assets collateralizing the ABCP may consist of a wide range of assets
including auto loans, commercial loans, trade receivables, credit card
receivables, student loans, and other securities. Like other types of
commercial paper, the term of ABCP typically is short, and the
liabilities are ``rolled,'' or refinanced, at regular intervals. Thus,
ABCP conduits generally fund longer-term assets with shorter-term
liabilities.
    As proposed, this risk retention option in Sec.  ----.9 of the
proposed rules would be available only for short-term ABCP
collateralized by receivables or loans and supported by a liquidity
facility that provides 100 percent liquidity coverage from a regulated
institution. This risk retention option would not be available to
entities or ABCP programs that operate as securities or arbitrage
programs.\77\ ABCP conduits that purchase loans or receivables from one
originator or multiple originators are commonly referred to as single-
seller ABCP programs and multi-seller ABCP programs, respectively. In
each of these programs, the sponsor of the ABCP conduit approves the
originators whose loans or receivables will collateralize the ABCP
issued by the conduit. An ``originator-seller'' will sell the eligible
loans or receivables to an intermediate, bankruptcy remote SPV
established by the originator-seller. The credit risk of the
receivables transferred to the intermediate SPV then typically is
separated into two classes--a senior interest that is purchased by the
ABCP conduit and a residual interest that absorbs first losses on the
receivables and is retained by the originator-seller. The residual
interest retained by the originator-seller typically is sized so that
it is sufficiently large to absorb all losses on the underlying
receivables.
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    \77\ Structured investment vehicles (SIVs) and securities
arbitrage ABCP programs both purchase securities (rather than
receivables and loans from originators). SIVs typically lack
liquidity facilities covering all of these liabilities issued by the
SIV, while securities arbitrage ABCP programs typically have such
liquidity support.
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    The ABCP conduit, in turn, issues short-term ABCP that is
collateralized by the senior interests purchased from the intermediate
SPVs (which itself is supported by the subordination provided by the
residual interest retained by the originator-seller). The sponsor of
these types of ABCP conduit, which is usually a bank or other regulated
financial institution, also typically provides (or arranges for another
regulated financial institution to provide) 100 percent liquidity
coverage on the ABCP issued by the conduit. This liquidity support
typically requires the support provider to provide funding to, or
purchase assets from, the ABCP conduit in the event that the conduit
lacks the funds necessary to repay maturing ABCP issued by the conduit.
    The proposal includes several conditions designed to ensure that
this option is available only to the type of single-seller or multi-
seller ABCP conduits described above. For example, this option is
available only with respect to ABCP issued by an ``eligible ABCP
conduit,'' as defined by the proposal. The proposal defines an eligible
ABCP conduit as an issuing entity that issues ABCP and that meets each
of the following criteria.\78\ First, the issuing entity must be
bankruptcy remote or otherwise isolated for insolvency purposes from
the sponsor and any intermediate SPV. Second, the ABS issued by an
intermediate SPV to the issuing entity must be collateralized solely by
assets originated by a single originator-seller.\79\ Third, all the
interests issued by an intermediate SPV must be transferred to one or
more ABCP conduits or retained by the originator-seller. Fourth, a
regulated liquidity provider must have entered into a legally binding
commitment to provide 100 percent liquidity coverage (in the form of a
lending facility, an asset purchase agreement, a repurchase agreement,
or similar arrangement) to all the ABCP issued by the issuing entity by
lending to, or purchasing assets from, the issuing entity in the event
that funds are required to repay maturing ABCP issued by the issuing
entity.\80\
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    \78\ See proposed rules at Sec.  --.2 (definition of ``eligible
ABCP conduit'').
    \79\ Under the proposal, an originator-seller would mean an
entity that creates assets through one or more extensions of credit
and sells those assets (and no other assets) to an intermediate SPV,
which in turn sells interests collateralized by those assets to one
or more ABCP conduits. The proposal defines an intermediate SPV as a
special purpose vehicle that is bankruptcy remote or otherwise
isolated for insolvency purposes that purchases assets from an
originator-seller and that issues interests collateralized by such
assets to one or more ABCP conduits. See proposed rules at Sec.
--.2 (definitions of ``originator-seller'' and ``intermediate
SPV'').
    \80\ The proposal defines a regulated liquidity provider as a
depository institution (as defined in section 3 of the Federal
Deposit Insurance Act (12 U.S.C. 1813)); a bank holding company (as
defined in 12 U.S.C. 1841) or a subsidiary thereof; a savings and
loan holding company (as defined in 12 U.S.C. 1467a) provided all or
substantially all of the holding company's activities are
permissible for a financial holding company under 12 U.S.C. 1843(k)
or a subsidiary thereof; or a foreign bank (or a subsidiary thereof)
whose home country supervisor (as defined in Sec.  211.21 of the
Federal Reserve Board's Regulation K (12 CFR 211.21)) has adopted
capital standards consistent with the Capital Accord of the Basel
Committee on Banking Supervision, as amended, provided the foreign
bank is subject to such standards. See http://www.bis.org/bcbs/index.htm for more information about the Basel Capital Accord.
---------------------------------------------------------------------------

    Under the proposed risk retention option applicable to ABCP conduit
structures, the sponsor of an eligible ABCP conduit would be permitted
to satisfy its base risk retention obligations under the rule if each
originator-seller that transfers assets to collateralize the ABCP
issued by the conduit retains the same amount and type of credit risk
as would be required under the horizontal risk retention option as if
the originator-seller was the sponsor of the intermediate SPV.
Specifically, the proposal provides that a sponsor of an ABCP
securitization transaction would satisfy its base risk retention
requirement with respect to the issuance of ABCP by an eligible ABCP
conduit if each originator-seller retains an eligible horizontal
residual interest in each intermediate SPV established by or on

behalf of that originator-seller for purposes of issuing interests to
the eligible ABCP conduit. The eligible horizontal residual interest
retained by the originator-seller must equal at least five percent of
the par value of all interests issued by the intermediate SPV.
Accordingly, each originator-seller would be required to retain credit
exposure to the receivables sold by that originator-seller to support
issuance of the ABCP.
    The eligible horizontal residual interest retained by the
originator-seller would be subject to the same terms and conditions as
apply under the horizontal risk retention option. Thus, for example, if
an originator-seller transfers $100 of receivables to an intermediate
SPV, which then issues senior interests and an eligible horizontal
residual interest with an aggregate par value of $100, the originator-
seller must retain an eligible horizontal residual interest with a par
value of $5 or more.\81\ Importantly, the originator-seller also would
be prohibited from selling, transferring, and hedging the eligible
horizontal residual interest that it is required to retain. This option
is designed to accommodate the special structure and features of these
types of ABCP programs.
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    \81\ As noted above, this would be the minimum amount of credit
risk that must be retained as part of a securitization transaction.
---------------------------------------------------------------------------

    Although the proposal would allow the originator-sellers (rather
than the sponsor) to retain the required eligible horizontal residual
interest, the proposal also imposes certain obligations directly on the
sponsor in recognition of the key role the sponsor plays in organizing
and operating an eligible ABCP conduit. Most importantly, the proposal
provides that the sponsor of an eligible ABCP conduit that issues ABCP
in reliance on this option would be responsible for compliance with the
requirements of this risk retention option. The proposal also would
require that the sponsor maintain policies and procedures to monitor
the originator-sellers' compliance with the requirements of the
proposal. In the event that the sponsor determines that an originator-
seller no longer complies with the requirements of the rule (for
example, because the originator-seller has sold the interest it was
required to retain), the sponsor would be required to promptly notify,
or cause to be notified, the investors in the securitization
transaction of such noncompliance.
    In addition, consistent with market practice, the proposal would
require that the sponsor:
    (i) Establish the eligible ABCP conduit;
    (ii) Approve the originator-sellers permitted to sell or transfer
assets, indirectly through an intermediate SPV, to the ABCP conduit;
    (iii) Establish criteria governing the assets the originator-
sellers are permitted to sell or transfer to an intermediate SPV;
    (iv) Approve all interests in an intermediate SPV to be purchased
by the eligible ABCP conduit;
    (v) Administer the ABCP conduit by monitoring the interests
acquired by the conduit and the assets collateralizing those interests,
arranging for debt placement, compiling monthly reports, and ensuring
compliance with the conduit documents and with the conduit's credit and
investment policy; and
    (vi) Maintain, and adhere to, policies and procedures for ensuring
that the requirements of the rule have been met.\82\
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    \82\ The sponsor of an ABCP conduit satisfies the definition of
``sponsor'' under the proposed rules. If the conduit does not
satisfy the conditions for an ``eligible ABCP conduit,'' the sponsor
must retain credit risk in accordance with another risk retention
option included in the proposal (unless an exemption for the
transaction exists).
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    The sponsor also would have to provide, or cause to be provided, to
potential purchasers a reasonable period of time prior to the sale of
any ABCP from the conduit, and to the Commission and its appropriate
Federal banking agency, if any, upon request, the name and form of
organization of each originator-seller that will retain (or has
retained) an interest in the securitization transaction pursuant to
Sec.  --.9 of the proposed rules (including a description of the form,
amount, and nature of such interest), and of each regulated liquidity
provider that provides liquidity support to the eligible ABCP conduit
(including a description of the form, amount, and nature of such
liquidity coverage).
    Section 15G permits the Agencies to allow an originator (rather
than a sponsor) to retain the required amount and form of credit risk
and to reduce the amount of risk retention required of the sponsor by
the amount retained by the originator.\83\ In developing the proposed
risk retention option for eligible ABCP conduits, the Agencies have
considered the factors set forth in section 15G(d)(2) of the Exchange
Act.\84\ The terms of the proposed option for eligible ABCP conduits
include conditions designed to ensure that the interests in the
intermediate SPVs sold to an eligible ABCP conduit have low credit
risk, and to ensure that originator-sellers have incentives to monitor
the quality of the assets that are sold to an intermediate SPV and
collateralize the ABCP issued by the conduit. In addition, the proposal
is designed to effectuate the risk retention requirements of section
15G of the Exchange Act in a manner that facilitates reasonable access
to credit by consumers and businesses through the issuance of ABCP
backed by consumer and business receivables. Finally, as noted above,
an originator-seller would be subject to the same restrictions on
transferring the retained eligible horizontal residual interest to a
third party as would apply to sponsors under the rule.
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    \83\ See 15 U.S.C. 78o-11(1)(c)(G)(iv) and (d) (permitting the
Commission and the Federal banking agencies to allow the allocation
of risk retention from a sponsor to an originator).
    \84\ 15 U.S.C. 78o-11(d)(2). These factors are whether the
assets sold to the securitizer have terms, conditions, and
characteristics that reflect low credit risk; whether the form or
volume of transactions in securitization markets creates incentives
for imprudent origination of the type of loan or asset to be sold to
the securitizer; and the potential impact of the risk retention
obligations on the access of consumers and businesses to credit on
reasonable terms, which may not include the transfer of credit risk
to a third party.
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Request for Comment
    59. Is the proposed risk retention option for eligible ABCP
conduits appropriate?
    60(a). Have the Agencies appropriately defined the terms (such as
an eligible ABCP conduit, intermediate SPV and originator-seller) that
govern use of this option? 60(b). Is the foregoing description of ABCP
structures accurate? 60(c) Are there additional ABCP structures that
are not easily adaptable to the risk retention options proposed? 60(d).
If so, should the proposed ABCP option be revised to include these
structures and if so, how?
    61. Should the proposed option for securitizations structured using
ABCP conduits require financial disclosure regarding the liquidity
provider?
    62(a). Also, should other entities be permitted to be liquidity
providers for purposes of the rule? For example, should the rule permit
an insurance company to be an eligible liquidity provider if the
company is in the business of providing credit protection (such as a
bond insurer or re-insurer) and is subject to supervision by a State
insurance regulator or is a foreign insurance company subject to
comparable regulation to that imposed by U.S. insurance companies?
    62(b). Why or why not?

