they could
incur under existing regulatory requirements, or because it would
impede a redeployment of capital for other projects.
    CLO managers that use the lead arranger option will be relying on
lead arranger commitments to hold 5 percent of the CLO-eligible tranche
for the duration of the loan. A CLO manager relying on the lead
arranger option would need to sell any tranches that cease to be CLO-
eligible tranches due to the failure of a loan arranger to hold the
required amount of risk, which could generate an otherwise unnecessary
loss if the forced sale provides a buyer with leverage to negotiate a
discount. However, a CLO manager should have some level of confidence
in a lead arranger's ongoing commitment to meet the requirement because
there will be recourse against the lead arranger for breach of
contract, as the lead arranger will warrant in the transaction
documents to hold 5 percent of the CLO-eligible tranche for the
duration of the loan. Any costs the CLO manager incurs from the forced
sale of the loan could be part of their claim against the loan arranger
for breach of contract. Moreover, failure of a lead arranger to keep
this commitment could harm their reputation with respect to continued
participation in the leveraged loan market because potential CLO
managers would be less willing to engage in their transactions, leaving
the lead arranger unable to sell or face higher costs in selling CLO-
eligible loan tranches or any other loans, in the future.
    To accommodate potential demand for CLO-eligible tranches and the
concomitant costs of the ongoing credit exposure from the risk
retention requirement, lead arrangers may be willing to charge higher
rates to borrowers and, as a result, continue generating revenue from
underwriting, warehousing, and selling leveraged loans. There is strong
incentive for loan arrangers to do so given that CLO purchases of
leveraged loans currently represent about half of the total investment
in the leveraged loan market.\456\ The prospect of CLO managers
declining to purchase non CLO-eligible loan tranches should encourage
lead arrangers to hold enough exposure to create CLO-eligible tranches
in order to meet current investor demand. Hence, the Commission
believes that CLO managers have significant influence over, and lead
arrangers will have increased incentive to facilitate, the use of the
lead arranger option and the creation of CLO-eligible tranches.
Moreover, if non-CLO investors perceive loans with CLO-eligible
tranches as higher quality loans, this may create additional demand for
CLO-eligible tranches that would lead to higher prices and lower
interest rates for such loans.
---------------------------------------------------------------------------

    \456\ See commentaries by Wells Capital Management, ``Global
Opportunities in Bank Loans'', February 2014, available at http://www.wellscap.com/docs/expert_commentary/global_bank_loans_0214.pdf
and by Loomis, Sayles & Company, L.P. Investment, ``The Myth of
Overcrowding in the Bank Loan Market'', May 2014, available at
http://www.loomissayles.com/internet/internetdata.nsf/0/
CA96B70BA0BE8BB585257CD8004F1A03/$FILE/The-Myth-of-Overcrowding-in-
the-Bank-Loan-Market.pdf for the leveraged loan investor base
breakdown. Statistics from both of these sources are based on data
from Standard & Poor's Capital IQ Leveraged Commentary & Data.
---------------------------------------------------------------------------

    The Commission acknowledges the concerns about the workability of
the option expressed in the comment letters and, as described above,
has considered the attendant costs, but continues to believe that
adopting the lead arranger option in the final rule will provide CLOs
with additional meaningful flexibility in satisfying the risk retention
requirements.
    If the lead arranger option is not used, then CLO managers will
have to satisfy the risk retention requirement using one of the
standard options. In this case, the Commission recognizes that the
final rule may have differing impacts on CLO managers, which could have
a negative effect on competition. The amount of capital available to
managers can vary with the size and affiliations of the manager. In
particular, the availability and cost of capital for managers with a
relatively smaller amount of capital available to finance required risk
retention may be less favorable than for managers with access to larger
balance sheets or sources of capital. This could result in different
funding costs between smaller and larger managers and could impact
competition by creating an advantage for managers with lower funding
costs, particularly larger financial institutions and banks.
    If smaller CLO managers do not have sufficient available capital to
hold 5 percent risk retention, then they will be unable to sponsor CLO
transactions unless they are able to get funding from another source. A
reduction in CLO managers may reduce the number of CLOs, which may lead
to a decrease in capital formation, a decrease in price efficiency for
leveraged loans, and a decrease in competition for leveraged loans. If
this impairs the supply of capital to borrowers using leveraged loans,
such borrowers could expect to pay higher rates or have less access to
financing. This potential impact on capital formation is ameliorated to
the extent that larger CLO managers--or other potential investors--are
able to replace smaller CLO managers as buyers of leveraged loans. Such
an outcome would benefit these other investors at the expense of
smaller CLO managers.
    A number of commenters asserted that the final rule would force
many smaller CLO managers to exit the CLO market. Because the
Commission did not have data with respect to the cost of funds for each
CLO manager or each CLO manager's desired return on capital, the
Commission was unable to directly analyze the potential cost of the
additional capital necessary to satisfy the risk retention requirements
or the relative portion of the current CLO market managed by those
smaller CLO managers that would no longer sponsor CLOs as a result of
the increased costs. In order to estimate the potential impact of the
exit of smaller CLO managers from the market, the Commission identified
and categorized 111 CLO managers known to have participated in the CLO
market between 2009 and 2013

using categorizations that serve as a proxy for the CLO managers'
access to capital, whether internal or external, and thus their
potential capital capacity and ability to satisfy the risk retention
requirements.\457\ The first category included CLO managers that are
not subject to the periodic reporting requirements of the Exchange Act
and do not appear to be subsidiaries of or affiliated with other
financial institutions (banks, insurance companies, diversified asset
managers that managed investment vehicles other than CLOs, etc.), which
the Commission believes is the set of CLO managers that may face the
greatest burden in obtaining capital to finance and retain the 5
percent required risk retention. These CLO managers were responsible
for 39 percent of the CLO market issuances between 2009 and 2013, 37
percent by dollar volume, and represented 48 percent of all CLO
managers analyzed.
---------------------------------------------------------------------------

    \457\ CLO market issuance data and the list of CLO managers that
were analyzed are from the Asset-Backed Alert database. The
Commission categorized CLO sponsors that issued CLOs in the U.S.
between January 1, 2009 and December 31, 2013. In order to estimate
the possible impact of the risk retention requirement we examine the
fraction of the CLO market that each group comprises. A sponsor's
category was determined by using the 2014 Fitch Ratings CLO Asset
Manager Handbook, sponsors' Web sites and other publicly available
information. If it was not immediately apparent which category best
described a manager, a conservative approach was taken and such
manager was included in the category of managers with limited access
to capital.
---------------------------------------------------------------------------

    The second category included CLO managers who fall into at least
one of the following categories (A) subject to the periodic reporting
requirements of the Exchange Act,\458\ or (B) also the sponsor of
asset-backed securities other than CLOs, or (C) a bank or insurance
company, or (D) affiliated with, or otherwise related to an entity
described in (A), (B) or (C). These CLO managers were responsible for
61 percent of CLO issuances between 2009 and 2013 by number or 63
percent of CLO issuance by dollar volume, and represented 52 percent of
the population of CLO managers analyzed. The Commission believes that
the second category of CLO managers, given their affiliations,
diversified business lines and demonstrated ability to raise capital in
public capital markets, would have greater access to capital, whether
internal or external, and would face fewer obstacles and lower funding
costs to obtain the capital necessary to satisfy the risk retention
requirements.
---------------------------------------------------------------------------

    \458\ The second category of CLO managers would also include
those CLO managers that maintain a listing of a class of securities
on an exchange in a non-U.S. jurisdiction.
---------------------------------------------------------------------------

    If the risk retention requirements cause certain CLO managers to
exit the leveraged loan market, there could be a commensurate decrease
in the supply of capital unless other investors compensate for their
exit. From the above analysis, the Commission believes it would be
reasonable to estimate that the exit of the first category of CLO
managers from the CLO market could impact current levels of capital
formation by CLOs by 37 percent, which is considerably less than Oliver
Wyman lower bound estimate of 60 percent.\459\ The Commission believes
that a significantly greater impact would be unlikely without an exit
from the market of entities with potentially easier access to capital.
---------------------------------------------------------------------------

    \459\ The Oliver Wyman estimate is based on a sample of the top
30 CLO managers and the assumption that managers that could feasibly
hold the 5 percent risk retention make up 25 percent of the CLO
assets under management.
---------------------------------------------------------------------------

    The potential impact of the loss of certain CLO managers will
depend on whether the CLO investors would continue to supply credit to
the leveraged loan market through alternative channels. If some senior
CLO tranches become unavailable, then, because of their sensitivity to
credit risk, banks and other investors whose investment guidelines
require purchasing of very high quality loans (e.g., triple-A rated)
and who buy senior CLO tranches may be less likely to provide direct
investment into leveraged loan market, which offers higher risk (e.g.,
single-B rated) investments on average. In contrast, CLO investors who
seek higher returns and tend to be less sensitive to credit risk may
decide to participate directly in the leveraged loan market or use
other intermediaries to do so because they have an appetite for that
level of credit risk. Both categories of investors may channel their
investments into one of multiple existing participants in the leveraged
loan market. Mutual funds, private equity funds, private equity
mezzanine loan funds and credit funds (entities that are generally
formed as partnerships with third-party capital and invest in loans or
make loans or otherwise extend the type of credit that banks are
authorized to undertake on their own balance sheet) currently invest
directly in the leveraged loan market and may increase their direct
purchase of leveraged loans if smaller CLO managers exit the market.
Thus, there are multiple existing sources of capital that could
compensate for any potential exit of some CLO managers.
    Based on estimates of the CLO investor base in the Oliver Wyman
study (Exhibit 4 of the study), approximately 20 percent of CLO
tranches are rated ``BBB'' or lower and are held by asset managers and
other investors such as hedge funds, pension funds, and structured
credit funds. If certain CLO deals were no longer available, assuming
that these investors in lower rated tranches would be able to find an
alternative channel to invest in the leveraged loan market and the
remaining 80 percent (the risk-sensitive investors that purchase higher
quality tranches) would not, then the overall estimated impact of a 37
percent decline in the supply of credit from the potential exit of
certain CLO managers would account for an approximately 14.8 percent
reduction in supply of capital to the leveraged loan market.\460\ This
assumes CLO sponsors comprise approximately 50 percent of the leveraged
loan market,\461\ and that any resulting increase in the underlying
loan rates would not encourage the emergence of other capital sources.
Because risk-sensitive CLO investors have other relatively low risk
means of investing in the leveraged loan market (e.g., mutual funds
that concentrate on leveraged loans), the Commission believes that the
actual impact may be lower.
---------------------------------------------------------------------------

