the return of u.s. structured finance

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The Return of U.S. Structured

Finance

June 26, 2013

Presented By Ken Kohler and Jerry Marlatt

NY2 719943

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State of the U.S. Structured Finance Markets

3

State of U.S. ABS and MBS Markets

• Our purpose is to provide an update on the state of the U.S.

securitization and covered bond markets for prospective issuers who

have been out of the U.S. market since the financial crisis.

• Many issuers have been put off by the uncertainty caused by the

large number of “reform” proposals resulting from the crisis.

• While there are still many uncertainties, the basic outline of the

future U. S. structured finance market is finally emerging.

• We will review the status of a number of reforms, both adopted and

still proposed.

• We will start with an overview of the markets since 2005.

• The following pages show, for 2005 to 2012:

• U.S. Mortgage-Related Securities Issuance

• U.S. Asset-Backed Securities Issuance

• European Securitization Issuance *Source: SIFMA

4

U.S. Mortgage-Related Securities Issuance (USD Billions)*

Agency Non Agency Total

Year MBS CMO CMBS RMBS Total

2005 983.3 364.4 156.7 726.0 2,230.5

2006 923.1 316.0 183.8 687.5 2,110.3

2007 1,189.0 276.6 229.2 509.5 2,204.3

2008 1,169.7 197.1 4.4 32.4 1,403.6

2009 1,734.2 288.7 8.9 9.2 2,041.1

2010 1,419.9 500.0 22.5 12.1 1,975.7

2011 1,238.6 376.7 34.3 2.8 1,660.2

2012 1,730.7 285.1 35.7 4.2 2,056.1

1Q13** 1,913.6 310.4 84.8 14.0 2,322.8

*Source: SIFMA **Annualized

5

U.S. Asset-Backed Securities Issuance (USD Billions)*


Year Auto Credit Cards Equipment Home Equity

Manufactured Housing

Other Student Loans

Total

2005 106.1 67.8 10.4 460.5 0.4 45.0 63.2 753.5

2006 90.4 66.9 8.8 483.9 0.2 36.5 67.1 753.9

2007 78.6 99.5 5.8 216.9 0.4 44.4 61.4 507.0

2008 36.2 59.1 3.1 3.8 0.3 8.9 28.2 139.5

2009 62.7 46.1 7.7 2.1 0.0 10.2 22.1 150.9

2010 59.3 7.4 7.8 4.6 14.9 15.5 109.5

2011 68.2 16.2 9.5 4.1 14.3 14.0 126.2

2012 90.1 39.7 19.3 4.1 0.0 20.1 26.1 199.4

1Q13** 94.9 28.4 14.3 10.1 0.0 30.6 20.5 198.7

6

European Securitization Issuance (USD Billions)*


ABS MBS

Year Auto Consumer Credit Cards

Leases Other CDO CMBS Mixed RMBS

2005 8.0 4.0 14.6 9.4 31.6 52.1 56.7 7.2 203.9

2006 14.8 16.1 3.8 8.9 37.1 81.9 82.2 2.2 330.5

2007 19.3 11.5 0.6 5.6 14.8 82.7 70.6 3.5 532.9

2008 18.6 36.7 18.2 19.2 5.5 130.6 7.9 7.3 894.7

2009 21.8 28.5 1.6 5.8 13.7 71.6 25.9 12.3 318.1

2010 18.8 9.6 7.6 2.5 2.8 38.8 8.0 0.8 360.1

2011 32.4 20.8 10.8 21.3 16.0 13.6 3.2 2.0 307.0

2012 34.5 16.0 10.7 2.3 3.4 17.7 6.5 0.0 170.5

IQ13** 23.5 9.8 - 6.7 8.2 1.7 7.9 - 54.3

7

State of U.S. Private-Label RMBS Market

• Residential MBS

• Redwood Trust

• Post-GFC RMBS pioneer

• Accounts for most of 2010 to 2012 U.S. RMBS Issuance

• Other issuers

• JPMorgan

• Credit Suisse

• Everbank

• Others: Bayview, Shellpoint

• Post-Crisis Deal Terms

• Arbitration

• Time-Limited Representations and Warranties

8

State of U.S. Private-Label RMBS Market – Cont’d

• Various governmental policies are impeding the market for private-label

securitizations • Low guarantee fees for GSE loans encourage GSE securitizations

• High conforming loan limits of the GSEs limit the number of loans for private-label