    63. In addition, the Agencies seek confirmation that the terms of
this option effectively prevent structures such as SIVs and ABCP
programs that operate as arbitrage programs from using this option.
    64. Should the rule, as proposed, allow the liquidity provider to
be a depository institution holding company or a subsidiary of a
depository institution instead of just the depository institution?
    65. Are the disclosures proposed sufficient to provide investors
with all material information concerning the originator-seller that
will retain an interest in the securitization transaction and of each
regulated liquidity provider that provides liquidity support to the
eligible ABCP conduit, as well as enable investors and the Agencies to
monitor whether the sponsor has complied with the rule?
    66(a). Should additional disclosures be required? 66(b). If so,
what should be required and why? 66(c). For example, should a sponsor
be required to disclose the material assumptions and methodology used
in determining the aggregate dollar amount of interests issued by each
intermediate SPV? 66(d). Would such a disclosure be beneficial to
investors? 66(e). In light of the broad range of asset classes that
underlie ABCP conduits, would such a disclosure pose any operational or
other challenges for sponsors of ABCP conduits?
    67(a). Should we, as proposed, require that the ABCP be for a term
of 270 days or less? 67(b). Should we allow for a longer term, such as
up to one year?
7. Commercial Mortgage-Backed Securities
    Section 15G(c)(1)(E) of the Exchange Act provides that, with
respect to securitizations involving commercial mortgages, the
regulations prescribed by the Agencies may provide for ``retention of
the first-loss position by a third-party purchaser that specifically
negotiates for the purchase of such first loss position, holds adequate
financial resources to back losses, provides due diligence on all
individual assets in the pool before the issuance of the asset-backed
securities, and meets the same standards for risk retention as the
Federal banking agencies and the Commission require of the
securitizer[.]'' \85\ In light of this provision, the Agencies are
proposing to permit a sponsor of ABS that is collateralized by
commercial real estate loans to meet its risk retention requirements if
a third-party purchaser acquires an eligible horizontal residual
interest in the issuing entity in the same form, amount, and manner as
the sponsor would have been required to retain under the horizontal
risk retention option and certain additional conditions are met.
---------------------------------------------------------------------------

    \85\ 15 U.S.C. 78o-11(c)(1)(E)(iv).
---------------------------------------------------------------------------

    The allocation of a first-loss position to a third-party purchaser
has been common practice in CMBS transactions for a number of
years.\86\ The third-party purchaser has been commonly referred to in
the CMBS marketplace as a ``B-piece buyer'' \87\ because the CMBS
tranche or tranches purchased by this investor were either unrated by
the credit rating agencies or assigned a below-investment grade credit
rating. Typically a B-piece buyer purchases at a discount to face value
the most subordinate tranche in the cash flow waterfall of the CMBS
transaction. In order to manage its risk, the B-piece buyer often is
involved early in the securitization process and has significant
influence over the selection of pool assets. For example, the B-piece
buyer often performs ``due diligence'' on the pool assets, which often
means a review of the loans in the pool at the property and loan level.
As a result of this review, a B-piece buyer may request that specific
loans be removed from the pool prior to securitization.
---------------------------------------------------------------------------

    \86\ See, e.g., Board Report.
    \87\ We note that under the proposal there is no requirement
that the tranche or tranches purchased by the third-party purchaser
be assigned any particular credit rating.
---------------------------------------------------------------------------

    Additionally, a B-piece buyer is often designated as the
``controlling class'' under the terms of the pooling and servicing
agreement governing the CMBS transaction, and in accordance with its
rights as the controlling class, a B-piece buyer often names itself, or
an affiliated company, as the ``special servicer'' in the transaction.
Such servicer typically is the servicer authorized to service loans in
default or having other non-payment issues. The control of special
servicing rights by the B-piece buyer has the potential to create
conflicts of interest with the senior certificate holders to the
securitization. For example, the control of special servicing rights
would allow the B-piece buyer to directly or indirectly manage any loan
modifications. While some CMBS transactions required an ``operating
advisor'' to oversee the servicing activities of the special servicer,
in many instances this operating advisor works on behalf of the
controlling class (i.e., the B-piece buyer unless and until losses
reduced its junior tranche to zero). To help better address the
potential conflict created by special servicer arrangements involving
B-piece buyers, newly issued CMBS for which investors received
financing through the Term-Asset Backed Securities Lending Facility
(``TALF'') were required to have an independent operating advisor that
acted on behalf of the investors as a collective whole, had
consultative rights over major decisions of the special servicer, and
had the ability to recommend replacement of the special servicer.\88\
These operating advisor requirements also were coupled with enhanced
disclosures to investors regarding major decisions by the B-piece buyer
and special servicer. Aspects of these TALF requirements have been
incorporated into recent CMBS transactions undertaken after the closing
of the TALF to new financings.
---------------------------------------------------------------------------

    \88\ The TALF was a special lending facility established by the
Federal Reserve and the Treasury Department in response to the
financial crisis to assist the financial markets in accommodating
the credit needs of consumers and businesses of all sizes by
facilitating the issuance of ABS collateralized by a variety of
consumer and business loans. The TALF also was intended to improve
the market conditions for ABS more generally. Additional information
concerning the TALF is available on the public Web sites of the
Board (see http://www.federalreserve.gov/monetarypolicy/bst_lendingother.htm ) and the Federal Reserve Bank of New York (see
http://www.newyorkfed.org/markets/talf.html).
---------------------------------------------------------------------------

    In light of the specific provisions of Section 15G(c)(1)(E) and the
historical market practice of third-party purchasers acquiring first-
loss positions in CMBS transactions, the Agencies' proposal would allow
a sponsor to meet its risk retention requirements under the rule if a
third-party purchaser retains the necessary exposure to the credit risk
of the underlying assets provided six conditions are met. These
conditions are designed to help ensure that the form, amount, and
manner of the third-party purchaser's risk retention are consistent
with the purposes of section 15G of the Exchange Act. This option would
be available only for securitization transactions where commercial real
estate loans constitute at least 95 percent of the unpaid principal
balance of the assets being securitized.\89\
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    \89\ See proposed rules at Sec.  --.10(a). ``Commercial real
estate loan'' is defined in Sec.  --.16 of the proposed rules to
mean a loan secured by a property with five or more single family
units, or by nonfarm nonresidential real property, the primary
source (fifty (50) percent or more) of repayment for which is
expected to be derived from the proceeds of the sale, refinancing,
or permanent financing of the property; or rental income associated
with the property other than rental income derived from any
affiliate of the borrower. A commercial real estate loan does not
include a land development and construction loan (including 1- to 4-
family residential or commercial construction loans); any other land
loan; a loan to a real estate investment trust (REIT); or an
unsecured loan to a developer.
---------------------------------------------------------------------------

    The first condition requires that the third-party purchaser retain
an eligible

horizontal residual interest in the securitization in the same form,
amount, and manner as would be required of the sponsor under the
horizontal risk retention option (proposed Sec.  --.5).\90\
Accordingly, the interest acquired by the third-party purchaser must be
the most junior interest in the issuing entity, and must be subject to
the same limits on payments as would apply if the eligible horizontal
residual interest were held by the sponsor pursuant to the horizontal
risk retention option.
---------------------------------------------------------------------------

    \90\ See proposed rules at Sec.  --.10.
---------------------------------------------------------------------------

    The second condition would require that the third-party purchaser
pay for the first-loss subordinated interest in cash at the closing of
the securitization without financing being provided, directly or
indirectly, from any other person that is a party to the securitization
transaction (including, but not limited to, the sponsor, depositor, or
an unaffiliated servicer), other than a person that is a party solely
by reason of being an investor.\91\ This would prohibit the third-party
purchaser or an affiliate of the third-party purchase from obtaining
financing from any such person as well as from any affiliate of any
such person. These requirements should help ensure that the third-party
purchaser has sufficient financial resources to fund the acquisition of
the first-loss subordinated interest and absorb losses on the
underlying assets to which it would be exposed through this
interest.\92\
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    \91\ See proposed rules at Sec.  --.10.
    \92\ This requirement is consistent with section
15G(b)(1)(E)(ii) of the Exchange Act, which provides that the
Agencies may consider whether a third-party purchaser of CMBS
``holds adequate financial resources to back losses.''
---------------------------------------------------------------------------

    The third condition relates to the third-party purchaser's review
of the assets collateralizing the ABS. This proposed condition would
require that the third-party purchaser perform a review of the credit
risk of each asset in the pool prior to the sale of the asset-backed
securities. This review must include, at a minimum, a review of the
underwriting standards, collateral, and expected cash flows of each
commercial loan in the pool.
    The fourth condition is intended to address the potential conflicts
of interest that can arise when a third-party purchaser serves as the
``controlling class'' of a CMBS transaction. This condition would
prohibit a third-party purchaser from (i) being affiliated with any
other party to the securitization transaction (other than investors);
or (ii) having control rights in the securitization (including, but not
limited to acting as servicer or special servicer) that are not
collectively shared by all other investors in the securitization. The
proposed prohibition of control rights related to servicing, would be
subject to an exception, however, if the underlying securitization
transaction documents provide for the appointment of an independent
operating advisor (Operating Advisor) with certain powers and
responsibilities.\93\ Under the proposal, an ``Operating Advisor''
would be defined as a party that (i) is not affiliated with any other
party to the securitization, (ii) does not directly or indirectly have
any financial interest in the securitization other than in fees from
its role as Operating Advisor, and (iii) is required to act in the best
interest of, and for the benefit of, investors as a collective whole.
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    \93\ See proposed rules at Sec.  --.10(a)(4)(i). The proposal
also includes a de minimis exception to the general prohibition on
affiliation with other parties to the securitization transaction.
Under this de minimis exception, the third-party purchaser would be
permitted to be affiliated with one or more originators of the
securitized assets so long as the assets contributed by such
originator(s) collectively comprise less than 10 percent of the
assets in the pool (as measured by dollar volume). See proposed
rules at Sec.  --.10(a)(4)(ii).
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    The Agencies believe that the introduction of an independent
Operating Advisor would minimize the ability of third-party purchasers
to manipulate cash flows through special servicing. In approving loans
for inclusion in the securitization, the third-party purchaser will be
mindful of the limits on its ability to offset the consequences of poor
underwriting through servicing tactics if a loan becomes troubled,
thereby providing stronger incentive for the third-party purchaser to
be diligent in assessing credit quality of the pool assets at the time
of securitization. For these types of securitization transactions, the
third-party purchaser's review of each loan can serve as an effective
check on the underwriting quality and credit risk of the underlying
loans and the reliability of key information utilized.
    Further, in order for a third-party purchaser to have servicing
rights in connection with the securitization transaction, the
securitization transaction documents must require that the Operating
Advisor have certain powers and responsibilities in order to ensure
that the Operating Advisor can effectively fulfill its advisory role in
the transaction.\94\ For example, as proposed, the transaction
documents must require that, if the third-party purchaser or an
affiliate acts as servicer, the servicer consult with the Operating
Advisor in connection with, and prior to, any major decision in
connection with the servicing of the securitized assets. Major
decisions would include, without limitation, any material modification
of, or waiver with respect to, any provision of a loan agreement, any
foreclosure upon or comparable conversion of the ownership of a
property, and any acquisition of a property.
---------------------------------------------------------------------------

    \94\ See proposed rules at Sec.  --.10(a)(4)(B)-(E).
---------------------------------------------------------------------------