    \460\ 14.8 percent is the product of the CLO market share of the
leveraged loan market, 50 percent, the CLO managers market share of
those CLO managers that the Commission believe it would be
reasonable to assume could exit the CLO market, 37 percent, and the
fraction of risk-sensitive investors in such CLOs that would not
invest through other means, 80 percent (the percentage of risk-
sensitive investors assumed by the Oliver Wyman study).
    \461\ See footnote 456 for references.
---------------------------------------------------------------------------

vii. Qualified Tender Option Bonds
    The final rule includes two options for tender option bonds (TOBs).
Both options require 100 percent liquidity protection and provide for a
mechanism by which the sponsors' incentives are aligned with the
investors. In the first option, the sponsor maintains horizontal risk
retention unless there is a tender option termination event (TOTE), in
which case the sponsor's interest converts to vertical risk retention.
After a TOTE, the sponsors will receive a distribution pari passu with
tender option bond holders. In a termination that is triggered by an
event that is not a TOTE the sponsor will continue to hold horizontal
risk retention and will receive the remaining balance after the
distribution is paid to the bond holders. The second option, which is
very similar to a representative sample option, allows the sponsor to
sell the entire TOB but requires the sponsor to hold municipal
securities from the same issuance with a face

value of 5 percent of the deposited municipal security.
    Commenters suggested providing a full exemption for TOBs, not
counting TOBs as a securitization, or allowing third-party risk
retention. Commenters also requested an exemption or recognition of
unfunded risk retention in the form of liquidity support. They also
commented on the cost to the TOB market, however, no commenter provided
data to allow us to calculate potential costs from requiring risk
retention to the TOB market. Requiring TOBs to hold risk retention
imposes a cost on sponsors who were not currently retaining exposure to
credit risk in a form permissible under the final rule.
    After considering comments, the agencies have decided to adopt the
reproposal options with some changes to further accommodate market
practices. The agencies were not persuaded to create a structural
exemption for TOBs, as commenters requested, as this would exempt
future TOB structures, with unknown incentive alignment, from risk
retention. Under the final rule, the agencies are accommodating the
bulk of those structures currently issuing in the market.
    By accommodating current market practice, these options help reduce
the cost of retaining risk but still effectively align the incentives
between sponsors and investors. The first option, by accommodating TOB
tax requirements, allows TOBs to hold horizontal risk retention. In the
absence of this accommodation, any TOB that tried to retain risk using
the standard horizontal form would be in violation of the IRS tax code,
invalidating the tax exemption of the TOB structure. By allowing TOB
sponsors to hold horizontal risk retention while maintaining their tax
exemption the first option provides additional flexibility for TOB
sponsors to retain risk in a manner that better suits their specific
needs, thereby reducing compliance costs. At the same time, investor-
sponsor incentive alignment is maintained because sponsors have
horizontal risk retention for the duration of the TOB unless a TOTE
occurs at which time the TOB is terminated and the sponsor shares any
losses with the investors in a pro-rata manner.
    The agencies believe that the second option described above is
appropriate in this specific context (as opposed to other ABS markets
where the agencies do not adopt a representative sample option) because
most TOBs are made up of one municipal bond, which is the same bond
held by the sponsor. Thus, there are no characteristics of underlying
assets that might make the representative sample different from the
underlying assets, thereby skewing incentives between the sponsor and
investor different. Consequently, the second option does not pose the
same complexities and costs that make the representative sample option
not feasible in other contexts. As with the first option, permitting
this additional flexibility will help to reduce costs for TOB sponsors
without jeopardizing investors' interests. In addition, the alignment
of incentives may encourage investors to invest in the TOB market,
which may increase capital formation. If there are more investors,
liquidity will also increase, which may lead to increased price
efficiency and reduce the cost of capital within the TOB market.
    As mentioned above, existing TOB transactions typically have a 100
percent liquidity guarantee, which the sponsor (or an affiliate) may be
providing. Thus requiring the sponsor to retain 5 percent of the risk
despite this liquidity guarantee will impose additional costs but helps
to ensure that the sponsor is selecting high-quality municipal bonds
and not selling off their risk to a third party. The Commission also
acknowledges that because these options are based on current TOB
structures it may be too costly for new structures to be created. This
may impact competition by creating a barrier to entry for future novel
types of TOB structures.
viii. Alternatives
    In developing the forms of permissible risk retention to be
included the final rule, the agencies considered a number of
alternative approaches. Some of the alternatives were suggested by
commenters and considered by the agencies following the previous rule
proposals.
    In response to the reproposal, for instance, several commenters
requested that the final rule recognize other forms of, or substitutes
for, risk retention such as: third party credit support, including
insurance policies, guarantees, liquidity facilities, and standby
letters of credit; 5 percent participation interest in each securitized
asset; representations and warranties; ``contractual'' risk retention;
private mortgage insurance; overcollateralization; subordination; and
conditional cash flows. One commenter requested that the final rule, at
a minimum, should permit such forms of unfunded risk retention for a
sub-set of sponsors, such as regulated banks. Another commenter
asserted that the final rule should provide more flexibility by
allowing sponsors to satisfy their risk retention requirement through a
combination of various means and that the rule should not mandate forms
of risk retention for specific types of asset classes or specific types
of transactions.
    The agencies have generally declined to recognize unfunded forms of
risk retention for the purposes of the final rule, except in the case
of the Enterprises under the conditions specified for their guarantees.
The Commission acknowledges that recognizing unfunded forms of risk
retention could help to reduce the costs of compliance, since many of
these features are currently used, to varying degrees, in the
securitization market. However, because these forms of credit support
generally are not funded at closing, they may not be available to
absorb credit losses at the time such losses occur. Therefore, the
Commission believes that unfunded forms of risk retention fail to
provide sufficient alignment of incentives between sponsors and
investors and could impose unwarranted costs on investors if recognized
as an eligible form of risk retention.
    Further, the agencies received several comments requesting that the
final rule include a representative sample or participation interest
option.\462\ The agencies considered allowing for loan participations
as a means of satisfying the risk retention requirements. The agencies
were concerned that offering loan participations as a standard option
would introduce substantial additional complexity to the rule in order
to ensure that these forms of retention were implemented in a way that
ensured that the holder had the same economic exposure as the holder of
an ABS interest. In addition, the agencies were concerned that
permitting these types of interests to be held as risk retention could
raise concerns about regulatory capital arbitrage. Accordingly, the
agencies decided not to add a loan participation option to the menu of
risk retention options. Since, according to one commenter, the option
currently is not widely used by the market, the Commission believes
that there may be little economic benefit to allowing this option.
---------------------------------------------------------------------------

    \462\ See Section 5.b.ii of this Economic Analysis for a
discussion of comments on a representative sample option.
---------------------------------------------------------------------------

c. Allocation to the Originator
    The final rule permits the originator to share the risk retained by
the sponsor. Specifically, the rule permits a sponsor to reduce its
required risk retention obligations in a securitization

transaction by the portion of risk retention obligations assumed by one
or more of the originators of the securitized assets as long as the
originator originates at least 20 percent of the securitized assets in
the underlying asset pool. The originator is required to hold its
allocated share of the risk retention obligation \463\ in the same
manner as would have been required of the sponsor, and subject to the
same restrictions on transferring, hedging, or financing the retained
interest.
---------------------------------------------------------------------------

    \463\ The amount of the retention interest held by each
originator that is allocated credit risk in accordance with the
final rule is required to be at least 20 percent, but not in excess
of the percentage of the securitized assets it originated.
---------------------------------------------------------------------------