securitizations

• Regulatory reform has created uncertainty in the market and, in some cases, favors GSE

securitizations

• At the same time, Congress and GSEs are attempting to develop the

secondary market for non-agency securitizations • In 2012, the Federal Housing Finance Agency (FHFA) proposed a strategic plan for building

infrastructure for a new secondary mortgage market

• Items in the proposal include building a single securitization platform, standardizing data

reporting and developing a standard pooling and servicing agreement

• In 2012, the FHFA and the Consumer Financial Protection Bureau announced a partnership to

create a National Mortgage Database containing loan-level information dating back to 1998

• “Jumpstart GSE Reform Act” introduced in March 2013 to promote reform of the GSEs

• Corker-Warner GSE reform proposed

9

State of U.S. Private-Label RMBS Market – Cont’d

• Private-label securitizations are on the rise • An April 2013 report by Standard & Poor’s projects U.S. RMBS Issuance could reach $20

billion or higher in 2013, up from $6 billion in 2012

• In May, S&P reports that $7.2 billion YTD private-label RMBS issuance is on pace for $20

billion 2013 projection

• Fannie/Freddie “private label” deals could further increase volume

• Unknown impact of recent interest rate spike

• Nonetheless, 2013 is likely to be the best year since 2008

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Post-Financial Crisis

Regulation

ABS-specific Rules Adopted

11

Dodd-Frank Section 943: Reps and Warranties Rule

• Reason for Section 943:

• High percentage of rep and warranty breaches claimed in post-financial crisis

securitization litigation (including related disclosure claims made in securities

litigation

• Party enforcing repurchase requirement often same entity or affiliate of sponsor

and/or loan originator who made the reps and warranties

• 34 Act Rule 15Ga-1 – Replacement and repurchase history

• Form ABS-15G – ongoing disclosure requirement on a quarterly basis of certain

repurchase activity

• Items 1104 and 1121 of Reg AB – requires similar information required under Rule

15Ga-1 to be disclosed in the prospectus

• 34 Act Rule 17g-7 – Rating agency disclosure of reps, warranties and enforcement

mechanisms

• Applies to both registered and unregistered ABS

• The Final Rule was issued on January 20, 2011 and became effective on March 28,

2011. There is a series of compliance dates listed in the final rules, including February 14,

2012 for the initial Form 15Ga-1 filing and Reg AB prospectus disclosure.

• NRSROs were required to become compliant with the requirements of Rule 17g-7 by

September 26, 2011.

12

Dodd-Frank Section 945: Issuer Diligence Rule

Rule 193 – requires issuers to perform a review of the assets that is

designed and effected to provide reasonable assurance that the disclosure

regarding pool assets in prospectus is accurate in all material respects • No specific type of review required

• Sampling may be used when appropriate

• Third-party may be hired to perform review

• If hired for review, third party either has to be named in prospectus and consent to be deemed

an “expert” under Section 7 of the ’33 Act and Rule 436 and subjected to Section 11 liability, or

the issuer has to attribute to itself the findings and conclusions of the independent third party

review

Item 1111 of Reg AB – prospectus disclosure of Rule 193 review • Identity of party that performed review; whether sampling was used, and if so, what sampling

technique was employed; findings and conclusions of review; whether any assets in pool

deviate from underwriting criteria; and provide data on assets for which compensating or

other factors were used

Final Rule was issued on January 20, 2011, and became effective on

March 28, 2011 for issuances after December 31, 2011.