    The securitization transaction documents must also provide that the
Operating Advisor is responsible for reviewing the actions of any
servicer that is, or is, affiliated with the third-party purchaser and
for issuing a report to investors and the issuing entity, on a periodic
basis, concerning whether the Operating Advisor believes, in its sole
discretion exercised in good faith, the servicer is in compliance with
any standards required of the servicer as provided in the applicable
transaction documents, and if not, the standard(s) with which the
servicer is out of compliance. In addition, the securitization
transaction documents must also provide that the Operating Advisor has
the authority to recommend that a servicer that is, or is affiliated
with, the third-party purchaser be replaced by a successor servicer if
the Operating Advisor determines, in its sole discretion exercised in
good faith, that the servicer has failed to comply with any standard
required of the servicer as provided in the applicable transaction
documents and that such replacement would be in the best interest of
the investors as a collective whole. The relevant transaction documents
must provide that, if such a recommendation is made, the servicer that
is, or affiliated with, the third-party purchaser must be replaced
unless a majority of each class of certificate holders eligible to vote
on the matter votes to retain the servicer.
    Consistent with other disclosure requirements under the proposed
rules, the fifth proposed condition requires that the sponsor provide,
or cause to be provided, potential purchasers certain information
concerning the third-party purchaser and other information concerning
the transaction. Specifically, the proposal would require that a
sponsor disclose to potential investors a reasonable time before the
sale of asset-backed securities and, upon request, to the Commission
and its appropriate Federal banking agency (if any) the name and form
of organization of the third-party purchaser, a description of the
third-party purchaser's experience in investing in CMBS, and any other
information regarding the third-party purchaser or the third-party
purchaser's retention of the eligible horizontal residual interest that
is material to

investors in light of the circumstances of the particular
securitization transaction.
    Additionally, a sponsor would be required to disclose the amount of
the eligible horizontal residual interest that the third-party
purchaser will retain (or has retained) in the transaction (expressed
as a percentage of ABS interests in the issuing entity and as a dollar
amount); the purchase price paid for such interest; the material terms
of such interest; and the amount of the interest that the sponsor would
have been required to retain if the sponsor had retained an interest in
the transaction pursuant to the horizontal menu option. The material
assumptions and methodology used in determining the aggregate amount of
ABS interests of the issuing entity, including any estimated cash flows
and the discount rate used, also must be included in the disclosure.
The proposed rules would require that the sponsor provide, or cause to
be provided, to potential investors the representations and warranties
concerning the securitized assets, the schedule of any securitized
assets that are determined not to comply with such representations and
warranties, and what factors were used to make the determination that a
securitized asset should be included in the pool notwithstanding that
it did not comply with such representations and warranties, such as
compensating factors or a determination that the exceptions(s) were not
material.
    Finally, the sixth condition would require that any third-party
purchaser acquiring an eligible horizontal residual interest under this
option comply with the hedging, transfer and other restrictions
applicable to such interest under the proposed rules if the third-party
purchaser was a sponsor who had acquired the interest under the
horizontal risk retention option.
    Although the third-party purchaser may retain the credit risk
required under Sec.  --.3 of the proposed rules, the proposal provides
that the sponsor remains responsible for compliance with the
requirements described above. Therefore, consistent with the menu
option available to eligible ABCP conduits, the proposal would require
that the sponsor maintain and adhere to policies and procedures to
monitor the third-party purchaser's compliance with these requirements.
In the event that the sponsor determines that the third-party purchaser
no longer complies with the requirements of the rule (for example,
because the third-party purchaser has sold the interest it was required
to retain), the sponsor must promptly notify the investors in the
securitization transaction of such noncompliance.
Request for Comment
    68(a). Should the rules allow a third-party purchaser to retain the
required amount of risk in a CMBS transaction as described above?
    68(b). Why or why not?
    69(a). Should a third-party purchaser option be available to other
asset classes besides CMBS? Would expanding this option to other asset
classes fulfill the purposes of section 15G? 69(b). If so, would any
adjustments or requirements be necessary?
    70. Should the use of this option be conditioned, as proposed, on a
requirement that the third-party purchaser separately examine the
assets in the pool and/or not sell or hedge the interest it is required
to retain?
    71(a). Should the use of this option be conditioned, as proposed,
on the requirement that the sponsor disclose the actual purchase price
paid by the third-party purchaser for the eligible horizontal residual
interest? 71(b). Why or why not?
    72. Is any disclosure concerning the financial resources of the
third-party purchaser necessary in light of the requirement that the
third-party purchaser fund the acquisition of the eligible horizontal
residual interest in cash without direct or indirect financing from a
party to the transaction?
    73(a). Should the rule specify the particular types of information
about a third-party purchaser that should be disclosed, rather than
requiring disclosure of any other information regarding the third-party
purchaser that is material to investors in light of the circumstances
of the particular securitization transaction? 73(b). Should the
specific types of information about a third-party purchaser be in
addition to any other information regarding the third-party purchaser
that is material to investors in light of the circumstances of the
particular securitization transaction?
    74. Are the conditions relating to servicing, including those
related to an Operating Advisor, appropriate or should they be modified
or supplemented?
    75(a). Should the Agencies require any other disclosure relating to
representations and warranties concerning the assets for CMBS?
    76(a). We are aware of at least one industry group developing model
representations and warranties for CMBS.\95\ Should the rule require
that a blackline of the representations and warranties for the
securitization transaction against an industry-accepted standard for
model representations and warranties be provided to investors at a
reasonable time prior to sale? 76(b). Would this provide more
information regarding the adequacy of the representation and warranties
being provided? 76(c). Would this be a costly requirement? 76(d). Could
investors easily create their own blacklines if needed?
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    \95\ See, e.g., comment letter to the Commission from CRE
Finance Council dated January 19, 2011, available at http://www.sec.gov/comments/df-title-ix/asset-backed-securities/assetbackedsecurities-37.pdf.
---------------------------------------------------------------------------

    77. Are the disclosures proposed sufficient to provide investors
with all material information concerning the third-party purchaser's
retained interest in the securitization transaction, as well as to
enable investors and the Agencies to monitor whether the sponsor has
complied with the rule?
    78(a). Should additional disclosures be required? 78(b). If so,
what should be required and why?
8. Treatment of Government-Sponsored Enterprises
    Section --.11 of the proposed rules would govern the credit risk
retention requirements for the Federal National Mortgage Association
(Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie
Mac) (jointly, the ``Enterprises'') while operating under the
conservatorship or receivership of FHFA, as well as for any limited-
life regulated entity succeeding to the charter of either Fannie Mae or
Freddie Mac pursuant to section 1367 of the Federal Housing Enterprises
Financial Safety and Soundness Act of 1992 (Safety and Soundness
Act).\96\ The primary business of the Enterprises under their
respective charter acts is to pool conventional mortgage loans and to
issue securities backed by these mortgages that are fully guaranteed as
to the timely payment of principal and interest by the issuing
Enterprise.\97\ Because of these activities, Fannie Mae or Freddie Mac
(or a successor limited-life regulated entity) would be the sponsor of
the asset-backed securities that it issues for purposes of section 15G.
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    \96\ 12 U.S.C. 4617.
    \97\ See 12 U.S.C. 1451, et seq. (Freddie Mac); 12 U.S.C. 1716,
et seq. (Fannie Mae).
---------------------------------------------------------------------------

    In considering how to address in the proposal the risk retention
requirements of section 15G with respect to the mortgage-backed
securities issued, and fully guaranteed as to timely payment of
principal and interest, by the Enterprises or a successor limited-life
regulated entity, the Agencies considered several factors. Because
Fannie Mae and Freddie Mac fully guarantee the timely payment of

principal and interest on the mortgage-backed securities they issue,
the Enterprises are exposed to the entire credit risk of the mortgages
that collateralize those securities.\98\
---------------------------------------------------------------------------

    \98\ The charters of Fannie Mae and Freddie Mac also place
limitations on the types of mortgages that the Enterprises may
guarantee and securitize.
---------------------------------------------------------------------------

    Both Fannie Mae and Freddie Mac have been operating under the
conservatorship of FHFA since September 6, 2008. As conservator, FHFA
has assumed all powers formerly held by each Enterprise's officers,
directors, and shareholders. In addition, FHFA, as conservator, is
authorized to take such actions as may be necessary to restore each
Enterprise to a sound and solvent condition and that are appropriate to
preserve and conserve the assets and property of each Enterprise.\99\
The primary goals of the conservatorships are to help restore
confidence in the Enterprises, enhance their capacity to fulfill their
mission, mitigate the systemic risk that contributed directly to
instability in financial markets, and maintain the Enterprises'
secondary mortgage market role until their future is determined through
legislation. To these ends, FHFA's conservatorship of the Enterprises
is directed toward minimizing losses, limiting risk exposure, and
ensuring that the Enterprises price their services to adequately
address their costs and risk. Any limited-life regulated entity
established by FHFA to succeed to the charter of an Enterprise also
would operate under the direction and control of FHFA, acting as
receiver of the related Enterprise.\100\
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    \99\ See 12 U.S.C. 4617(b)(2)(D).
    \100\ See 12 U.S.C. 4617(i). The affairs of a limited-life
regulated entity must be wound up not later than two years after its
establishment, subject to the potential for a maximum of three one-
year extensions at the discretion of the Director of FHFA.
---------------------------------------------------------------------------

    Concurrently with being placed in conservatorship under section
1367 of the Safety and Soundness Act, each Enterprise entered into a
Senior Preferred Stock Purchase Agreement (PSPA) with the United States
Department of the Treasury (Treasury). Under each PSPA, Treasury
purchased senior preferred stock of each Enterprise. In addition, if
FHFA determines that the Enterprise's liabilities have exceeded its
assets under generally accepted accounting principles (GAAP), Treasury
will contribute cash capital to that Enterprise in an amount equal to
the difference between its liabilities and assets. In exchange for this
cash contribution, the liquidation preference of the senior preferred
stock purchased from each Enterprise under the respective PSPA
increases in an equivalent amount. The senior preferred stock of each
Enterprise purchased by Treasury is senior to all other preferred
stock, common stock or other capital stock issued by the Enterprise,
and dividends on the aggregate liquidation preference of the senior
preferred stock purchased by Treasury are payable at a rate of 10
percent per annum.\101\ Under each PSPA, Treasury's commitment to each
Enterprise is the greater of (1) $200 billion, or (2) $200 billion plus
the cumulative amount of the Enterprise's net worth deficit as of the
end of any calendar quarter in 2010, 2011 and 2012, less any positive
net worth as of December 31, 2012.\102\ Accordingly, the PSPAs provide
support to the relevant Enterprise should the Enterprise have a net
worth deficit as a result of the Enterprise's guaranty of timely
payment on the asset-backed securities it issues. By their terms, the
PSPA with an Enterprise may not be assigned or transferred, or inure to
the benefit of, any limited-life regulated entity established with
respect to the Enterprise without the prior written consent of
Treasury.
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    \101\ Under the PSPAs, the rate rises to 12 percent per annum if
the dividends are not paid in cash.
    \102\ The PSPAs also provide for the retained portfolios of each
Enterprise to be reduced over time.
---------------------------------------------------------------------------

    In light of the foregoing, Sec.  --.11 of the proposed rules
provides that the guaranty provided by an Enterprise while operating
under the conservatorship or receivership of FHFA with capital support
from the United States will satisfy the risk retention requirements of
the Enterprise under section 15G of the Exchange Act with respect to
the mortgage-backed securities issued by the Enterprise. Similarly, an
equivalent guaranty provided by a limited-life regulated entity that
has succeeded to the charter of an Enterprise, and that is operating
under the direction and control of FHFA under section 1367(i) of the
Safety and Soundness Act, will satisfy the risk retention requirements,
provided that the entity is operating with capital support from the
United States. If either Enterprise or a successor limited-life
regulated entity were to begin to operate other than as provided in the
proposed rules, that Enterprise or entity would no longer be able to
avail itself of the credit risk retention option set forth in Sec.
--.11.
    For similar reasons, the proposed rules provide that the premium
capture cash reserve account requirements in Sec.  --.12, as well as
the hedging and financing prohibitions in Sec.  --.14(b), (c), and (d),
of the proposed rules shall not apply to an Enterprise while operating
under the conservatorship or receivership of FHFA with capital support
from the United States, or to a limited-life regulated entity that has
succeeded to the charter of an Enterprise and that is operating under
the direction and control of FHFA with capital support from the United
States. In the past, the Enterprises have sometimes acquired pool
insurance to cover a percentage of losses on the mortgage loans
comprising the pool.\103\ Because Sec.  --.11 requires each Enterprise,
while in conservatorship or receivership, to hold 100 percent of the
credit risk on MBS that it issues, the prohibition on hedging related
to the credit risk that the retaining sponsor is required to retain
would limit the ability of the Enterprises to require such pool
insurance in the future. Because the exception would continue only so
long as the relevant Enterprise operates under the control of FHFA and
with capital support from the United States, the proposed exception
from these restrictions should be consistent with the maintenance of
quality underwriting standards, in the public interest, and consistent
with the protection of investors.
---------------------------------------------------------------------------

    \103\ Typically, insurers would pay the first losses on a pool
of loans, up to one or two percent of the aggregate unpaid principal
balance of the pool.
---------------------------------------------------------------------------

    A sponsor utilizing this section shall provide to investors, in
written form under the caption ``Credit Risk Retention'' and, upon
request, to FHFA and the Commission, a description of the manner in
which it has met the credit risk retention requirement of this part.
    The Agencies recognize both the need for, and importance of, reform
of the Enterprises. In recent months, the Administration and Congress
have been considering a variety of proposals to reform the housing
finance system and the Enterprises. The Agencies expect to revisit and,
if appropriate modify Sec.  --.11 of the proposed rules after the
future of the Enterprises and of the statutory and regulatory framework
for the Enterprises becomes clearer.
Request for Comment
    79. Is our proposal regarding the treatment of the Enterprises
appropriate?
    80. Would applying the hedging prohibition to all of the credit
risk that the Enterprises are required to retain when using Sec.  --.11
to satisfy the risk retention requirements be an unduly burdensome
result for the Enterprises?