    Comments on the allocation-to-originator proposal focused on the 20
percent threshold for allocation and the requirement that an originator
to which risk retention was allocated share pro rata in all of the
losses allocated to the type of interest (i.e., horizontal or vertical)
it holds rather than only the losses on assets that it originated. Some
of the commenters asserted that the 20 percent minimum should be
eliminated and that it would hurt small originators while another
commenter supported the limit and asserted that it protected small
originators. With respect to the required pro rata sharing by the
originator, commenters stated that because securitization tranches are
developed so that tranche holders share pari passu in losses, it would
cause unnecessary complexity to limit an originator's interests to the
loans that it had originated. The agencies concluded that the changes
to the reproposal suggested by the commenters are not necessary or
appropriate. Therefore, the agencies are adopting the option largely as
reproposed with minor changes.
    This option benefits sponsors by allowing them to reduce their
costs of retaining risk by sharing the costs with willing originators.
This is also a benefit to investors as incentives are aligned at the
level closer to loan origination, which could increase investor
confidence and improve capital formation. As commenters noted, the
allocation to originator option may create barriers to entry for
smaller originators who will not be able to afford to share in
retaining risk and therefore find their portfolios less liquid or more
costly for sponsors to purchase. This would negatively affect
competition within the securitization market. However, as noted above,
the 20 percent threshold serves to make the allocation option available
only for entities whose assets form a significant portion of a pool and
who, thus, ordinarily could be expected to have some bargaining power
with a sponsor. This will prevent sponsors from forcing the allocation
to originator on smaller originators as a condition of buying the loans
they originate that can increase cost of capital for such small
originators or force such originators from the market thereby reducing
competition. In addition, allowing smaller originators to retain a
smaller fraction of credit risk of the pool could dilute the incentives
generated by the risk retention requirement to monitor the credit
quality of the loans in the pool, thereby undermining the intended
benefits of the rule. A benefit of the adopted approach is that larger
originators will be are able to help smaller sponsors that may have a
harder time retaining risk and otherwise would not participate in the
asset-backed securities market. Providing more sponsors with feasible
options in meeting the requirements may increase capital formation and
allocative efficiency.
d. Hedging, Transfer and Financing Restrictions
    Under the final rule, a sponsor and its consolidated affiliates
generally would be prohibited from hedging or transferring the risk
they are required to retain, except for currency and interest rate
hedges and some index hedging. Additionally, the sponsor and its
consolidated affiliates would be prohibited from financing the retained
interest on a non-recourse basis.
    While some commenters supported the proposed restrictions on
hedging, others criticized the provisions as being overly restrictive,
and certain commenters requested clarification as to the scope of the
proposed restrictions. According to some commenters, the proposed
restrictions were overly broad, raising questions about what
constitutes permissible and impermissible hedges.
    The agencies are adopting hedging, transfer and financing
restrictions as reproposed. Without the hedging and transfer
restrictions, sponsors could hedge/transfer their (credit) risk
exposure to the retained interests, thereby eliminating the ``skin in
the game'' intent of the rule. Thus, the restriction benefits investors
by preventing actions that could undermine the purpose of the final
rule. More narrowly tailored restrictions could impose costs on
investors by inadvertently excluding transactions that have the effect
of hedging or transferring credit risk. On the other hand, the broad
nature of the adopted restrictions could create uncertainty about which
transactions are covered by the prohibition. This uncertainty may
induce strategic responses that are designed to evade the rule. For
example, derivative or cash instrument positions can be used to hedge
risk, but it may be difficult to determine whether such a hedge is
designed to evade the rule.
    Costs related to the hedging and transfer restrictions include
direct administrative costs and compliance monitoring costs. The
hedging, transfer, and financing restrictions cover sponsors and their
affiliates, and, thus, to assure compliance a sponsor must track both
its own portfolio and the portfolios of all its affiliates to verify
that no prohibited transactions are included in the aggregate
portfolio. Such tracking may present additional challenges for large
financial organizations with many affiliates. However, because the
hedging and transfer prohibitions cover only hedging against the risks
of the specific pool or securities based on the specific pool, the
ultimate cost of monitoring compliance should be minimal even for large
organizations.
6. General Exemptions
    In certain cases the agencies have determined to exempt asset
classes from the risk retention requirements altogether or adopt
reduced risk retention requirements. As discussed below, the Commission
believes these exemptions are warranted because there is either
sufficient incentive alignment already in place or other features to
make further constraints unnecessary to address moral hazard concerns.
In particular, the securitizations of these exempted asset classes have
characteristics that help to ensure that the quality of the assets is
high. For example, if the pool of assets are drawn from an asset class
with a low probability of default, opportunities to exploit potentially
misaligned incentives are fewer and investors may have a
correspondingly lesser need for the protection accorded by risk
retention requirements. Below the Commission describes the particular
costs and benefits relevant to each of the asset classes that the
agencies are exempting from risk retention.
a. Federally Insured or Guaranteed Residential, Multifamily, and Health
Care Mortgage Loan Assets
    Consistent with Section 15G, the agencies are adopting an exemption
from the risk retention requirements for any securitization transaction
that is collateralized solely by residential, multifamily, or health
care facility mortgage loan assets if the assets are insured or
guaranteed in whole or in part as to the payment of principal and
interest by the United States or an

agency of the United States. The agencies are also adopting an
exemption from the risk retention requirements for any securitization
transaction that involves the issuance of ABS if the ABS are insured or
guaranteed as to the payment of principal and interest by the United
States or an agency of the United States and that are collateralized
solely by residential, multifamily, or health care facility mortgage
loan assets, or interests in such assets.
    Several commenters expressed support for the exemption for
securitization transactions collateralized solely by assets (or that
involve the issuance of ABS) that are insured or guaranteed as to the
payment of principal and interest by the United States or its agencies.
One commenter urged the agencies to extend the government-backed
exemptions to ABS backed by foreign governments. Another commenter
requested that the agencies clarify that GSE securitizations of
multifamily loans are exempt from the risk retention requirements.
    Risk retention is not currently mandated or practiced for these
securitizations and, thus, this exemption will maintain consistency
with current market practice. Because these securitizations are
guaranteed by the United States or its agencies, and there is no
default risk beyond what is otherwise priced in a U.S. Treasury
security, there is no benefit to investors from sponsors retaining risk
and it would otherwise create costs to sponsors where they are not
necessary. However, the exemption will provide continued incentives to
sponsors to use federally insured or guaranteed assets, which increases
the value of the securities sold. This could have an adverse impact on
the capital-raising ability of sponsors offering securitizations in the
same asset classes where the underlying assets are not federally
insured or guaranteed, requiring these sponsors to compete for investor
capital by offering higher yields and thereby selling asset backed
securities interests at lower prices. As a result, there may be less
demand from sponsors and investors to securitize these (non-federally
insured or guaranteed) assets under private labels, which would impede
the capital formation process in public markets for originators in the
same asset classes that do not qualify under these programs. This
could, in turn, increase borrowing costs for underlying borrowers in
these assets classes.
    There would be potentially significant effects, however, from not
granting this exemption. In particular, these programs provide
subsidized access to credit for consumers who may not otherwise qualify
for loans underwritten by private issuers, and thereby promote social
benefits in the public interest. For example, FHA-insured mortgages
enable many home buyers, particularly those with impaired credit or who
are first time buyers, to purchase a home with a low down payment that
may not otherwise be possible because they would not qualify for a
privately underwritten mortgage.\464\ The economic footprint of this
program is large. At the end of 2013, the FHA had 7.8 million active
loans with insurance in force,\465\ and during that year (2013),
insured 1.3 million new mortgages with the total loan value of $240
billion,\466\ larger than all other federally insured loan programs
combined.\467\ In total, the FHA provided mortgage insurance to more
than 15 percent of households that purchased houses in 2012.\468\
---------------------------------------------------------------------------

    \464\ The Federal Reserve Board Report to the Congress on Risk
Retention, October 2010, available at http://www.federalreserve.gov/boarddocs/rptcongress/securitization/riskretention.html.
    \465\ FHA Single Family Loan Performance Trends, January 2014,
Table 3, available at http://portal.hud.gov/hudportal/HUD?src=/program_offices/housing/hsgrroom/loanperformance.
    \466\ Quarterly Report to Congress on FHA Single-Family Mutual
Mortgage Insurance Fund Programs, 2014, Quarter 1, Exhibits A-1 and
A-2 available at http://portal.hud.gov/hudportal/HUD?src=/program_offices/housing/rmra/oe/rpts/rtc/fhartcqtrly.
    \467\ Other federal mortgage loan guarantee programs include
programs run by the Department of Veterans Affairs, the Farm Service
Agency (FSA), the Rural Housing Service (RHS), and the Department of
Housing and Urban Development's Office of Public and Indian Housing
(PIH). Among them, for example, U.S. Department of Veterans Affairs
guaranteed 630,000 loans in 2013 and Rural Housing Service
guaranteed 163,000 loans in 2013, see 2013 VBA Performance and
Accountability Report available at http://www.benefits.va.gov/reports/annual_performance_reports.asp and USDA Rural Development
Housing Obligations Fiscal Year 2013 Year-End Report available at
http://ruralhome.org/storage/documents/rd_obligations/fy2013/yearend/usdard-fy13-ye-obligations-combined.pdf.
    \468\ See FHA Share of Home Purchase Activity, June 2012,
available at http://portal.hud.gov/hudportal/HUD?src=/program_offices/housing/rmra/oe/rpts/fhamktsh/fhamkt.
---------------------------------------------------------------------------

    The exemption from the risk retention requirements for
securitizations of federally insured or guaranteed loans will not
provide for the incentive alignment that sponsors would otherwise have
with investors in the securitization if they had an economic exposure
to the performance of the securitization. We note, however, that under
one large federally guaranteed program, the program run by the U.S.
Department of Veterans Affairs (VA), the lender has some stake in how
the borrower performs unless the lender sells the loan. The VA provides
insurance in the form of a first-loss guarantee,\469\ but VA lenders
have residual risk after the VA's first-loss obligation is exhausted.
We also note that mortgage loans guaranteed by both FHA and VA programs
performed better than mortgage loans securitized through private-label
RMBS. For instance, both VA-guaranteed and FHA-insured mortgages
originated in 2006, at the peak of the housing boom, had a
significantly lower serious delinquency rate (15 percent for VA-
guaranteed loans,\470\ and between 18 percent \471\ and 31 percent
\472\ by different estimates for FHA-insured loans) than mortgages
securitized through private-label RMBS transactions (58 percent).\473\
Although risk retention requirements were not historically practiced in
private label securitizations, and delinquency rates of securitizations
with risk retention during the mortgage crisis period are therefore not
available, the disparity in performance between VA- and FHA-insured
loans and other loans purchased for private label securitizations
suggests that the combination of underwriting practices, mortgage
insurance premiums, and lenders' residual risk exposure, has a material
impact on the mitigation of the moral hazard problem in the
securitization process.
---------------------------------------------------------------------------

    \469\ 25 percent of the loan amount with a minimum guarantee of
$36,000.
    \470\ See Table 1 in Urban Institute Commentary, July 2014, ``VA
Loans Outperform FHA Loans. Why? And What Can We Learn?'' available
at http://www.urban.org/UploadedPDF/413182-VA-Loans-Outperform-FHA-Loans.pdf.
    \471\ See the FHA Loan Performance Trends report available at
http://portal.hud.gov/hudportal/HUD?src=/program_offices/housing/hsgrroom/loanperformance.
    \472\ See footnote 471.
    \473\ The serious delinquency rate for mortgages securitized
through private-label RMBS is calculated by DERA staff based on
MBSData dataset.
---------------------------------------------------------------------------

    While the historical loan performance data indicate that FHA-
insured mortgages performed better than other mortgages purchased by
private label securitizations, one commenter was concerned that, with
the exemption, the increase in the FHA's share of the market will be
difficult to shrink to a more rational proportion of the mortgage
market. While the current 15 percent market share is considerably
greater than 4 to 6 percent market shares during the 2004 to 2007
period, it is consistent with the historical market shares of between
12 and 14 percent during the 1993 to 2002 period, and below the 19
percent market share recorded in 2009 and 2010.\474\ Hence,

the current FHA market share does not seem out of proportion relative
to certain previous periods. Instead, the trend shows a strong counter
cyclical relation with the health of the private market, consistent
with the benefits of a federally insured program for home mortgage that
provides access to capital when private markets are unable to do so.
---------------------------------------------------------------------------