    81(a). Instead of the broad exception from the hedging prohibition
for the Enterprises, when satisfying the risk retention requirements
pursuant to Sec.  --.11, should the rules prohibit an Enterprise from
hedging five percent of the total credit risk in any securitization
transaction where the Enterprise acts as a sponsor (thus ensuring the
Enterprise retains at least that amount of exposure to the credit risk
of the assets)? 81(b). Would this be consistent with statutory intent?
81(c). Would that be feasible for the Enterprises to monitor?
9. Premium Capture Cash Reserve Account
    In many securitization transactions, particularly those involving
residential and commercial mortgages, conducted prior to the financial
crisis, sponsors sold premium or interest-only tranches in the issuing
entity to investors, as well as more traditional obligations that paid
both principal and interest received on the underlying assets. By
selling premium or interest-only tranches, sponsors could thereby
monetize at the inception of a securitization transaction the ``excess
spread'' that was expected to be generated by the securitized assets
over time. By monetizing excess spread before the performance of the
securitized assets could be observed and unexpected losses realized,
sponsors were able to reduce the impact of any economic interest they
may have retained in the outcome of the transaction and in the credit
quality of the assets they securitized. This created incentives to
maximize securitization scale and complexity, and encouraged aggressive
underwriting.
    In order to achieve the goals of risk retention, the Agencies
propose to adjust the required amount of risk retention to account for
any excess spread that is monetized at the closing of a securitization
transaction. Otherwise, a sponsor could effectively negate or reduce
the economic exposure it is required to retain under the proposed
rules. Furthermore, prohibiting sponsors from receiving compensation in
advance for excess spread income expected to be generated by
securitized assets over time should better align the interests of
sponsors and investors and promote more robust monitoring by the
sponsor of the credit risk of securitized assets, thereby encouraging
the use of sound underwriting in connection with securitized loans. It
also should promote simpler and more coherent securitization structures
as sponsors would receive excess spread over time and would not be able
to reduce the economic exposure they are required to retain.
    Accordingly, as proposed, if a sponsor structures a securitization
to monetize excess spread on the underlying assets--which is typically
effected through the sale of interest-only tranches or premium bonds--
the proposed rule would ``capture'' the premium or purchase price
received on the sale of the tranches that monetize the excess spread
and require that the sponsor place such amounts into a separate
``premium capture cash reserve account.'' \104\ The amount placed into
the premium capture cash reserve account would be separate from and in
addition to the sponsor's base risk retention requirement under the
proposal's menu of options, and would be used to cover losses on the
underlying assets before such losses were allocated to any other
interest or account. As a likely consequence to this proposed
requirements, the Agencies expect that few, if any, securitizations
would be structured to monetize excess spread at closing and, thus,
require the establishment of a premium capture cash reserve account,
which should provide the benefits described above.
---------------------------------------------------------------------------

    \104\ See proposed rules at Sec.  --.12.
---------------------------------------------------------------------------

    Specifically, the proposal would require that a sponsor retaining
credit risk under the vertical, horizontal, L-shaped, or revolving
asset master trust options of the proposed rules establish and fund (in
cash) at closing a premium capture cash reserve account in an amount
equal to the difference (if a positive amount) between (i) the gross
proceeds received by the issuing entity from the sale of ABS interests
in the issuing entity to persons other than the sponsor (net of closing
costs paid by a sponsor or the issuing entity to unaffiliated parties);
and (ii) 95 percent of the par value of all ABS interests in the
issuing entity issued as part of the transaction. The 95 percent of par
value amount is designed to take into account the five percent interest
that the sponsor is required to retain in the issuing entity under each
of these options.
    If the sponsor will retain (or caused to be retained) credit risk
under the representative sample, ABCP, or CMBS third-party purchaser
options of the proposed rules, the sponsor would have to fund in cash
at closing a premium capture cash reserve account in an amount equal to
the difference (if a positive amount) between (i) the gross proceeds
received by the issuing entity from the sale of ABS interests to
persons other than the sponsor (net of the closing costs described
above), and (ii) 100 percent of the par value of the ABS interests in
the issuing entity issued as part of the transaction. In these cases,
the proposal uses 100 percent (rather than 95 percent) of the par value
of the ABS interests issued because the relevant menu options do not
require that the sponsor itself retain any of the ABS interests issued
in the transaction and, accordingly, potentially all of such interests
could be sold to third parties.
    Under the proposed rules, a premium capture cash reserve account
would have to be established and funded whenever a positive amount
resulted from the relevant calculation described in the preceding
paragraphs. These calculations are designed to capture the amount of
excess spread that a sponsor may seek to immediately monetize at
closing such as through the issuance of an interest-only tranche (which
may have a nominal value assigned to it, but does not have a par value)
or premium bonds that are sold for amounts in excess of their par
value. On the other hand, the proposal would not require a sponsor to
establish and fund a premium capture cash reserve account if the
sponsor does not structure the securitization to immediately monetize
excess spread, thus resulting in no ``premium'' that would be captured
by the calculations described above. Accordingly, existing types of
securitization structures that do not monetize excess spread at closing
would not trigger establishment of a premium capture reserve account.
Going forward, sponsors would have the ability to structure their
securitization transactions in a manner that does not monetize excess
spread at closing and would not require the establishment of such a
premium capture cash reserve account.
    The proposed rules include a number of conditions and limitations
on a premium capture cash reserve account. Specifically, the proposed
rules would require that the premium capture cash reserve account be
held by the trustee, or person performing functions similar to a
trustee, in the name and for the benefit of the issuing entity. In
addition, until all ABS interests in the issuing entity (including
junior or residual interests) are paid in full or the issuing entity is
dissolved, amounts in the account would be required to be released to
satisfy payments on ABS interests in the issuing entity (in order of
the securitization transaction's priority of payments) on any payment
date where the issuing entity has insufficient funds to make such
payments. The proposal specifies that, the determination of whether
insufficient funds are available must be made prior to the allocation
of any

losses to (i) any eligible horizontal residual interest held under the
horizontal, L-shaped, ABCP, or CMBS third-party purchaser risk
retention options; or (ii) the class of ABS interests in the issuing
entity that is allocated losses before other classes if no eligible
horizontal residual interest in the issuing entity is held under such
options (or if the contractual terms of the securitization transaction
do not provide for the allocation of losses by class, the class of ABS
interests that has the most subordinate claim to payment of principal
or interest by the issuing entity). Thus, amounts in a premium capture
reserve account would be used to cover losses on the underlying assets
first before any other interest in or account of the issuing entity,
including an eligible horizontal residual interest or a horizontal cash
reserve account.\105\
---------------------------------------------------------------------------

    \105\ Until needed to cover losses, amounts in a premium capture
cash reserve account may be invested in U.S. Treasury securities
with remaining maturities of 1 year or less and in fully-insured
deposits at one or more insured depository institutions. Interest
received on such investments could be released from the account to
any person (including the sponsor), but the principal amount
invested must remain in the account and available to absorb losses.
---------------------------------------------------------------------------

    In order to prevent a sponsor from circumventing the premium
capture requirements of the proposal by taking back at closing, and
then reselling, additional ABS interests (thereby reducing the gross
proceeds received at closing from the sale of interests to third
parties), the proposal includes a special anti-evasion provision. Under
this provision, the retaining sponsor would need to add to the ``gross
proceeds'' amount that is used to calculate the amount (if any) that
must be placed in the premium capture cash reserve account an amount
equal to the par value of any ABS interest (or the fair value of the
ABS interest if it does not have a par value) in the issuing entity
that is directly or indirectly transferred to the sponsor in connection
with the closing of the securitization transaction and that (i) the
sponsor does not intend to hold to maturity; or (ii) represents a
contractual right to receive some or all of the interest, and no more
than a minimal amount of principal payments received by the issuing
entity, and that has a priority of payment of interest (or principal,
if any) senior to the most subordinated class of interests in the
issuing entity. The condition in (i) above is designed to capture
proceeds from those interests that the sponsor retains at closing, but
expects to sell to third parties after closing. ABS interests retained
and expected to be held to maturity by the sponsor increase the
sponsor's exposure to the credit risk of the underlying assets, thus
mitigating the concerns of a sponsor trying to evade the risk retention
requirements.
    A sponsor could, however, seek to achieve the same economic
benefits that could be achieved from the sale of an interest-only
tranche by retaining an interest-only tranche at or near the top of the
waterfall that diverts to the sponsor excess spread on the underlying
assets before other interests are paid. For this reason, the proposal
requires that the value of any interest-only tranche that the sponsor
retains at closing be included in the calculation of the premium
capture reserve account (regardless of whether the sponsor intends to
hold it to maturity) if such tranche has priority of payment senior to
the most subordinated class of interests in the issuing entity.\106\
---------------------------------------------------------------------------

    \106\ To avoid double counting, the calculation would not
include any interest-only tranche required to be retained by a
sponsor using the vertical or L-shaped options to meet its risk
retention requirement. Also, because an eligible horizontal residual
interest, by definition, must have the most subordinated claim to
payments of both principal and interest, a sponsor selecting this
option of risk retention would be required to include the value of
any excess spread tranche retained by the sponsor in its calculation
of gross proceeds received by the issuing entity.
---------------------------------------------------------------------------

    Sponsors required to fund a premium capture cash reserve account
under the proposed rules would be required to provide potential
investors before the sale of asset-backed securities as part of the
securitization transaction and, upon request, the Commission and its
appropriate Federal banking agency (if any) disclosures describing the
dollar amount the sponsor was required to place in the account and the
actual amount the sponsor will deposit (or has deposited) in the
account at closing. The sponsor would also be required to disclose the
material assumptions and methodology used in (i) determining the fair
value of any ABS interest in the issuing entity that does not have a
par value (and that was used in calculating the amount required for the
premium capture cash reserve account) and is subject to the anti-
evasion provisions described above; and (ii) the aggregate amount of
ABS interests in the issuing entity, including those pertaining to any
estimated cash flows and the discount rate used.
Request for Comment
    82. Do you believe the premium capture cash reserve account will be
an effective mechanism at capturing the monetization of excess spread,
promoting sponsor monitoring of credit quality, and promoting the sound
underwriting of securitized assets?
    83. The Agencies seek input on alternative methods for removing
incentives to monetize excess spread and whether the proposed premium
capture reserve account would have any adverse effects on
securitizations that are inconsistent with the purposes of section 15G.
For example, is the method of calculating the premium capture cash
reserve account appropriate or are there alternative methodologies that
would better achieve the purpose of the account?
    84. Should amounts from the premium capture reserve account be used
only for amounts due to the senior-most class of ABS interests?
    85(a). Alternatively, are the conditions imposed on the premium
capture cash reserve account more than what is needed to achieve the
objectives of the account? 85(b). If so, how?