    \474\ See FHA Share of Home Purchase Activity, June 2012,
available at http://portal.hud.gov/hudportal/HUD?src=/program_offices/housing/rmra/oe/rpts/fhamktsh/fhamkt.
---------------------------------------------------------------------------

b. Securitizations of Assets Issued, Insured or Guaranteed by the
United States or any Agency of the United States
    Consistent with Section 15G, the final rule contains exemptions
from risk retention for any securitization transaction if the ABS
issued in the transaction were (1) collateralized solely (excluding
servicing assets) by obligations issued by the United States or an
agency of the United States; (2) collateralized solely (excluding
servicing assets) by assets that are fully insured or guaranteed as to
the payment of principal and interest by the United States or an agency
of the United States (other than residential, multifamily, or health
care facility mortgage loan securitizations discussed above); or (3)
fully guaranteed as to the timely payment of principal and interest by
the United States or any agency of the United States. Also consistent
with Section 15G, the final rule contains an exemption from risk
retention for ABS issued or guaranteed by any state of the United
States (including a political subdivision or public instrumentality of
a state).
    One commenter requested that the final rule retain the full
exemption for securities issued by a state (including a political
subdivision or public instrumentality of a state), and for securities
that meet the definition of a qualified scholarship funding bond. This
commenter requested that the exemption for state-issued securities and
qualified scholarship funding bonds be extended to both securities
issued on a federally taxable basis and securities issued on a federal
tax-exempt basis. Another commenter urged that the agencies clarify
that all securities issued by housing finance agencies and other state
government agencies and backed by loans financed by housing finance
agencies are exempted.
    Risk retention is not currently mandated or practiced for these
asset classes and thus, this exemption maintains consistency with
current market practice. Because investors will be sufficiently
protected from loss by the government guarantee that applies to these
securities, there is no benefit to investors from sponsors retaining
risk, and it would otherwise create costs to sponsors where they are
not necessary. However, as with the exemption for federally insured
mortgages, this exemption will incentivize sponsors to use federally
insured or guaranteed assets, which will have an impact on competition
with other assets that are not federally insured or guaranteed.
c. Certain Student Loan Securitizations
    The final rule provides a separate exemption for securitization
transactions that are collateralized by student loans that were made
under the Federal Family Education Loan Program (FFELP). Under the
final rule, a securitization transaction that is collateralized solely
by FFELP loans that are guaranteed as to 100 percent of defaulted
principal and accrued interest will be exempt from the risk retention
requirements. A securitization transaction that is collateralized
solely by FFELP loans that are guaranteed as to at least 98 percent of
defaulted principal and accrued interest will have the sponsor's risk
retention requirement reduced to 2 percent. All other securitizations
collateralized solely by FFELP loans will have the sponsor's risk
retention requirement reduced to 3 percent. Because loans underlying
FFELP student loan securitizations are federally guaranteed from 97
percent to 100 percent depending on the date of origination, and there
is little to no default risk beyond what is otherwise priced in a U.S.
Treasury security, there is no benefit to investors from sponsors
retaining risk and it would otherwise create costs to sponsors where
they are not necessary.
    Several commenters suggested different ways to expand the scope of
the exemption or add new categories of student loans to the exemption.
Other commenters recommended that the agencies accept alternative forms
of risk retention for FFELP loan securitizations. The suggested
alternative forms of risk retention include a simplified representative
sample method, an exemption for on-balance sheet transactions where the
structure clearly demonstrates at least 5 percent risk retention,
initial equity contribution, overcollateralization, and other unfunded
forms of risk retention.
    The agencies believe that expansion of the definitions of exempted
assets would undercut the purpose of risk retention of aligning
incentives of sponsors and investors because other student loans would
not be guaranteed by the U.S. government and, thus, would be subject to
the same moral hazard problem described above. The agencies have also
generally declined to recognize unfunded forms of risk retention for
the purposes of the risk retention rule and continue to believe that
unfunded forms of risk retention fail to provide sufficient alignment
of incentives between sponsors and investors.
    The economic impact of this exemption will likely be minimal
because FFELP was eliminated in 2010 and student loans were no longer
issued under the program after June 2010.\475\
---------------------------------------------------------------------------

    \475\ Health Care and Education Reconciliation Act of 2010, Pub.
L. 111-152, Sec.  2201, 124 Stat. 1029, 1074.
---------------------------------------------------------------------------

d. Resecuritizations
    The proposed rule would have provided two exemptions for certain
resecuritizations where duplicative risk retention requirements would
not appear to provide any added benefit. The first of these exemptions
would have applied to pass-through resecuritizations that met certain
specified conditions. The second one would have applied only to
resecuritizations of certain first pay classes of mortgage backed
securities. Under the reproposal, sponsors of resecuritizations that
were not structured to meet the terms of one of these two exemptions
would have been required to meet the credit risk retention requirements
with respect to the resecuritization transaction unless another
exemption was available.
    The agencies received a number of comments on the proposed
resecuritization exemptions. The comments did not raise specific
objections or concerns with either of the two proposed exemptions, but
generally urged the agencies to expand the exemptions to other types of
structures, including those that re-tranche credit risk. Commenters
noted that applying risk retention to resecuritizations of asset-backed
securities that are already in the market, especially where the
underlying interests are asset-backed securities compliant with the
risk retention requirement, cannot alter the incentives for the
original ABS sponsor to ensure high-quality assets. Other commenters
stated that the lack of a broad resecuritization exemption would
negatively affect markets by making it harder for investors to re-
structure and sell existing ABS. A number of commenters stated that the
agencies should provide an exemption for resecuritizations of ABS that
were issued prior to the effective date of the rule. Still others
expressed the view that the agencies could develop an exemption that
would allow credit tranching in resecuritized ABS while

limiting the scope of such exemption, such as by excluding actively
managed pools, to address the agencies' concerns with CDOs and similar
structures.
    The agencies are adopting these exemptions as reproposed. For
transactions that meet the exemptions' requirements, the
resecuritization process would neither increase nor reallocate the
credit risk of the underlying asset-backed securities because, by
definition, there is no tranching of the credit risk in a pass through
security. Hence, the resecuritization does not alter the incentive
alignment present in the original securitizations that are already
compliant with the risk retention requirement. Under the final rule,
sponsors of resecuritizations that do not have one of the structures
described above would not be exempted from risk retention. These
resecuritization transactions re-tranche the credit risk of the
underlying asset-backed securities, and are subject to the same moral
hazard problem that exists in the underlying securitizations, because
sponsors' discretion in the choice of underlying securitizations allows
for the reallocation of credit risk. Hence, these resecuritizations
will be subject to risk retention requirements to the same extent as
the underlying asset-backed securities (unless the underlying
securities qualify for an exemption). Thus, not exempting these
resecuritizations is consistent with the purposes of the rule and
lessens the likelihood of unwarranted costs on investors.
    Because the exemption would allow the creation of securities that
may be used to aggregate asset-backed securities backed by small asset
pools, the exemption for these types of resecuritization could improve
access to credit at reasonable terms to consumers and businesses by
allowing for the creation of an additional investment vehicle for such
asset pools. This, in turn, would lead to increased liquidity of such
pools and attendant decrease in cost of capital for some borrowers.
However, the final rule may also have an adverse impact on capital
formation and efficiency if they make certain resecuritization
transactions costlier or infeasible to conduct because of two layers of
credit risk retention.
e. Other Exemptions and Alternatives
    The reproposal also included exemptions for utility legislative
securitizations, seasoned loans, and securitization transactions that
are sponsored by the FDIC acting as conservator or receiver.
    The agencies received no comments on the utility legislative
securitization exemption, and are adopting the exemption as reproposed.
The agencies continue to believe the implicit state guarantee in place
for these securitizations addresses the moral hazard problem discussed
above and adding the cost of risk retention would create costs to
sponsors where they are not necessary as the incentive alignment
problem is already being addressed.
    The agencies received a number of comments on the seasoned loan
exemption. Commenters generally favored expanding the seasoned loan
exemption, although they differed in how to expand the exemption.
Because seasoned loans have had a sufficient period of time to prove
their performance, adding the cost of risk retention would create costs
to sponsors where they are not necessary as any risk associated with
the underlying assets' moral hazard problem will have manifested
itself.
    Risk retention is not currently mandated or practiced for these
asset classes, and thus, permitting these exemptions will maintain
consistency with current market practice. As discussed above, because
these assets classes have unique features that sufficiently protect
investors from loss, there is no benefit to investors from sponsors
retaining risk, and it would create costs to sponsors where they are
not necessary. However, providing these exemptions will incentivize the
creation of utility legislative securitizations and securitizations
with seasoned loans, thus potentially lowering the cost of capital
formation for these loans.
    In the reproposal, the agencies provided an exemption from risk
retention for securitization transactions that are sponsored by the
FDIC, acting as conservator or receiver. One commenter expressly
supported this exemption, noting, among other things, that it would
help the FDIC maximize the value of assets in conservatorship and
receivership. The agencies are adopting the FDIC securitization
exemption as reproposed. There is no benefit to investors from FDIC
retaining risk on its securitizations because its actions are guided by
sound underwriting practices and the quality of the assets is carefully
monitored in accordance with the relevant statutory authority, and
absence of exemption would otherwise create costs to FDIC where they
are not necessary.
    In response to the reproposal, commenters also asked for exemptions
for other specific asset classes such as: Corporate debt repackagings,
legacy loan securitizations, securitizations of unsecured direct
obligations of the sponsor, and servicer advance receivables. These
asset classes have either unfunded risk retention or include loans
created before the new underwriting qualifications were in place and
they do not have features that mitigate the moral hazard problem. Thus,
providing an exemption would impose an unwarranted cost on investors.
f. Safe Harbor for Certain Foreign-Related Securitizations
    The final rule includes a safe harbor provision for certain,
predominantly foreign, transactions based on the limited nature of the
transactions' connections with the United States and U.S. investors.
Specifically, the safe harbor excludes from the risk retention
requirements transactions in which, among other limitations, no more
than 10 percent of the value of the ABS interests are sold to U.S.
persons and no more than 25 percent of the assets collateralizing the
ABS assets are acquired from U.S. persons. The safe harbor is intended
to exclude from the risk retention requirements transactions in which
the effects on U.S. interests are sufficiently remote so as not to
significantly impact underwriting standards and risk management
practices in the United States or the interests of U.S. investors.
    Commenters on the proposal generally supported the existence of a
safe harbor for certain foreign securitizations. A few commenters
suggested increasing the 10 percent limit on the value of ABS interests
permitted to be sold to or for the account of U.S. persons. These
commenters also requested that the agencies clarify that the 10 percent
limit applies only at the time of initial issuance and does not include
secondary market transfers. Commenters also proposed to exclude from
the 10 percent limitation (A) securitization transactions with a
sponsor or issuing entity that is a U.S. person in which no offers are
made to U.S. persons and (B) asset-backed securities issuances that
comply with Regulation S under the Securities Act.
    Several commenters requested that the rule provide for coordination
of the rule's risk retention requirement with foreign risk retention
requirements, including by permitting a foreign sponsor to comply with
home country or other applicable foreign risk retention rules. In this
regard, some commenters stated that the U.S. risk retention rules may
be incompatible with foreign risk retention requirements, such as the
European Union risk retention