C. Allocation to the Originator

    As a general matter, the proposed rules would provide that the
sponsor of a securitization transaction is solely responsible for
complying with the risk retention requirements established under
section 15G of the Exchange Act. However, subject to a number of
considerations, section 15G authorizes the Agencies to allow a sponsor
to allocate at least a portion of the credit risk it is required to
retain to the originator(s) of securitized assets.\107\ Accordingly,
subject to conditions and restrictions discussed below, Sec.  --.13 of
the proposed rules permits a sponsor to reduce its required risk
retention obligations in a securitization transaction by the portion of
risk retention obligations assumed by the originator(s) of the
securitized assets.
---------------------------------------------------------------------------

    \107\ As discussed above, 15 U.S.C. 78o-11(a)(4) defines the
term ``originator'' as a person who, through the extension of credit
or otherwise, creates a financial asset that collateralizes an
asset-backed security; and who sells an asset directly or indirectly
to a securitizer (i.e., a sponsor or depositor). Because this
definition refers only to the person that ``creates'' a loan or
other receivable, only the original creditor of a loan or
receivable--and not a subsequent purchaser or transferee--would be
deemed to be the ``originator'' for purposes of the proposed rules.
See 15 U.S.C. 78o-11(c)(1)(G)(iv); (d).
---------------------------------------------------------------------------

    When determining how to allocate the risk retention requirements,
the Agencies are directed to consider whether the assets sold to the
sponsor have terms, conditions, and characteristics that reflect low
credit risk; whether the form or volume of the transactions in
securitization markets creates incentives for imprudent origination of
the type of loan or asset to be sold to the sponsor; and the potential
impact of the risk retention obligations on the access of consumers

and businesses to credit on reasonable terms, which may not include the
transfer of credit risk to a third party.\108\
---------------------------------------------------------------------------

    \108\ 15 U.S.C. 78o-11(d)(2). The Agencies note that section
15G(d) appears to contain an erroneous cross-reference.
Specifically, the reference at the beginning of section 15G(d) to
``subsection (c)(1)(E)(iv)'' is read to mean ``subsection
(c)(1)(G)(iv)'', as the former subsection does not pertain to
allocation, while the latter is the subsection that permits the
Agencies to provide for the allocation of risk retention obligations
between a securitizer and an originator in the case of a securitizer
that purchases assets from an originator.
---------------------------------------------------------------------------

    The Agencies are proposing a framework that would permit a sponsor
of a securitization to allocate a portion of its risk retention
obligation to an originator that contributes a significant amount of
assets to the underlying asset pool. The Agencies have endeavored to
create appropriate incentives for both the securitization sponsor and
the originator(s) to maintain and monitor appropriate underwriting
standards, respectively, without creating undue complexity, which
potentially could mislead investors and confound supervisory efforts to
monitor compliance. Importantly, the proposal does not mandate
allocation to an originator. Therefore, it does not raise the types of
concerns about credit availability that might arise if certain
originators, such as mortgage brokers or small community banks (that
may experience difficulty obtaining funding to retain risk positions),
were required to do so. Mandatory allocation of risk retention to the
originator of the securitized assets also could pose significant
operational and compliance problems, as a loan may be sold or
transferred several times between origination and securitization and,
accordingly, an originator may not know when a loan it has originated
is included in a securitization transaction.
    The proposed rules would permit a securitization sponsor that
satisfies its base risk retention obligation either under the vertical
risk retention option as set forth in Sec.  --.4 or under the
horizontal risk retention option through the acquisition of an eligible
horizontal interest as set forth in Sec.  --.5, to allocate a portion
of its risk retention obligation under such option to any originator of
the underlying assets that contributed at least 20 percent of the
underlying assets in the pool. The amount of the retention interest
held by each originator that is allocated credit risk in accordance
with the proposal must be at least 20 percent, but could not exceed the
percentage of the securitized assets it originated. The originator
would also have to hold its allocated share of the risk retention
obligation in the same manner as would have been required of the
sponsor and subject to the same restrictions on transferring, hedging,
and financing the retained interest that would apply to the sponsor.
Thus, for example, if the sponsor satisfies its risk retention
requirements by acquiring an eligible horizontal residual interest
under the horizontal risk retention option, an originator allocated
risk under Sec.  --.13 of the proposal would have to acquire a portion
of that horizontal first-loss interest, in an amount not exceeding the
percentage of pool assets created by the originator. The sponsor's risk
retention requirements would be reduced by the amount allocated to the
originator.
    The Agencies believe this approach is a relatively straightforward
way to allow both the sponsor and the originator to retain credit risk
in securitized assets, on a basis that should reduce the potential for
confusion by investors in asset-backed securities.
    By limiting this option to originators that have originated at
least 20 percent of the asset pool, the Agencies have sought to ensure
that the originator retains risk in an amount significant enough to
function as an actual incentive for the originator to monitor the
quality of all the assets being securitized (and to which it would
retain some credit risk exposure). In addition, by restricting
originators to holding no more than their proportional share of the
risk retention obligation, the proposal seeks to prevent sponsors from
circumventing the purpose of the risk retention obligation by
transferring an outsized portion of the obligation to an originator
that may be seeking to acquire a speculative investment. These
requirements should also reduce the proposal's potential complexity and
facilitate investor and regulatory monitoring.
Request for Comment
    86(a). Should the proposed rules permit allocation to originators
where the sponsor is using other menu options, such as the L-shaped
risk retention option in Sec.  --.6 of the proposed rules, and if so,
under what specific conditions and requirements? 86(b). In what cases
is it likely that this alternative approach actually would be used?
86(c). What are the specific benefits of an alternative approach, and
do they outweigh concerns regarding complexity?
    87. Should the rule permit allocation to originators if the sponsor
elects the horizontal cash reserve account option in proposed Sec.
--.5(b)?
    88(a). Should the proposed rules permit allocation of risk to
originators that have originated less than 20 percent of the asset
pool? 88(b). Alternately, is the minimum 20 percent threshold
sufficient to ensure that an originator allocated risk has an incentive
to monitor the quality of the entire collateral pool?
    89(a). Are there alternative mechanisms for allocating risk to an
originator that should be permitted by the Agencies? For example,
should the rules permit or require that an originator that is allocated
risk retention by a sponsor retain exposure only to the assets that the
originator itself originates? 89(b). If so, how might such an
allocation mechanism feasibly be structured, incorporated into the
rule, and monitored by investors and supervisors?
    90. Should the rules permit sponsors to allocate risk to a third
party, and if so, how to ensure that incentives between the sponsor and
investors are aligned in a manner that promotes quality underwriting
standards?
    91. Are the proposed disclosures sufficient to provide investors
with all material information concerning the originator's retained
interest in a securitization transaction, as well as to enable
investors to monitor the originator(s) and the Agencies to assess the
sponsor's compliance with the rule?
    92(a). Should additional disclosures be required? 92(b). If so,
what should be required and why?
    93(a). As proposed, the retaining sponsor is responsible for
compliance with the rule and must maintain and adhere to policies and
procedures reasonably designed to monitor compliance by each originator
retaining credit risk, including the anti-hedging restrictions. 93(b).
What are the practical implications if the originator fails to comply?
    94(a). To help ensure that the originator has sufficient incentive
to retain its interest in accordance with the rule, should the rule
require that a sponsor obtain a contractual commitment from the
originator to retain the interest in accordance with the rule? 94(b).
If so, how should the Agencies implement this requirement?
    95. Are there other methods that could be implemented to help
ensure that a sponsor satisfies its obligations under the rule?

D. Hedging, Transfer and Financing Restrictions

    Section 15G(a)(1)(A) provides that the risk retention regulations
prescribed shall ``prohibit a securitizer from directly or indirectly
hedging or otherwise transferring the credit risk that the securitizer
is required to retain

with respect to an asset.'' \109\ Consistent with this statutory
directive, the proposed rules would prohibit a sponsor from
transferring any interest or assets that it is required to retain under
the rule to any person other than an affiliate whose financial
statements are consolidated with those of the sponsor (a consolidated
affiliate). The rule permits a transfer to one or more consolidated
affiliates because the required risk exposure would remain within the
consolidated organization and, thus, would not reduce the
organization's financial exposure to the credit risk of the securitized
assets.
---------------------------------------------------------------------------

    \109\ 15 U.S.C. 78o-11(a)(1)(A).
---------------------------------------------------------------------------

    The proposal also would prohibit a sponsor or any consolidated
affiliate from hedging the credit risk the sponsor is required to
retain under the rule. The proposal extends the hedging prohibition to
a sponsor's consolidated affiliates because the rule would allow a
sponsor to transfer the risk it is required to retain to a consolidated
affiliate. Moreover, even absent such a transfer, if a consolidated
affiliate was permitted to hedge the risks required to be retained by a
sponsor, the net effect of the hedge on the organization controlling
the sponsor would offset the credit risk required to be retained and
defeat the purposes of section 15G.
    The proposal prohibits a sponsor and its consolidated affiliates
from purchasing or selling a security or other financial instrument, or
entering into an agreement (including an insurance contract),
derivative or other position, with any other person if: (i) Payments on
the security or other financial instrument or under the agreement,
derivative, or position are materially related to the credit risk of
one or more particular ABS interests, assets, or securitized assets
that the retaining sponsor is required to retain, or one or more of the
particular securitized assets that collateralize the asset-backed
securities; and (ii) the security, instrument, agreement, derivative,
or position in any way reduces or limits the financial exposure of the
sponsor to the credit risk of one or more of the particular ABS
interests, assets, or securitized assets, or one or more of the
particular securitized assets that collateralize the asset-backed
securities. The statutory hedging prohibition is focused on the credit
risk associated with the interest or assets that a sponsor is required
to retain, which itself is dependent on the credit risk of the
particular securitized assets that underlie the ABS interests.
Therefore, hedge positions that are not materially related to the
credit risk of the particular ABS interests or exposures required to be
retained by the sponsor or its affiliate would not be prohibited under
the proposal. Such positions would include hedges related to overall
market movements, such as movements of market interest rates (but not
the specific interest rate risk, also known as spread risk, associated
with the ABS interest that is otherwise considered part of the credit
risk), currency exchange rates, home prices, or of the overall value of
a particular broad category of asset-backed securities. Likewise,
hedges tied to securities that are backed by similar assets originated
and securitized by other sponsors, also would not be prohibited. On the
other hand, a security, instrument, derivative or contract generally
would be ``materially related'' to the particular interests or assets
that the sponsor is required to retain if the security, instrument,
derivative or contract refers to those particular interests or assets
or requires payment in circumstances where there is or could reasonably
be expected to be a loss due to the credit risk of such interests or
assets (e.g., a credit default swap for which the particular interest
or asset is the reference asset).
    The proposal also addresses other hedges based on indices that may
include one or more tranches from a sponsor's asset-backed securities
transactions, as well as tranches of asset-backed securities
transactions of other sponsors. The proposal provides that holding a
security tied to the return of an index (such as the subprime ABX.HE
index) would not be considered a prohibited hedge by the retaining
sponsor so long as: (i) Any class of ABS interests in the issuing
entity that were issued in connection with the securitization
transaction and that are included in the index represented no more than
10 percent of the dollar-weighted average of all instruments included
in the index, and (ii) all classes of ABS interests in all issuing
entities that were issued in connection with any securitization
transaction in which the sponsor was required to retain an interest
pursuant to the proposal and that are included in the index represent,
in the aggregate, no more than 20 percent of the dollar-weighted
average of all instruments included in the index. These restrictions
are designed to prevent a sponsor (or a consolidated affiliate) from
evading the hedging restrictions through the purchase of instruments
that are based on an index that is composed, to a significant degree,
of asset-backed securities from securitization transactions in which a
sponsor is required to retain risk under the proposed rules.
    The proposal would also prohibit a sponsor and a consolidated
affiliate from pledging as collateral for any obligation (including a
loan, repurchase agreement, or other financing transaction) any
interest or asset that the sponsor is required to retain unless the
obligation is with full recourse to the sponsor or consolidated
affiliate. Because the lender of a loan that is not with full recourse
to the borrower has limited rights against the borrower on default, and
may rely more heavily on the collateral pledged (rather than the
borrower's assets generally) for repayment, a limited recourse
financing supported by a sponsor's risk retention interest may transfer
some of the risk of the retained interest to the lender during the term
of the loan. If the sponsor or consolidated affiliate pledged the
interest or asset to support recourse financing and subsequently
allowed (whether by consent, pursuant to the exercise of remedies by
the counterparty or otherwise) the interest or asset to be taken by the
counterparty to the financing transaction, the sponsor will have
violated the prohibition on transfer.
    The proposed rules would specify that the issuing entity in a
securitization would not be deemed a consolidated affiliate of the
sponsor for the securitization even if its financial statements are
consolidated with those of the sponsor under applicable accounting
standards.\110\ This provision is designed to ensure that an issuing
entity may continue to engage in hedging activities itself because such
activities would be for the benefit of all investors in the asset-
backed securities.\111\ However, if an issuing entity were to obtain
credit protection or hedge the exposure on the particular interests or
assets that the sponsor is required to retain under the proposal, such
credit protection or hedge could negate or limit the sponsor's credit
exposure to the securitized assets. Accordingly, under the proposal,
any credit protection by or hedging protection obtained by an issuing
entity may not cover any ABS interest or asset that the sponsor is
required to retain under the rule. For example, if the sponsor uses the
vertical approach to

risk retention, an issuing entity may purchase (or benefit from) a
credit insurance wrap that covers up to 95 percent of the tranches, but
not the five percent of such tranches required to be retained by the
sponsor.
---------------------------------------------------------------------------

    \110\ See proposed rules at Sec.  ----.2 (definition of
``consolidated affiliate'').
    \111\ For example, the proposal would not prohibit an issuing
entity (and indirectly its investors) from being the beneficiary of
loan-level private mortgage insurance (PMI) taken out by borrowers
in connection with the underlying assets that are securitized.
---------------------------------------------------------------------------

Request for Comment
    96(a). Under the proposal, a sponsor would not be permitted to sell
or otherwise transfer any interest or assets that the sponsor is
required to retain to any person other than an entity that is and
remains a consolidated affiliated. Is the permitted transfer to
consolidated affiliates appropriate?
    96(b). Why or why not?
    97. Is the proposed hedging prohibition appropriately structured?
    98(a). Would the proposal inadvertently capture any kinds of
hedging that should be permissible? 98(b). If so, please provide
specific recommendations on how we can appropriately tailor the
requirements.
    99. Does the proposed approach appropriately implement the
statutory requirement to prohibit direct and indirect hedging?
    100(a). Does the proposal permit hedging that is inconsistent with
risk retention and should be prohibited? 100(b). If so, please provide
specific recommendations on how we can more appropriately tailor the
requirements.
    101. Are the proposed provisions concerning the pledging of
retained assets appropriate? Should the rule instead prohibit the
pledging of retained assets even where the financial transaction is
recourse to the sponsor or consolidated affiliate?
    102(a). Under the proposal, a sponsor (or a consolidated affiliate)
would be prohibited from transferring the retained interest or assets
until the retained interest or assets were fully repaid or
extinguished. Is this appropriate, or should a sponsor be permitted to
freely transfer or hedge its retained exposure after a specified period
of time? 102(b). If so, should a period of time be established for
different types of securitizations?
    103. Are the proposal's requirements pertaining to index hedging
appropriate?
    104. Are the 10 percent and 20 percent thresholds discussed above
consistent with market practice and the underlying goals of the
statutory risk retention requirements?
    105. Should credit protection and hedging by the issuing entity of
any portion of the credit risk on the securitized assets be permitted
or, because such credit protection and hedges could limit the incentive
of investors to conduct due diligence on the securitized assets, should
all credit protection and hedging by the issuing entity (other than
interest rate and currency risk) be prohibited?

IV. Qualified Residential Mortgages

    Section 15G provides that the risk retention requirements shall not
apply to an issuance of ABS if all of the assets that collateralize the
ABS are QRMs.\112\ Section 15G also directs all of the Agencies to
define jointly what constitutes a QRM, taking into consideration
underwriting and product features that historical loan performance data
indicate result in a lower risk of default.\113\ Moreover, section 15G
requires that the definition of a QRM be ``no broader than'' the
definition of a ``qualified mortgage'' (QM), as the term is defined
under section 129C(b)(2) of the Truth in Lending Act (TILA) (15 U.S.C.
1639C(b)(2)), as amended by the Dodd-Frank Act, and regulations adopted
thereunder.\114\
---------------------------------------------------------------------------

    \112\ See 15 U.S.C. 78o-11(c)(1)(C)(iii).
    \113\ See id. at sec. 78o-11(e)(4).
    \114\ See id. at sec. 78o-11(e)(4)(C). As adopted, the text of
section 15G(e)(4)(C) cross-references section 129C(c)(2) of TILA for
the definition of a QM. However, section 129C(b)(2), and not section
129C(c)(2), of TILA contains the definition of a ``qualified
mortgage.'' The legislative history clearly indicates that the
reference in the statute to section 129C(c)(2) of TILA (rather than
section 129C(b)(2) of TILA) was an inadvertent technical error. See
156 Cong. Rec. S5929 (daily ed. July 15, 2010) (statement of Sen.
Christopher Dodd) (``The [conference] report contains the following
technical errors: the reference to `section 129C(c)(2)' in
subsection (e)(4)(C) of the new section 15G of the Securities and
Exchange Act, created by section 941 of the [Dodd-Frank Act] should
read `section 129C(b)(2).' In addition, the references to
`subsection' in paragraphs (e)(4)(A) and (e)(5) of the newly created
section 15G should read `section.' We intend to correct these in
future legislation.'').
---------------------------------------------------------------------------

A. Overall Approach to Defining Qualifying Residential Mortgages

    In considering how to define a QRM for purposes of the proposed
rules, the Agencies were guided by several factors and principles. The
sponsor of an ABS that is collateralized solely by QRMs is completely
exempt from the risk retention requirement with respect to such
securitization. Accordingly, under the statute, a sponsor will not be
required to retain any portion of the credit risk associated with the
securitization of residential mortgages that meet the requirements to
be a QRM. This requirement suggests that the underwriting standards and
product features for QRMs should help ensure that such residential
mortgages are of very high credit quality.
    In considering how to determine if a mortgage is of sufficient
credit quality, the Agencies also examined data from several sources.
For example, the Agencies reviewed data on mortgage performance
supplied by the Applied Analytics division (formerly McDash Analytics)
of Lender Processing Services (LPS). To minimize performance
differences arising from unobservable changes across products, and to
focus on loan performance through stressful environments, for the most
part, the Agencies considered data for prime fixed-rate loans
originated from 2005 to 2008. This dataset included underwriting and
performance information on approximately 8.9 million mortgages.
    As is typical among data provided by mortgage servicers, the LPS
data do not include detailed information on borrower income and on
other debts the borrower may have in addition to the mortgage. For this
reason, the Agencies also examined data from the 1992 to 2007 waves of
the triennial Survey of Consumer Finances (SCF).\115\ Because families'
financial conditions will change following the origination of a
mortgage, the analysis of SCF data focused on respondents who had
purchased their homes either in the survey year or the previous year.
This data set included information on approximately 1,500 families. The
Agencies also examined a combined data set of loans purchased or
securitized by the Enterprises from 1997 to 2009. This data set
consisted of more than 75 million mortgages, and included data on loan
products and terms, borrower characteristics (e.g., income and credit
score), and performance data through the third quarter of 2010.\116\
---------------------------------------------------------------------------

    \115\ The SCF is conducted every three years by the Board, in
cooperation with the Treasury, to provide detailed information on
the finances of U.S. families. The SCF collects information on the
balance sheet, pension, income, and other demographic
characteristics of U.S. families. To ensure the representativeness
of the study, respondents are selected randomly using a scientific
sampling methodology that allows a relatively small number of
families to represent all types of families in the nation.
Additional information on the SCF is available at http://www.federalreserve.gov/pubs/oss/oss2/method.html.
    \116\ Additional information concerning the Enterprise data used
by the Agencies in developing the proposed QRM standards is provided
in Appendix A in the proposed common rule.
---------------------------------------------------------------------------

    Based on these and other data, the underwriting and product
features established by the Agencies for QRMs include standards related
to the borrower's ability and willingness to repay the mortgage (as
measured by the borrower's debt-to-income (DTI) ratio); the borrower's
credit history; the borrower's down payment amount and sources; the
loan-to-value (LTV) ratio for the loan; the form of valuation used in
underwriting the loan; the type of

mortgage involved; and the owner-occupancy status of the property
securing the mortgage. A substantial body of evidence, both in academic
literature and developed for this rulemaking, supports the view that
loans that meet the minimum standards established by the Agencies have
low credit risk even in stressful economic environments that combine
high unemployment with sharp drops in house prices.\117\
---------------------------------------------------------------------------

    \117\ For the importance of loan-to-value ratio at origination,
see Quigley, J. and R. Van Order. ``Explicit tests of contingent
claims models of mortgage default,'' Journal of Real Estate Finance
and Economics, 11, 99-117 (1995) and the extensive literature that
has followed, including Foote, C., K. Gerardi and P. Willen,
``Negative equity and foreclosures: Theory and evidence,'' Federal
Reserve Bank of Boston Public Policy Discussion Papers Number 08-3.
(2008) http://www.bos.frb.org/economic/ppdp/2008/ppdp0803.pdf; for
the importance of credit history, see Barakova, I., R. Bostic, P.
Calem, and S. Wachter, ``Does credit quality matter for
homeownership?'' Journal of Housing Economics, 12, 318-336 (2003);
for several other underwriting criteria see Foote, C., K. Gerardi
and P. Willen, ``Negative equity and foreclosures: theory and
evidence,'' Federal Reserve Bank of Boston Public Policy Discussion
Papers Number 08-3 (2008). http://www.bos.frb.org/economic/ppdp/2008/ppdp0803.pdf, Mayer, C., K. Pence and S. M. Sherlund ``The rise
in mortgage defaults: facts and myths,'' Manuscript, Federal Reserve
Board, Washington, DC. (2008), and S. Sherlund, ``The past, present,
and future of subprime mortgages,'' Finance and Economics Discussion
Series No. 2008-63, Federal Reserve Board, Washington, DC (2008).
http://www.federalreserve.gov/pubs/feds/2008/200863/200863abs.html.
---------------------------------------------------------------------------

    Any set of fixed underwriting rules likely will exclude some
creditworthy borrowers. For example, a borrower with substantial liquid
assets might be able to sustain an unusually high DTI ratio above the
maximum established for a QRM. As this example indicates, in many cases
sound underwriting practices require judgment about the relative weight
of various risk factors (e.g., the tradeoff between LTV and DTI
ratios). These decisions are usually based on complex statistical
default models or lender judgment, which will differ across originators
and over time. However, incorporating all of the tradeoffs that may
prudently be made as part of a secured underwriting process into a
regulation would be very difficult without introducing a level of
complexity and cost that could undermine any incentives for sponsors to
securitize, and originators to originate, QRMs.
    The Agencies recognize that many prudently underwritten residential
mortgage loans will not meet the proposed definition of a QRM. Sponsors
of ABS backed by these mortgages will be required to retain some of the
credit risk of these mortgage loans in accordance with the proposed
regulation (unless another exemption is available). However, as
discussed further in Part III.B of this Supplementary Information, the
Agencies have sought to provide sponsors with several options for
complying with the risk retention requirements of section 15G so as to
reduce the potential for these requirements to disrupt securitization
markets, including those for non-QRM residential mortgages, or
materially affect the flow or pricing of credit to borrowers and
businesses. Moreover, the amount of non-QRM residential mortgages
should be sufficiently large, and include enough prudently underwritten
loans, so that ABS backed by non-QRM residential mortgages may be
routinely issued and purchased by a wide variety of investors. As a
result, the market for such securities should be relatively liquid, all
else being equal. Indeed, the broader the definition of a QRM, the less
liquid the market ordinarily would be for residential mortgages falling
outside the QRM definition.
    The Agencies also have sought to make the standards applicable to
QRMs transparent to, and verifiable by, originators, securitizers,
investors and supervisors. As discussed further below, whether a
residential mortgage meets the definition of a QRM can and will be
determined at or prior to the time of origination of the mortgage loan.
For example, the DTI ratio and the LTV ratio are measured at or prior
to the closing of the mortgage transaction. The Agencies believe that
this approach should assist originators of all sizes in determining
whether residential mortgages will qualify for the QRM exemption, and
assist ABS issuers and investors in assessing whether a pool of
mortgages will meet the requirements of the QRM exemption. In addition,
the approach taken by the proposal would allow individual QRM loans to
be modified after securitization without the loan ceasing to be a QRM
in order to avoid creating a disincentive to engage in appropriate loan
modifications.
    In developing the proposed criteria for a QRM, the Agencies also
considered how best to address the interaction between the definitions
and standards for QRM and QM, as mandated by the Dodd-Frank Act.\118\
The Board currently has sole rulemaking authority for the QM standards,
which authority will transfer to the Consumer Financial Protection
Bureau (the CFPB) on the designated transfer date, which is set as July
21, 2011 (transfer date). In addition, while Section 15G's risk
retention requirements are to be prescribed by the Agencies no later
than 270 days after enactment of the Dodd-Frank Act (April 17, 2011),
the Dodd-Frank Act provides that the rules implementing the QM
standards must be prescribed before the end of the 18-month period
beginning on the transfer date.
---------------------------------------------------------------------------