requirements and, accordingly, that sponsors required to comply with
both U.S. and foreign risk retention regulations could be subject to
conflicting rules.
    As noted in the reproposal the costs of the foreign transaction
safe harbor should be small. There will be negligible effect of the
safe harbor on efficiency, competition and capital formation in the
United States (compared to the universal application of the risk
retention rule) because the affected ABS are predominantly foreign with
limited connection to U.S. markets. As noted above, the foreign
transaction safe harbor is narrowly tailored to capture only those
transactions in which the effects on U.S. interests are sufficiently
remote so as not to significantly impact U.S. underwriting standards
and risk management practices or the interests of U.S. investors. The
agencies asked for comment on whether or not the 10 percent proceeds
trigger should be different. Commenters suggested the proceeds trigger
be raised to 20 percent or 40 percent. The agencies are adopting the
foreign safe harbor provision as reproposed. The relatively narrow
scope of the foreign safe harbor provision may have negative effect on
foreign sponsors that seek U.S. investors because they may need to
satisfy risk retention requirements of two jurisdictions (their home
country and the United States). In addition, the rule may reduce
competition and investment opportunities for U.S. investors because
foreign securitizers may exclude U.S. persons from their transactions
to avoid triggering the risk retention requirements. These costs may be
mitigated by the fact that the final rule provides flexibility for
sponsors with respect to the forms of eligible risk retention, which
may permit foreign sponsors seeking a material U.S. investor base to
retain risk in a format that satisfies both home country and U.S.
regulatory requirements, without jeopardizing protection to the U.S.
investors in the form of risk retention. Moreover, raising the trigger
could provide sponsors relying on the safe harbor with a competitive
advantage of not needing to hold risk retention. The larger the amount
of the securitization foreign sponsors are allowed to sell to U.S.
persons without triggering risk retention, the more competition
domestic securitization deals will have to face.
7. Reduced Risk Retention Requirements for ABS Backed by Qualifying
Assets
    As contemplated by Section 15G, the agencies are adopting
exemptions for securitizations consisting solely of automobile loans,
commercial real estate loans, commercial loans, and residential
mortgage loans that satisfy certain specific underwriting standards
that indicate a low credit risk with respect to the loan.\476\
---------------------------------------------------------------------------

    \476\ Section 15G allocates authority to prescribe the
underwriting criteria for qualifying assets to the federal banking
agencies, and the SEC is not promulgating this aspect of the final
rule. Consequently, the Commission's Economic Analysis does not
address this aspect of the final rule. However, see the discussion
below for a general discussion of the economic effects of providing
an exemption for qualifying assets, as contemplated by Section 15G.
---------------------------------------------------------------------------

    The benefit to exempting qualifying assets from risk retention is
that it will avoid tying up sponsors' capital in transactions in which
the underlying assets are subject to underwriting standards that
indicate a low credit risk and thus a diminished need for risk
retention to address the moral hazard problem. Avoiding this
unnecessary restraint will leave sponsors with more capital available
to deploy for other and potentially more efficient purposes. The
economic consequences of exempting qualifying assets are analogous to
the discussion associated with requiring stricter lending standards for
a ``qualified mortgage'' (QM) in the residential lending market. Also
there will be fewer administrative, monitoring and compliance costs for
sponsors of qualifying assets if there is no risk retention. Lower
costs of securitizing loans may enhance competition in the market for
qualifying auto, commercial real estate and commercial loans by
allowing more firms to be profitable. While we believe that the
qualified standards will result in only a small percentage of
securitizations to be exempt from risk retention, we believe that many
of these asset classes have existing practices that are consistent with
the risk retention requirements that the agencies are adopting
today.\477\ Further, as discussed elsewhere in this economic analysis,
the agencies have made adjustments to other areas of the rule (e.g.,
CMBS option, horizontal risk retention) to address concerns about the
implementation of risk retention to particular asset classes or
structures.
---------------------------------------------------------------------------

    \477\ But see discussion of open market CLOs in Section 5.b.vi
of this Economic Analysis.
---------------------------------------------------------------------------

a. Blended Pools of Qualifying Assets
    The reproposal would permit sponsors to blend pools of qualifying
automobile loans, qualifying commercial loans or QCRE loans with non-
qualifying assets of the same class to receive up to a 50 percent
reduction in the minimum required risk retention amount.
    While many sponsor commenters supported the ability to blend pools
of qualifying and non-qualifying assets to obtain a reduced risk
retention amount, these commenters requested that the agencies remove
the 50 percent limit on the reduction for blended pools of commercial,
CRE, or automobile loans. Investor commenters, however, generally
opposed allowing blended pools of qualifying and non-qualifying assets.
    The agencies are adopting the provision as reproposed. Allowing
blended pools with a reduced risk retention requirement will improve
efficiency, competition and capital formation by allowing sponsors to
securitize more loans when it is difficult to obtain a large enough
pool of qualifying assets to issue an ABS consisting entirely of
exempted assets.
    By allowing reduced risk retention on blended pools, sponsors hold
less risk retention on lower quality loans than they would otherwise.
For example, a sponsor that holds vertical risk retention and that
forms of pool of 50 percent non-qualifying loans would be exposed to
2.5 percent of the credit risk of the non-qualifying loans compared to
5 percent if the pool were comprised entirely of non-qualifying loans.
Hence, increasing the fraction of qualifying loans into the pool
lessens the fraction of credit exposure to the remaining non-qualifying
loans. In the extreme, inclusion of 1 percent of non-qualifying loans
would result in a sponsor being exposed to only 0.05 percent of the
non-qualifying loans. This could erode the disincentives of the
originate-to-distribute model that the risk retention requirement was
designed to address. In order to ensure sponsors hold a meaningful
amount of risk and do not have incentives to underwrite and securitize
low quality loans the limit on the reduction of risk retention
requirement is 50 percent. Thus, even in the case of a pool of 1
percent non-qualified loans a sponsor would still have to retain 2.5
percent of the credit risk of the pool.
b. Buyback Requirement
    Exempting certain type of loans gives sponsors an incentive to
misrepresent qualifications of loans, similar to what was observed in
the run-up to the financial crisis. However, the final rule requires
that, if after issuance of a qualifying asset securitization, it was
discovered that a loan did not meet the

qualifying underwriting criteria, the sponsor would have to repurchase
or cure the loan (buyback requirement).
    Commenters did not provide any comments on the buyback requirement
except for the effect of the provision on CLOs. Some sponsor commenters
opposed the buyback provision for CLOs, noting that open market CLO
managers are thinly capitalized and generally would not have
significant financial resources available to buy back loans in the
pools they manage. The agencies are adopting this provision as
reproposed.
    The benefit of this provision is that it helps to prevent and
disincentivize sponsors from trying to include non-qualifying loans in
the securitization without representing them as such for the purpose of
avoiding risk retention. The buyback provision should increase
investors' willingness to invest because it makes sponsors of asset-
backed securities responsible for correcting discovered underwriting
mistakes and ensures that the actual characteristics of the underlying
asset pool conform to the promised characteristics.
c. Qualified Residential Mortgages
    The risk to financial markets from poor underwriting practices and
inadequate disclosure of risks to investors in the RMBS securitizations
is considerable. A body of academic literature has emerged since the
financial crisis that supports the view that, during the early to mid-
2000s, residential mortgage-backed securitizations (RMBSs) contributed
to a significant decline in underwriting standards for residential
mortgage loans, particularly in the private label securitization
market.\478\ During this time, the volume of private label RMBS
issuance increased significantly from $343 billion in 2003 to $726
billion in 2005 and $685 billion by 2006.\479\ GSE sponsored
securitizations fell during this same period. An analysis of historical
performance among loans securitized into private-label RMBS that
originated between 1997 and 2009 shows that those meeting the QM
standard sustained exceedingly high serious delinquency rates, greater
than 30 percent during that period.\480\
---------------------------------------------------------------------------

    \478\ Keys, Mukherjee, Seru and Vig, ``Did Securitization Lead
to Lax Screening? Evidence from Subprime Loans'', Quarterly Journal
of Economics, vol. 125, no. 1, pp. 307-362, February 2010 and
Nadauld and Sherlund, ``The Impact of Securitization on the
Expansion of Subprime Credit'', Journal of Financial Economics, vol.
107, no. 2, February 2013, pp. 454-476.
    \479\ Source: SIFMA Statistics available at http://www.sifma.org/research/statistics.aspx.
    \480\ See Joshua White and Scott Bauguess, Qualified Residential
Mortgage: Background Data Analysis on Credit Risk Retention, (August
2013), available at http://www.sec.gov/divisions/riskfin/whitepapers/qrm-analysis-08-2013.pdf.
---------------------------------------------------------------------------

    These high delinquency rates underscore the moral hazard problem
described earlier that can arise when disclosures to investors do not
provide sufficient detail to adequately evaluate the quality of the
loans backing the security. This problem was exacerbated by the fact
that the underlying RMBS loan pools were typically comprised of
thousands of loans that required time and resources to evaluate, but
with key features of the loans not always available to investors in
sufficient detail to make those evaluations. The resulting information
asymmetry, combined with the originate-to-distribute incentives that
allowed sponsors to receive full compensation before investors had the
opportunity to learn about loan quality and ultimate risks, generated
the conditions that contributed to the financial crisis. It is these
conditions that the risk retention rule is designed to address.
    The rule the agencies are adopting today exempts from the risk
retention requirements any securitization comprised exclusively of
QRMs. Section 15G requires that asset-backed securities that are
collateralized solely by QRMs be completely exempted from risk
retention requirements and allows the agencies to define the terms and
conditions under which a residential mortgage would qualify as a QRM.
Section 15G mandates that the definition of a QRM be no broader than
the definition of a QM, as such term is defined under Section
129C(b)(2) of the Truth in Lending Act.
    Pursuant to the statutory mandate, the agencies are exempting
securitizations collateralized solely by QRMs and, pursuant to the
discretion permitted, are defining QRMs as QMs. As outlined in the
reproposal, the Commission believes that this definition of QRM would
achieve a number of important benefits. First, since the criteria
established by the Consumer Financial Protection Bureau (CFPB) to
define QMs focus on underwriting standards, less risky product
features, and affordability, the Commission believes that aligning the
definition of QRM with QM is likely to promote more prudent lending and
contribute to a sustainable, resilient and liquid mortgage
securitization market.
    Second, the Commission believes that a single mortgage quality
standard (as opposed to creating a second mortgage quality standard)
would benefit market participants by simplifying the lending and
securitization requirements and eligibilities applicable to the
residential mortgage and RMBS market. Moreover, having a separate
mortgage standard for the exemption from risk retention could impact
the relevance of the QM standard, particularly if the definitions were
not sufficiently different. For example, if the two standards resulted
in qualified mortgages of similar risk, it is possible that sponsors
would focus on securitizing only mortgages that met the higher QRM
standard because of the exemption from risk retention. If so, this
could impact access to capital for creditworthy borrowers who could not
secure a QRM, because their loans would be less attractive to
securitizers and impact an originator's ability to sell it. Commenters
suggested that this would hit middle income and first time borrowers
the hardest, and have a detrimental impact to capital formation.
    Third, a broad definition of QRM avoids the potential effect of
squeezing out certain lenders, such as community banks and credit
unions, which may not have sufficient resources to hold the capital
associated with the origination of non-QRMs, thus enhancing competition
within this segment of the lending market. The Commission believes that
a broad QRM definition will increase the ability of these lenders to
securitize their mortgage originations and thus increase their ability
to generate new loans and facilitate enhanced borrower access to
capital.
    Finally, a broad definition of QRM may help encourage the re-
emergence of private capital in securitization markets. The Enterprises
currently have a competitive advantage over private label
securitizations because the Enterprises benefit from lower funding
costs attributed to the recognition of their explicit Federal capital
support, a subsidy to their lending activity that is not available to
private label securitizations. Moreover, the Enterprises' current
guarantee of their securitizations fulfill the risk retention
requirements as long as they are in receivership and conservatorship
and meet other conditions, and they would not have the same concomitant
costs of complying with the rule as private parties during this time.
Hence, the less restrictive QRM criteria should enhance the
competitiveness of sponsors of private label securitizations by
expanding the scope of loans eligible for securitization without
triggering risk retention requirements. This, in turn, would reduce the
need for borrowers to rely on programs offered by the Enterprises.
    Aligning the definition of QRM to QM incorporates into the
definition of QRM certain loan product features that historical
performance data indicates

results in a lower risk of default. The Commission thus acknowledges
that the QM standard does not fully address the loan underwriting
features that are most likely to result in a lower risk of default,
including down payment requirements and measures of borrower credit
history. The Commission, however, believes that other regulatory
developments may provide investors with additional information that
allows them to more effectively assess the potential risks underlying
securitizations as well as more effective recourse against sponsors
when problems arise with the performance of underlying loans. In
particular, the Commission has recently adopted revisions to Regulation
AB \481\ that require in registered RMBS transactions disclosure of
detailed loan-level information at the time of issuance and on an
ongoing basis. As previously described, for registered offerings
covered by the revised Regulation AB, the loan level disclosures should
enhance an investor's ability to accurately assess the quality of the
underlying assets. The revised Regulation AB also requires issuers to
provide investors with this information in sufficient time prior to the
first sale of securities so that they can analyze this information when
making their investment decision and provides additional transactional
safeguards for registered shelf offerings. These regulatory reforms,
combined with the prudential underwriting standards embodied in the QM
definition, should serve to significantly mitigate the moral hazard
problem for registered RMBS securitizations. As previously discussed,
private-label securitizations issued through unregistered offerings are
not subject to the asset-level requirements under revised Regulation
AB.
---------------------------------------------------------------------------

    \481\ See 79 FR 57184.
---------------------------------------------------------------------------

    The Commission is aware that defining QRMs broadly to equate with
the definition of QM may result in a number of economic costs. Most
notably, sponsors will not be required to retain an economic interest
in the credit risk of QRM loans, and thus, there will be less
incentivized to avoid the originate-to-distribute model that can
contribute to poor quality underwriting and the obfuscation of risk to
the ultimate investors in RMBS securitizations. Moreover, although the
QRM exemption is based on the premise that well-underwritten mortgages
were not the cause of the financial crisis, the criteria for QM loans
do not account for all borrower characteristics that may provide
additional information about default rates. In particular, QM loans do
not account for certain underwriting and product features that
historical loan performance indicate lower risk of default. For
instance, borrowers' credit history, down payment and loan-to-value
ratio have been shown to be significantly associated with lower
borrower default rates.\482\ This introduces additional risk into
securitizations without a risk retention requirement relative to a more
narrowly defined QRM definition.
---------------------------------------------------------------------------

    \482\ See footnote 481.
---------------------------------------------------------------------------

    Some commenters indicated that the QM-Plus alternative proposal
that included a down payment requirement was unnecessarily restrictive,
did not account for compensating factors in underwriting practices, and
that the foreclosure crisis was predominantly a result of abusive loan
terms and practices that are addressed by the QM definition. The
commenters concluded that the QM definition adequately addresses
product features that historical loan performance data indicate result
in a lower risk of default, that low down payment loans have been used
with great success to promote sustainable homeownership, and aligning
the definition of QRM to QM strikes the right balance of improved
standards and the need to improve access to affordable credit on
reasonable terms.
    Commenters also questioned the estimated delinquency rates reported
in the Commission analysis of historical loan performance among loans
packaged by private label securitizations that would have met the
current QM definition. These commenters claimed that the SEC staff
study included loans with risky features linked to default that would
not meet the QM definition, and that the period of analysis of the SEC
staff study focused too narrowly on the origination years leading up to
the financial crisis, and thus the most poorly underwritten mortgages.
As a result, these commenters stated that the 34 percent estimated
serious delinquency rate among securitized private label loans found in
the SEC staff study did not fairly reflect the effect of the QM
definition, which when applied to their broader sample of mortgages
(that included GSE purchased loans and non-securitized loans) was 5.8
percent.
    The Commission recognizes that estimates of delinquency rates are
sensitive to the sample of mortgages analyzed, and in particular, can
vary significantly based on the time period and types of loans
analyzed. In particular, as previously noted, there is a large
difference in the historical performance of GSE purchased loans, for
which GSEs' current guarantee fulfills the risk retention requirements
as long as GSEs are in receivership and conservatorship and meet other
conditions, which effectively currently exempts such loans from risk
retention requirements, and securitized private labels loans. The SEC
staff study focused on securitized private labels loans to respond to
previous commenter concern that the original proposal inappropriately
focused on loans purchased by GSEs and thus excluded originations held
in non-GSE securitizations. The SEC staff study also focused on the
years leading up to the crisis years because this was the period of
underwriting abuses for which the presence of a QM definition would
have had the most relevance. Moreover, the 34 percent delinquency rate
reported in the SEC staff study is consistent with estimates provided
in the analysis of another commenter when restricted to the same loan
types and period.\483\
---------------------------------------------------------------------------

    \483\ Urban Institute, Table 1 reports 36 percent delinquency
rate for Private Label Securities originated during the 2006-2008
period.
---------------------------------------------------------------------------

    As previously discussed, some asymmetric information issues
contributing to the moral hazard problem of the originate-to-distribute
model are addressed by the revisions to Regulation AB. In particular,
while registered RMBS backed by QRM loans are exempt from risk
retention, issuers of such securities are required to provide loan-
level information for each asset in the underlying pool in accordance
with revised Regulation AB. Thus, the moral hazard problem is reduced
for these issuances because asset-level disclosure should mitigate the
information asymmetry problem to the extent that the disclosures
adequately inform investors of the risks.
    At present, private label RMBS transactions comprise only a small
fraction of the total non-agency asset-backed securities market--6.4
percent by dollar volume in 2013.\484\ Moreover, only 16 percent of
RMBS were registered issues. This is far below the pre-crisis levels.
For example, the issuance volume of private label RMBS securitizations
was $801 billion in 2006, which accounted for 39 percent of the total
non-agency asset-backed securities issuance in 2006. Of these
transactions, only 9.3 percent were privately-issued offerings (e.g.,
resales under Rule 144A or private placements), transactions that would
not be subject to asset-level disclosures by the revised Regulation AB
rules. If the private label

securitization market were to return to pre-crisis levels and
registration practices, then a significant portion of the RMBS market
would be subject to asset-level disclosures. For the remaining
unregistered offerings, risk retention requirements would still apply
and address the potential moral hazard problem to the extent that the
underlying securitizations were not comprised of QRMs.
---------------------------------------------------------------------------