    \118\ See 15 U.S.C. 78o-11(e)(4)(C).
---------------------------------------------------------------------------

    In light of these provisions, the Agencies propose to incorporate
the statutory QM standards, in addition to other requirements, into the
QRM requirements and apply those standards strictly in setting the QRM
requirements in order to ensure that, consistent with Congress'
directive, the definition of a QRM be no broader than a QM. The
Agencies have proposed this approach to minimize any potential for
conflicts between the QRM standards in the proposed rules and the QM
standards that ultimately will be proposed or adopted under TILA, as
well as to provide the public a reasonable opportunity to comment on
the proposed QRM standards, including those that are bounded by the
statutory QM standards. The proposed approach also helps reinforce the
goal of ensuring that QRMs are of very high credit quality.
    As noted above, rulemaking authority for the QM standards is vested
initially in the Board and, after the transfer date, the CFPB. TILA
provides the QM rulewriting agency with the authority to establish key
aspects of the QM definition (e.g., any qualifying ratios of the
borrower's total debt to monthly income) and to revise, add to, or
subtract from the criteria for a residential mortgage loan to qualify
as a QM.\119\ Accordingly, the Agencies expect to monitor the rules
adopted under TILA to define a QM and will review those rules to
determine whether changes to the definition of QRM are necessary or
appropriate to ensure that the definition of a QRM is ``no broader''
than the definition of a QM as defined in section 129C(b)(2) of TILA
and to appropriately implement the risk retention requirement of
section 15G.\120\ In light of the different purposes and effects of the
QRM and the QM standards,\121\ as well as the different

agencies responsible for implementing these standards, the proposed
standards for QRMs should not be interpreted in any way as reflecting
or suggesting the way in which the QM standards under TILA may be
defined either in proposed or final form.
---------------------------------------------------------------------------

    \119\ See Section 129C(b)(3)(B)(i) of TILA.
    \120\ Under section 15G(e)(4)(C), future changes to the QM
definition do not, in and of themselves, alter the QRM definition.
The QRM definition will not change until the Agencies have
determined, through joint rulemaking, that the QRM definition should
be altered.
    \121\ The function of the QM standard is to provide lenders with
a presumption of compliance with the requirement in section 129C(a)
of TILA to assess a borrower's ability to repay a residential
mortgage loan. The purposes of these provisions are to ensure that
consumers are offered and receive residential mortgage loans on
terms that reasonably reflect their ability to repay the loans and
that are understandable and not unfair, deceptive, or abusive. See
section 129B(a)(2) of TILA.
---------------------------------------------------------------------------

    As required by section 15G, the Agencies also considered
information regarding the credit risk mitigation effects of mortgage
guarantee insurance or other credit enhancements obtained at the time
of origination.\122\ If such guarantees are backed by sufficient
capital, they likely lower the credit risk faced by lenders or
purchasers of securities because they typically pay out when borrowers
default. Such guarantees have historically been required for loans with
higher LTV ratios, where borrowers have relatively thin equity
cushions.\123\ Mortgage insurance companies charge a risk-based premium
for this insurance, as well as impose additional underwriting
restrictions. The Agencies considered a variety of information and
reports relative to such guarantees and other credit enhancements.
While this insurance protects creditors from losses when borrowers
default, the Agencies have not identified studies or historical loan
performance data adequately demonstrating that mortgages with such
credit enhancements are less likely to default than other mortgages,
after adequately controlling for loan underwriting or other factors
known to influence credit performance, especially considering the
important role of LTV ratios in predicting default. Therefore, the
Agencies are not proposing to include any criteria regarding mortgage
guarantee insurance or other types of insurance or credit enhancements
at this time. The Agencies note that mortgage guarantee insurance is a
form of credit enhancement accepted by the Enterprises for mortgages
with higher LTV ratios that allows such mortgages to be securitized
through mortgage-backed securities guaranteed by the Enterprises. For
the reasons explained in Part III.B.8 of this Supplemental Information,
under Sec.  ----.11 of the proposed rules, the guarantee provided by an
Enterprise while operating under the conservatorship or receivership of
FHFA with capital support from the United States would satisfy the risk
retention requirements of the Enterprise with respect to the mortgage-
backed securities issued by the Enterprise.
---------------------------------------------------------------------------

    \122\ See 15 U.S.C. 78o-11(e)(4)(B)(iv).
    \123\ See National Association of Realtors, ``Financing the Home
Purchase: The Real Estate Professional's Guide 1993,'' Chicago:
National Association of Realtors, at 20 and 117.
---------------------------------------------------------------------------

    A number of the proposed standards developed for the QRM exemption
(e.g., the DTI ratios and acceptable sources of borrower funds) are
dependent upon certain definitions, calculations and verification
requirements that are critical to the robustness of the QRM standards.
The Agencies believe that it is important to provide clarity on what
these definitions, calculations, and verification requirements include
for purposes of the QRM standards. The Agencies considered how best to
achieve this goal in a manner that is transparent, uniform, and
familiar to the mortgage industry. After carefully considering a
variety of options, the Agencies propose to incorporate and use certain
definitions and key terms established by HUD and required to be used by
lenders originating residential mortgages that are insured by the
Federal Housing Administration (FHA). Specifically, the proposed rules
incorporate the definitions and standards currently set out in the HUD
Handbook 4155.1 (New Version), Mortgage Credit Analysis for Mortgage
Insurance, as in effect on December 31, 2010 (HUD Handbook) \124\ for
determining and verifying borrower funds and the borrower's monthly
housing debt, total monthly debt and monthly gross income. This
proposed approach provides a transparent, uniform and well-known basis
for lenders to determine whether a residential mortgage loan qualifies
as a QRM, without requiring the Agencies to establish and maintain--and
lenders to comply with--new requirements.
---------------------------------------------------------------------------

    \124\ See HUD Handbook, available at http://www.fhaoutreach.gov/FHAHandbook/prod/contents.asp?address=4155-1.
---------------------------------------------------------------------------

    In order to facilitate the use of these standards for QRM purposes,
the Agencies propose to include in the Additional QRM Standards
Appendix of the proposed rules all of the standards in the HUD Handbook
that are used for QRM purposes. The only modifications made to the
relevant standards in the HUD Handbook would be those necessary to
remove those portions unique to the FHA underwriting process (e.g.,
TOTAL Scorecard instructions). The proposed rules and the Additional
QRM Standards Appendix would not affect or change any of the standards
in the HUD Handbook as they apply to FHA-insured mortgages. Moreover,
HUD continues to have sole authority to modify the HUD Handbook. Any
such amendments would not affect the Additional QRM Standards Appendix
of the proposed rules unless separately adopted by the Agencies under
section 15G.
Request for Comment
    106. Is the overall approach taken by the Agencies in defining a
QRM appropriate?
    107. What impact might the proposed rules have on the market for
securitizations backed by QRM and non-QRM residential mortgage loans?
    108. What impact, if any, might the proposed QRM standards have on
pricing, terms, and availability of non-QRM residential mortgages,
including to low and moderate income borrowers?
    109(a). The Agencies seek general comment on the overall approach
of using certain longstanding HUD standards for certain definitions and
standards within the QRM exemption and whether the Agencies should
adopt a different approach. 109(b). Are there any other existing,
transparent, and widely recognized standards that the Agencies should
use for ensuring that lenders follow consistent and sound processes in
determining whether a residential mortgage loan meets the
qualifications for a QRM?
    110. The Agencies seek comment on all aspects of the proposed
definition of a QRM, including the specific terms and conditions
discussed in the following section.
    111(a). The Agencies seek comment on whether mortgage guarantee
insurance or other types of insurance or credit enhancements obtained
at the time of origination would or would not reduce the risk of
default of a residential mortgage that meets the proposed QRM criteria
but for a higher adjusted LTV ratio. Commenters are requested to
provide historical loan performance data or studies and other factual
support for their views if possible, particularly if they control for
loan underwriting or other factors known to influence credit
performance. 111(b). If the information indicates that such products
would reduce the risk of default, should the LTV ratio limits be
increased to account for the insurance or credit enhancement? 111(c).
If so, by how much?
    112(a). If the proposed QRM criteria were adjusted for the
inclusion of mortgage guarantee insurance or other types of insurance
or credit enhancements, what financial eligibility standards should be
incorporated for mortgage insurance or financial product providers and
how might those standards be monitored and enforced?
    112(b). What disclosure regarding the entity would be appropriate?
    113. Are there additional ways that the Agencies could clarify the
standards

applicable to QRMs to reduce the potential for uncertainty as to
whether a residential mortgage loan qualifies as a QRM at origination?

B. Exemption for QRMs

    Consistent with section 15G, Sec.  --.15(b) of the proposed rules
provides that a sponsor is exempt from the risk retention requirements
of the proposed rules with respect to any securitization transaction if
all of the securitized assets that collateralize the ABS are QRMs, and
none of the securitized assets that collateralize the ABS are other
ABS. These conditions implement the requirements in 15 U.S.C. 78o-
11(c)(1)(C)(iii) and (e)(5).
    Section --.15(b) of the proposed rules includes two additional
requirements for a securitization transaction to qualify for the QRM
exemption. First, the proposal would require that, at the closing of
the securitization transaction, each QRM collateralizing the ABS is
currently performing (i.e., the borrower is not 30 days or more past
due, in whole or in part, on the mortgage).\125\ Because QRMs are
completely exempt from the risk retention requirements, the proposed
rules would not permit a residential mortgage loan that satisfied the
conditions to be a QRM upon origination to be included in an ABS
transaction exempt under Sec.  --.15(c) of the proposed rules if the
loan was not currently performing at the time of closing of the
securitization transaction. Second, the depositor \126\ for the ABS
must certify that it evaluated the effectiveness of its internal
supervisory controls for ensuring that all of the assets that
collateralize the ABS are QRMs and that it has determined that its
internal supervisory controls are effective. This evaluation must be
performed as of a date within 60 days prior to the cut-off date (or
similar date) for establishing the composition of the collateral pool.
The sponsor also must provide, or cause to be provided, a copy of this
certification to potential investors a reasonable period of time prior
to the sale of ABS and, upon request, to the Commission and its
appropriate Federal banking agency, if any. These evaluation and
certification conditions implement the requirements in 15 U.S.C. 78o-
11(e)(6).\127\
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    \125\ See proposed rules at Sec.  --.15(a) (definition of
``currently performing'' for QRM purposes).
    \126\ See proposed rules at Sec.  --.2 (definition of
``depositor'').
    \127\ For these purposes, the Agencies interpret the term
``issuer'' as used in section 15G(e)(6) to refer to the depositor
for the transaction.
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C. Eligibility Criteria