    \484\ All figures in this paragraph are calculated by DERA staff
using the Asset-Backed Alert and Commercial Mortgage Alert
databases.
---------------------------------------------------------------------------

    Broadly, by aligning the definition of QRM to QM the agencies are
fostering the least restrictive capital formation regime for
residential mortgages allowed under the statute. This alignment allows
for securitizations exempt from the requirement of risk retention that
include loans with low down payment and loans without down payment or
borrower credit history requirements. By not adopting these additional
credit overlays, the agencies have sought to facilitate the ability of
mortgage originators to have sponsors package their loans into
securitizations and thereby generate new capital for the continued
origination of new mortgages. In the near term, under prevailing tight
mortgage lending conditions, this definition is intended to promote
borrower access to capital, especially for low-and moderate income,
minority and first-time home buyers, and accelerate the recovery of the
private label RMBS market.
    However, aligning the definition of QRM to QM also provides the
least restrictive regulatory measure available under the statute to
mitigate the reemergence of the moral hazard problem in the RMBS
market. By exempting from the risk retention requirement
securitizations comprised of loans with characteristics that
historically have been indicators of a higher probability of mortgage
default, the same economic incentives for the originate-to-distribute
model that existed prior to the onset of the financial crisis may
persist.
    Hence the alignment of the definition of the two mortgage standards
involves a tradeoff between, on the one hand, promoting financial
market recovery and borrower access to capital, and, on the other hand,
adding additional credit requirements that may lessen the likelihood of
future moral hazards related to the lending practices in the housing
market but also further constrain mortgage credit. The agencies have
sought to address this tradeoff through the introduction of a periodic
review of the QRM definition that allows the agencies to monitor the
rule's effects as the RMBS market evolves in the new regulatory
environment. The agencies will review the QRM definition at regular
intervals and in response to any changes made to the QM definition by
the CFPB, and as a result of these reviews, may or may not decide to
modify the definition of QRM through notice and comment rulemaking.
Moreover, the agencies will commence a review at any time upon the
request of any one of the agencies. By including this review process in
the final rule, the agencies recognize that prevailing market
conditions could change in a way that merits a stricter definition of
QRM, and have introduced a process by which the alignment of QRM to QM
can be assessed going forward.
d. Mortgage Loans Exempt From QM
    The agencies are also adopting an exemption from risk retention for
securitizations of loans originated through community-focused lending
programs that are currently exempt from the CFPB's ability-to-repay
requirements and an exemption for certain three-to-four unit mortgage
loans.
    Exempting securitizations of loans originated through community-
focused lending programs that are currently exempt from the CFPB's
ability-to-repay requirements from risk retention will increase capital
formation. The mission of many of these community-based lenders is to
provide access to capital for underserved communities; requiring risk
retention for them would impose a cost that might impinge on their
ability to make loans or might increase their cost of capital. The
borrowers that rely on community based lenders may also avoid higher
borrowing costs as the result of this exemption. Efficiency may be
improved to the extent community based underwriters have more
information about their borrowers than other lenders and use soft
information to underwrite their loans.\485\ We acknowledge, however,
that underwriting standards may change allowing lower quality loans to
be securitized. The exemption for these loans, as with QRM, however,
will be subject to periodic review by the agencies.
---------------------------------------------------------------------------

    \485\ See, e.g., O.E. Ergungor, ``Bank Branch Presence and
Access to Credit in Low- to Moderate-Income Neighborhoods'' Journal
of Money, Credit, and Banking, 2010; S. Agrawal, B. Ambrose, S.
Chomsisengphet, and C. Liu, ``The role of Soft Information in a
Dynamic Contract Setting: Evidence from the Home Equity Credit
Market,'' Journal of Money Credit and Banking, 2011; C. Chang, G.
Liao, Z. Yu, Z. Ni, ``Information From Relationship Lending:
Evidence from Loan Defaults in China,'' working paper, 2010.
---------------------------------------------------------------------------

    The agencies are also providing an exemption from the risk
retention requirements for certain mortgage loans secured by three-to-
four unit residential properties that meet the criteria for QM other
than being a consumer credit transaction, as well as an exemption to
permit sponsors to securitize these exempted mortgage loans with QRMs.
The exemption for these loans, as with QRM, will be subject to periodic
review by the agencies.
    Even though three-to-four unit mortgages comprise a relatively
small fraction of the one-to-four residential mortgage market,
exempting securitizations of such loans from risk retention could
increase access to capital for these borrowers. Among loans acquired or
guaranteed by Fannie Mae (Freddie Mac) between 2000 and 2013, only 0.93
percent (0.70 percent) of loans by initial balance were three-to-four
unit mortgages, and the total principal balance of such mortgages
acquired or guaranteed by the Enterprises exceeded $56 billion. Three-
to-four unit mortgages were slightly more prominent in the private-
label securitization market, for which 1.51 percent of loans by initial
balance were three-to-four unit mortgages, with the total original
principal balance of almost $23 billion.\486\
---------------------------------------------------------------------------

    \486\ DERA staff calculations based on MBSData dataset. The
dataset provides data for the number of units for 31.3 percent of
the loans securitized privately between 2000 and 2012.
---------------------------------------------------------------------------

    Currently, the Enterprises' guarantee is an acceptable form of risk
retention as long as they are in receivership or conservatorship and
meet other conditions. Thus, under current conditions, three-to-four
unit mortgages guaranteed by the Enterprises can be securitized without
having to comply with the risk retention requirements. However, without
the exemption, should the Enterprises in the future no longer be in
receivership or conservatorship, these three-to-four unit mortgages
would be subject to the risk retention requirements even if they
otherwise met the QM criteria. The exemption will allow such mortgages
to continue to be securitized with two unit mortgages, as has been
historical practice, regardless of the legal status of the Enterprises
and provided that all of the loans in the pool meet the QM criteria. In
this way, the exemption will help to facilitate continued access to
capital for borrowers of three-to-four unit mortgages.
    Based on historical data, three-to-four unit residential mortgages
that otherwise satisfy the QM criteria exhibit comparable or lower
delinquency rates as QM two unit residential mortgages. The average
serious delinquency rate \487\

among such three-to-four unit mortgages securitized through private-
label securitizations in 2000-2009 was 36 percent, whereas among two
unit mortgages it was 41 percent. Moreover, the difference in
delinquency rates are not statistically different when controlling for
other factors known to influence delinquency rates like credit score,
loan-to-value ratio, debt-to-income ratio, etc.\488\ These results
indicate that historical three-to-four unit residential mortgage
delinquency rates are no higher than those of two unit residential
mortgages, and thus do not provide any evidence that exempting such
mortgages from risk retention would introduce additional risk into
securitizations that would include such loans. The Commission believes
that this equivalent performance is likely to continue after the
implementation of this exemption because both two unit and three-to-
four unit mortgages would be required to satisfy the same QM
underwriting criteria.
---------------------------------------------------------------------------

    \487\ Serious delinquency (SDQ) is defined as a loan having ever
been 90 days late, foreclosed, or real estate owned.
    \488\ Specifically, DERA staff ran the predictive logit
regression from the White and Bauguess (2013) study (see footnote
446) for privately securitized 2, 3, and 4 unit mortgages in the
MBSData database satisfying QM criteria and originated over the
period 2000-2009. Adding an indicator variable marking three-to-four
unit residential mortgages does not generate a statistically
significant coefficient estimate, and does not improve the
regression's goodness-of-fit measure (pseudo-R-squared).
---------------------------------------------------------------------------

D. OCC Unfunded Mandates Reform Act of 1995 Determination

    Section 202 of the Unfunded Mandates Reform Act of 1995, Public Law
104-4 (UMRA) requires that an agency prepare a budgetary impact
statement before promulgating a rule that includes a Federal mandate
that may result in an expenditure by State, local, and tribal
governments, in the aggregate, or by the private sector, of $100
million or more, adjusted for inflation ($152 million in 2014) in any
one year. If a budgetary impact statement is required, section 205 of
the UMRA also requires an agency to identify and consider a reasonable
number of regulatory alternatives before promulgating a rule.
    The OCC has determined this final rule is likely to result in the
expenditure by the private sector of $152 million or more in any one
year. The OCC has prepared a budgetary impact analysis and identified
and considered alternative approaches, including approaches suggested
by commenters and discussed in the SUPPLEMENTARY INFORMATION section
above. When the final rule is published in the Federal Register, the
full text of the OCC's analysis will be available at: http://www.regulations.gov, Docket ID OCC-2013-0010.

E. FHFA: Considerations of Differences Between the Federal Home Loan
Banks and the Enterprises

    Section 1313 of the Federal Housing Enterprises Financial Safety
and Soundness Act of 1992 requires the Director of FHFA, when
promulgating regulations relating to the Federal Home Loan Banks
(Banks), to consider the following differences between the Banks and
the Enterprises (Fannie Mae and Freddie Mac): cooperative ownership
structure; mission of providing liquidity to members; affordable
housing and community development mission; capital structure; and joint
and several liability.\489\ The Director also may consider any other
differences that are deemed appropriate. In preparing the portions of
this final rule over which FHFA has joint rulemaking authority, the
Director considered the differences between the Banks and the
Enterprises as they relate to the above factors and determined that the
rule was appropriate. No comments were received on the reproposed rule
with respect to this issue.
---------------------------------------------------------------------------

    \489\ See 12 U.S.C. 4513.
---------------------------------------------------------------------------

Text of the Common Rule

(All Agencies)

    The text of the common rule appears below:

PART_--CREDIT RISK RETENTION

Subpart A--Authority, Purpose, Scope and Definitions

Sec.
_.1 [Reserved]
_.2 Definitions.
Subpart B--Credit Risk Retention
_.3 Base risk retention requirement.
_.4 Standard risk retention.
_.5 Revolving pool securitizations.
_.6 Eligible ABCP conduits.
_.7 Commercial mortgage-backed securities.
_.8 Federal National Mortgage Association and Federal Home Loan
Mortgage Corporation ABS.
_.9 Open market CLOs.
_.10 Qualified tender option bonds.
Subpart C--Transfer of Risk Retention
_.11 Allocation of risk retention to an originator.
_.12 Hedging, transfer and financing prohibitions.
Subpart D--Exceptions and Exemptions
_.13 Exemption for qualified residential mortgages.
_.14 Definitions applicable to qualifying commercial loans,
commercial real estate loans, and automobile loans.
_.15 Qualifying commercial loans, commercial real estate loans, and
automobile loans.
_.16 Underwriting standards for qualifying commercial loans.
_.17 Underwriting standards for qualifying CRE loans.
_.18 Underwriting standards for qualifying automobile loans.
_.19 General exemptions.
_.20 Safe harbor for certain foreign-related transactions.
_.21 Additional exemptions.
_.22 Periodic review of the QRM definition, exempted three-to-four
unit residential mortgage loans, and community-focused residential
mortgage exemption.

Subpart A--Authority, Purpose, Scope and Definitions

Sec.  _.1  [Reserved]

Sec.  _.2  Definitions.

    For purposes of this part, the following definitions apply:
    ABS interest means:
    (1) Any type of interest or obligation issued by an issuing entity,
whether or not in certificated form, including a security, obligation,
beneficial interest or residual interest (other than an uncertificated
regular interest in a REMIC that is held by another REMIC, where both
REMICs are part of the same structure and a single REMIC in that
structure issues ABS interests to investors, or a non-economic residual
interest issued by a REMIC), payments on which are primarily dependent
on the cash flows of the collateral owned or held by the issuing
entity; and
    (2) Does not include common or preferred stock, limited liability
interests, partnership interests, trust certificates, or similar
interests that:
    (i) Are issued primarily to evidence ownership of the issuing
entity; and
    (ii) The payments, if any, on which are not primarily dependent on
the cash flows of the collateral held by the issuing entity; and
    (3) Does not include the right to receive payments for services
provided by the holder of such right, including servicing, trustee
services and custodial services.
    Affiliate of, or a person affiliated with, a specified person means
a person that directly, or indirectly through one or more
intermediaries, controls, or is controlled by, or is under common
control with, the person specified.
    Appropriate Federal banking agency has the same meaning as in
section 3 of the Federal Deposit Insurance Act (12 U.S.C. 1813).

    Asset means a self-liquidating financial asset (including but not
limited to a loan, lease, mortgage, or receivable).
    Asset-backed security has the same meaning as in section 3(a)(79)
of the Securities Exchange Act of 1934 (15 U.S.C. 78c(a)(79)).
    Collateral means, with respect to any issuance of ABS interests,
the assets that provide the cash flow and the servicing assets that
support such cash flow for the ABS interests irrespective of the legal
structure of issuance, including security interests in assets or other
property of the issuing entity, fractional undivided property interests
in the assets or other property of the issuing entity, or any other
property interest in or rights to cash flow from such assets and
related servicing assets. Assets or other property collateralize an
issuance of ABS interests if the assets or property serve as collateral
for such issuance.
    Commercial real estate loan has the same meaning as in Sec.  _.14.
    Commission means the Securities and Exchange Commission.
    Control including the terms ``controlling,'' ``controlled by'' and
``under common control with'':
    (1) Means the possession, direct or indirect, of the power to
direct or cause the direction of the management and policies of a
person, whether through the ownership of voting securities, by
contract, or otherwise.
    (2) Without limiting the foregoing, a person shall be considered to
control another person if the first person:
    (i) Owns, controls or holds with power to vote 25 percent or more
of any class of voting securities of the other person; or
    (ii) Controls in any manner the election of a majority of the
directors, trustees or persons performing similar functions of the
other person.
    Credit risk means:
    (1) The risk of loss that could result from the failure of the
borrower in the case of a securitized asset, or the issuing entity in
the case of an ABS interest in the issuing entity, to make required
payments of principal or interest on the asset or ABS interest on a
timely basis;
    (2) The risk of loss that could result from bankruptcy, insolvency,
or a similar proceeding with respect to the borrower or issuing entity,
as appropriate; or
    (3) The effect that significant changes in the underlying credit
quality of the asset or ABS interest may have on the market value of
the asset or ABS interest.
    Creditor has the same meaning as in 15 U.S.C. 1602(g).
    Depositor means:
    (1) The person that receives or purchases and transfers or sells
the securitized assets to the issuing entity;
    (2) The sponsor, in the case of a securitization transaction where
there is not an intermediate transfer of the assets from the sponsor to
the issuing entity; or
    (3) The person that receives or purchases and transfers or sells
the securitized assets to the issuing entity in the case of a
securitization transaction where the person transferring or selling the
securitized assets directly to the issuing entity is itself a trust.
    Eligible horizontal residual interest means, with respect to any
securitization transaction, an ABS interest in the issuing entity:
    (1) That is an interest in a single class or multiple classes in
the issuing entity, provided that each interest meets, individually or
in the aggregate, all of the requirements of this definition;
    (2) With respect to which, on any payment date or allocation date
on which the issuing entity has insufficient funds to satisfy its
obligation to pay all contractual interest or principal due, any
resulting shortfall will reduce amounts payable to the eligible
horizontal residual interest prior to any reduction in the amounts
payable to any other ABS interest, whether through loss allocation,
operation of the priority of payments, or any other governing
contractual provision (until the amount of such ABS interest is reduced
to zero); and
    (3) That, with the exception of any non-economic REMIC residual
interest, has the most subordinated claim to payments of both principal
and interest by the issuing entity.
    Eligible horizontal cash reserve account means an account meeting
the requirements of Sec.  _.4(b).
    Eligible vertical interest means, with respect to any
securitization transaction, a single vertical security or an interest
in each class of ABS interests in the issuing entity issued as part of
the securitization transaction that constitutes the same proportion of
each such class.
    Federal banking agencies means the Office of the Comptroller of the
Currency, the Board of Governors of the Federal Reserve System, and the
Federal Deposit Insurance Corporation.
    GAAP means generally accepted accounting principles as used in the
United States.
    Issuing entity means, with respect to a securitization transaction,
the trust or other entity:
    (1) That owns or holds the pool of assets to be securitized; and
    (2) In whose name the asset-backed securities are issued.
    Majority-owned affiliate of a person means an entity (other than
the issuing entity) that, directly or indirectly, majority controls, is
majority controlled by or is under common majority control with, such
person. For purposes of this definition, majority control means
ownership of more than 50 percent of the equity of an entity, or
ownership of any other controlling financial interest in the entity, as
determined under GAAP.
    Originator means a person who:
    (1) Through an extension of credit or otherwise, creates an asset
that collateralizes an asset-backed security; and
    (2) Sells the asset directly or indirectly to a securitizer or
issuing entity.
    REMIC has the same meaning as in 26 U.S.C. 860D.
    Residential mortgage means:
    (1) A transaction that is a covered transaction as defined in Sec.
1026.43(b) of Regulation Z (12 CFR 1026.43(b)(1));
    (2) Any transaction that is exempt from the definition of ``covered
transaction'' under Sec.  1026.43(a) of Regulation Z (12 CFR
1026.43(a)); and
    (3) Any other loan secured by a residential structure that contains
one to four units, whether or not that structure is attached to real
property, including an individual condominium or cooperative unit and,
if used as a residence, a mobile home or trailer.
    Retaining sponsor means, with respect to a securitization
transaction, the sponsor that has retained or caused to be retained an
economic interest in the credit risk of the securitized assets pursuant
to subpart B of this part.
    Securitization transaction means a transaction involving the offer
and sale of asset-backed securities by an issuing entity.
    Securitized asset means an asset that:
    (1) Is transferred, sold, or conveyed to an issuing entity; and
    (2) Collateralizes the ABS interests issued by the issuing entity.
    Securitizer means, with respect to a securitization transaction,
either:
    (1) The depositor of the asset-backed securities (if the depositor
is not the sponsor); or
    (2) The sponsor of the asset-backed securities.
    Servicer means any person responsible for the management or
collection of the securitized assets or making allocations or
distributions to holders of the ABS interests, but does not include a
trustee for the issuing entity or the asset-backed securities that
makes allocations or distributions to

holders of the ABS interests if the trustee receives such allocations
or distributions from a servicer and the trustee does not otherwise
perform the functions of a servicer.
    Servicing assets means rights or other assets designed to assure
the servicing or timely distribution of proceeds to ABS interest
holders and rights or other assets that are related or incidental to
purchasing or otherwise acquiring and holding the issuing entity's
securitized assets. Servicing assets include amounts received by the
issuing entity as proceeds of securitized assets, including proceeds of
rights or other assets, whether as remittances by obligors or as other
recoveries.
    Single vertical security means, with respect to any securitization
transaction, an ABS interest entitling the sponsor to a specified
percentage of the amounts paid on each class of ABS interests in the
issuing entity (other than such single vertical security).
    Sponsor means a person who organizes and initiates a securitization
transaction by selling or transferring assets, either directly or
indirectly, including through an affiliate, to the issuing entity.
    State has the same meaning as in Section 3(a)(16) of the Securities
Exchange Act of 1934 (15 U.S.C. 78c(a)(16)).
    United States or U.S. means the United States of America, including
its territories and possessions, any State of the United States, and
the District of Columbia.
    Wholly-owned affiliate means a person (other than an issuing
entity) that, directly or indirectly, wholly controls, is wholly
controlled by, or is wholly under common control with, another person.
For purposes of this definition, ``wholly controls'' means ownership of
100 percent of the equity of an entity.

Subpart B--Credit Risk Retention

Sec.  _.3  Base risk retention requirement.

    (a) Base risk retention requirement. Except as otherwise provided
in this part, the sponsor of a securitization transaction (or majority-
owned affiliate of the sponsor) shall retain an economic interest in
the credit risk of the securitized assets in accordance with any one of
Sec. Sec.  _.4 through __.10. Credit risk in securitized assets
required to be retained and held by any person for purposes of
compliance with this part, whether a sponsor, an originator, an
originator-seller, or a third-party purchaser, except as otherwise
provided in this part, may be acquired and held by any of such person's