1. Eligible Loans, First Lien, No Subordinate Liens, Original Maturity
and Written Application Requirements
    The proposed definition limits a QRM to a closed-end first-lien
mortgage to purchase or refinance a one-to-four family property, at
least one unit of which is the principal dwelling of a borrower.\128\
Under the proposal, construction loans, ``bridge'' loans with a term of
twelve months or less, loans to purchase time-share properties, and
reverse mortgages could not be QRMs. Construction loans, bridge loans
and other loans designed to offer temporary financing have typically
not been securitized in the past, and their underwriting is notably
more complex than that of standard mortgage loans. Thus, expanding the
definition of QRMs to include such loans would be complex and seem to
offer few, if any, benefits. Any loan relating to a time share also may
not be a QRM, as these types of loans are excluded from the definition
of a ``residential mortgage loan'' that may be a QM under section
103(cc)(5) of TILA.
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    \128\ Closed-end credit and the related terms consumer credit
and open-end credit are defined in a manner consistent with the
definition of such terms under the Board's Regulation Z, which
implements TILA.
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    Even before the financial crisis, the overwhelming majority of
reverse mortgages were insured by the FHA.\129\ Reverse mortgages
insured by the FHA are separately exempted from the risk retention
requirements of section 15G.\130\ In addition, reverse mortgages may be
QMs only to the extent that they meet certain standards to be
determined by regulation by the Board or CFPB under section
129C(b)(2)(A)(ix) of TILA. Because the extent to which reverse
mortgages may be considered a QM under TILA is not yet known, the
Agencies have excluded reverse mortgages from potential QRM status.
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    \129\ See Hui Shan, ``Reversing the Trend: The Recent Expansion
of the Reverse Mortgage Market Finance and Economics Discussion
Series,'' Board of Governors of the Federal Reserve System, 2009-42
(2009), available at http://www.federalreserve.gov/pubs/feds/2009/200942/200942pap.pdf .
    \130\ See 15 U.S.C. 78o-11(e)(3)(B).
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    Under the proposal, a QRM must be secured by a first-lien,
perfected in accordance with applicable law, on the one-to-four family
property to be purchased or refinanced. In addition, consistent with
the QM requirement under section 129C(b)(2) of TILA, the maturity date
of a QRM, at the closing of the mortgage transaction, must not exceed
30 years. A one-to-four family property is defined to mean real
property that is (i) held in fee simple, or on leasehold under a lease
for not less than 99 years which is renewable, or under a lease having
a period that is at least 10 years longer than the mortgage, and (ii)
improved by a residential structure that contains one to four
units.\131\ A one-to-four family property may include an individual
condominium or cooperative unit, as well as a manufactured home that is
constructed in conformance with the National Manufactured Home
Construction and Safety Standards and erected on, or otherwise affixed
to, a foundation in accordance with requirements established by the
FHA.
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    \131\ See proposed rules at Sec.  --.15(a) (definition of ``one-
to-four family property'').
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    If the mortgage transaction is to purchase a one-to-four family
property, no other recorded or perfected liens on the one-to-four
family property can, to the creditor's knowledge, exist at the time of
the closing of the mortgage transaction. Thus, the proposed rules
prohibit the use of a junior lien in conjunction with a QRM to purchase
a home. Data indicate that, controlling for other factors, including
combined LTV ratio, the use of junior liens at origination to decrease
down payments--so-called ``piggyback'' mortgages--significantly
increased the risk of default.\132\ The proposal would not prohibit the
existence of junior liens in connection with the refinancing of an
existing loan secured by an owner-occupied one-to-four family property,
provided that the combined LTV ratio at closing of the mortgage
transaction does not exceed certain thresholds established by the
proposed rules.\133\ The Agencies have not proposed to prohibit the
existence of a junior lien in connection with a refinancing transaction
(subject to certain combined LTV limits) because the Agencies recognize
that some borrowers may have existing home equity loans or lines of
credit and are currently performing on all of their mortgage
obligations.\134\ A prohibition on junior liens in connection with a
refinancing transaction would force such performing borrowers to
terminate their existing home equity loans or lines of credit and
obtain a new home equity loan or line of credit shortly thereafter,
with additional transaction costs

(including a loan origination fee). To help ensure that the borrower
continues to have the ability and incentive to repay a QRM that is
originated as part of a refinancing transaction, the proposal includes
certain combined LTV limits on refinancing transactions and DTI limits
both of which assume that any home equity loan or line of credit is
fully drawn.
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    \132\ See Kristopher Gerardi, Andreas Lehnert, Shane Sherlund,
and Paul S. Willen, ``Making Sense of the Subprime Crisis,''
Brookings Papers on Economic Activity (Fall 2008), at 86, Table 3.
    \133\ See proposed rules at Sec.  --.15(d)(9).
    \134\ As discussed further below, the proposed rules would
require that the borrower be currently performing on all of the
borrower's debt obligations--including any current first mortgage,
home equity loan or line of credit--for any new mortgage to qualify
as a QRM.
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    The proposed rules also would require that the borrower complete
and submit to the creditor a written application for the mortgage
transaction. The application, as supplemented or amended prior to
closing of the mortgage transaction, must include an acknowledgement by
the borrower that the information provided in the application is true
and correct as of the date executed by the borrower, and that any
intentional or negligent misrepresentation of the information provided
in the application may result in civil liability and/or criminal
penalties under 18 U.S.C. 1001.\135\ This standard is consistent with
the written acknowledgement in the Uniform Residential Loan Application
(Form 1003) used by the Enterprises.
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    \135\ See proposed rules at Sec.  --.15(d)(9).
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Request for Comment
    114(a). The Agencies request comment on each of these conditions
for QRM eligibility. In addition, should a loan be disqualified from
being a QRM if the creditor has ``reason to know'' of another recorded
or perfected lien on the property in a purchase transaction? 114(b). If
so, what would constitute a ``reason to know'' by the creditor?
2. Borrower Credit History
    The Agencies' own analysis, as well as work published in academic
journals,\136\ indicates that borrower credit history is among the most
important predictors of default. In many datasets, credit history is
proxied using a credit score, often the FICO score determined under the
credit scoring model devised by Fair Isaac Corporation. Among the
residential mortgage loans in the LPS dataset described above, 13
percent of all loans defaulted (defined as ever having missed three or
more consecutive payments or ever being in foreclosure). However, 24.5
percent of residential mortgage loans taken out by borrowers with a
FICO score of 690 or below defaulted, compared to a default rate of 7.7
percent among residential mortgage loans taken out by borrowers with a
FICO score greater than 690. Even among the higher-FICO group,
differences remained: borrowers with FICO scores of 691 to 740 had a
default rate of 11.4 percent, while borrowers with FICO scores above
740 had a default rate of 4 percent. Thus, in these data, mortgage
borrowers with a FICO score of 690 or below were more than six times as
likely to default as borrowers with FICO scores of above 740.
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    \136\ See, e.g., Avery, Robert B., Raphael Bostic, Paul S.
Calem, and Glenn B. Canner, ``Credit Risk, Credit Scoring, and the
Performance of Home Mortgages,'' Federal Reserve Bulletin 82(7) 621-
48 (1996); Pennington-Cross, Anthony, ``Credit History and the
Performance of Prime and Nonprime Mortgages,'' Journal of Real
Estate Finance and Economics 27(3) 279-301 (2003); Calem, Paul and
Susan Wachter, ``Community Reinvestment and Credit Risk: Evidence
from an Affordable-Home-Loan Program,'' Real Estate Economics 27(1)
105-134 (1999).
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    A similar pattern emerges from the SCF data described above.
Although the SCF data do not record the borrower's credit score, they
do report several important contributors to low credit scores. The most
important predictor of whether a household in the SCF data set was
delinquent on its mortgage payment was whether it currently was behind
on any non-mortgage debt. The second-most important variable was
whether the household had filed for bankruptcy within the past five
years. Households that were current on their non-mortgage obligations
and had not filed for bankruptcy within the previous five years had a
mortgage delinquency rate of 0.2 percent, compared to a delinquency
rate of 17.9 percent for other households.
    Data on residential mortgages purchased or securitized by the
Enterprises also show the importance of borrower credit scores as a
predictor of default. From 1997 through 2002, loans that are estimated
to meet the proposed QRM requirements (except for credit history) had
cumulative rates of serious delinquency ranging from 31 to 44 basis
points if the borrower's credit score was above 690, but ranged from
267 to 356 basis points for borrowers with credit scores of 690 or
lower. The data show that, in the peak years of the housing bubble
(from 2005 to 2007), rates of serious delinquency for loans that were
estimated to meet the proposed QRM standards with credit scores above
690 ranged from 186 to 272 basis points, while similar loans to
borrowers with lower credit scores ranged from 833 to 1,103 basis
points.\137\
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    \137\ See Appendix A in the proposed common rule.
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    In developing the proposal, the Agencies carefully considered how
to incorporate a borrower's credit history into the standards for a
QRM. The Agencies are aware that credit scores are used often by
originators in the loan underwriting process. However, the Agencies do
not propose to use a credit score threshold as part of the QRM
definition because such a standard would require reliance on credit
scoring models developed and maintained by privately owned entities and
such models may change materially at the discretion of such entities.
There also may be inconsistencies across the various credit scoring
models used by consumer reporting agencies, as well as among different
scoring models used by a single provider. Consequently, in order to
ensure that creditors could continue to choose among different credit
score providers, the Agencies would have to determine a cutoff score
under multiple scoring models and periodically revise the regulation in
response to new scoring models that might arise.
    Instead, the proposed rules define a set of so-called ``derogatory
factors'' relating to a borrower that would disqualify a mortgage for
such borrower from qualifying as a QRM. The Agencies considered how
these derogatory factors related to the credit scores observed in the
data. A 2007 report to Congress by the Board found that, among all
persons with a FICO score, 42 percent had scores below 700, 18 percent
had scores between 700 and 749, and 40 percent had scores of 750 or
above.\138\ Thus, the median FICO score is somewhere between 700 and
749. The analysis of the LPS data found that borrowers with prime
fixed-rate mortgages with FICO scores below 700 were substantially more
likely than the average of such borrowers to default. The Board's
report to Congress also found that any major derogatory factor,
including being substantially late on any debt payment (not just a
mortgage), as well as bankruptcy or foreclosure, would push a
borrower's credit score down substantially. Thus, the relatively
stringent set of credit history derogatory factors set forth in Sec.
--.15(d)(5) of the proposed rules is designed to be a reasonable proxy
for the credit score thresholds associated with low delinquency rates
in the data.
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    \138\ See Report to the Congress on Credit Scoring and Its
Effects on the Availability and Affordability of Credit, Board of
Governors of the Federal Reserve System (August 2007), available at
http://www.federalreserve.gov/boarddocs/rptcongress/creditscore/creditscore.pdf.
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    Specifically, under the proposal, a mortgage loan could qualify as
a QRM only if the borrower was not currently 30 or more days past due,
in whole or in part, on any debt obligation, and the borrower had not
been 60 or more days past due, in whole or in part, on any

debt obligation within the preceding 24 months. Further, a borrower
must not have, within the preceding 36 months, been a debtor in a
bankruptcy proceeding, had property repossessed or foreclosed upon,
engaged in a short sale or deed-in-lieu of foreclosure, or been subject
to a Federal or State judgment for collection of any unpaid debt.
    The proposal would require that the originator verify and document,
within 90 days prior to the closing of the mortgage transaction, that
the borrower satisfied these credit history requirements. The Agencies
are proposing a safe harbor that would allow an originator to satisfy
the documentation and verification requirements regarding a borrower's
credit history by obtaining, no more than 90 days before the closing of
the mortgage, credit reports from at least two consumer reporting
agencies that compile and maintain files on consumers on a nationwide
basis.\139\ Such credit reports must demonstrate that the borrower
satisfies the credit history requirements for a QRM and the originator
must maintain paper or electronic copies of such credit reports in the
loan file for the mortgage transaction. This safe harbor would not be
available if the creditor later obtained an additional credit report
before closing of the mortgage which indicated that the borrower did
not meet the proposed rules' credit history requirements.
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    \139\ The proposal defines a ``consumer reporting agency that
compiles and maintains files on a nationwide basis'' by reference to
the definition of that term in the Fair Credit Reporting Act (15
U.S.C. 1681a(p)). See the proposed rules at Sec.  --.15(a)(7).
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Request for Comment
    115. Are the proposed credit history standards useful and
appropriate indicators of the likelihood that a borrower might default
on a new residential mortgage loan?
    116. Are there additional or different standards that should be
used in considering how a borrower's credit history may affect the
likelihood that the borrower would default on a new mortgage?
    117(a). Should the Agencies include minimum credit score thresholds
as an additional or alternative QRM standard? 117(b). If so, how might
the rules incorporate privately developed credit scoring models in a
manner that (i) ensures that borrowers, originators, and investors have
adequate notice, and an opportunity to comment on, changes to scoring
methodologies that may affect a borrower's eligibility for a QRM, (ii)
maintains a level competitive playing field for providers and
developers of credit scores, and (iii) ensures that any credit scoring
methodology used for QRM purposes is and remains predictive of a
borrower's default risk?
    118. The Agencies request comment on the appropriateness of the
safe harbor that would allow an originator to satisfy the documentation
and verification requirements regarding a borrower's credit history by
obtaining credit reports from at least two consumer reporting agencies
that compile and maintain files on consumers on a nationwide basis.
3. Payment Terms
    Section --.15(d)(6) of the proposed rules addresses the payment
terms of a QRM, based on the terms of the mortgage transaction at
closing. Consistent with the requirements for a QM under section
129C(b)(2)(A)(i) of TILA, the proposed rules would prohibit QRMs from
having, among other features, payment terms that allow interest-only
payments or negative amortization. Under the proposed rules, regularly
scheduled principal and interest payments on the mortgage transaction
may not result in an increase of the unpaid principal balance of the
mortgage and may not allow the borrower to defer payment of interest or
repayment of principal.