13

Dodd-Frank Section 942(a): Elimination of Automatic Suspension

of SEC Reporting

• Section 15(d) of ’34 Act suspends reporting requirements for issuers

of registered offerings for any fiscal year, other than the fiscal year

within which the registration statement became effective, if, at the

beginning of such fiscal year, there were less than 300 holders of the

class that were sold in a registered transaction.

• Section 942(a) eliminated automatic suspension for ABS issuers

14


of SEC Reporting - Cont’d

• SEC issued no-action letter in January 2011 stating it wouldn’t

recommend enforcement action if an ABS issuer continues to

determine its reporting obligations based on the standards of Section

15(d) of the ‘34 Act if:

• reporting obligation in respect of outstanding ABS had been suspended by

operation of Section 15(d) immediately prior to the date of enactment of Dodd-

Frank;

• the issuer continues to comply with requirements under the ABS transaction

agreements to make ongoing information regarding the ABS and the related pool

assets available to security holders, directly or through the trustee; and

• the issuer retains the information for at least five years after ABS are no longer

outstanding and, upon request, furnishes a copy of any or all such information to

SEC.

15


of SEC Reporting – Cont’d

• Rule 15d-22(b) – suspends or terminates ABS reporting for registered

deals (i) as to any semi-annual fiscal period, if, at the beginning of the

semi-annual fiscal period, other than a period in the fiscal year within

which the registration statement became effective or, for shelf

offerings, the takedown occurred, there are no ABS of such class that

were sold in a registered transaction held by non-affiliates of the

depositor and a certification on Form 15 has been filed, or (ii) when

there are no ABS of such class that were sold in a registered

transaction still outstanding, immediately upon the filing with the

Commission of a certification on Form 15 if the issuer has filed all

required reports for the most recent three fiscal years

16


of SEC Reporting – Cont’d

• Rule 15d-22(b) amends Form 15 to add a checkbox for ABS issuers

to indicate that they are relying on Exchange Act Rule 15d-22(b) to

suspend their reporting obligation and adds two Notes:

• Note 1 indicates that securities held of record by a broker, dealer, bank or

nominee shall be considered as held by the separate accounts for which the

securities are held, and

• Note 2 includes an anti-avoidance provision providing that an issuer may not

suspend reporting if securities are acquired and resold by affiliates as part of a

plan or scheme to evade the reporting obligations

• The Final Rule on Section 942(a) was published in the Federal

Register on August 23, 2011, and became effective on September 22,

2011.

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Regulation

ABS-specific Rules Proposed

18

Regulation AB

• Adopted in December 2004

• Governs disclosure and reporting requirements for SEC-registered

securitization transactions

• Proposed and adopted on the view that the securitization market had

become so significant that additional regulatory attention was

warranted

19

Regulation AB II

• In April 2010, the SEC proposed substantial revisions in the wake of

the financial crisis, attempting to provide greater investor protection

and restore investor confidence

• The SEC re-proposed its revisions in July 2011 following Dodd-Frank

Act provisions concerning asset-level disclosure, broker and

originator compensation and risk retention

• Adoption of the final rules expected in 2013 and currently lays over

the ABS market

20

Regulation AB II – Proposed Revisions

• Extensive asset-level data disclosure

• Reg AB extended to cover Rule 144A and Reg D offerings

• same disclosure as S-1 offering

• departure from “sophisticated purchaser” paradigm for private placements

• Shelf offerings require:

• a preliminary prospectus be available 5 days prior to pricing

• executive officer certification that structure designed to produce cash flow

sufficient to pay offered securities

• “Credit risk manager” to perform an asset review in certain

circumstances (e.g. when credit enhancements not met or at

direction of investors)

21

Regulation AB II – Proposed Revisions

• Issuers to file a computer program giving effect to “waterfall”

provisions. The SEC is reconsidering this requirement and expected

to re-propose separately

• Reg AB II will apply to any issuer offering MBS and ABS in the U.S. (if

private offerings included)

22

Dodd-Frank Section 941: Risk Retention Rules

• Proposed rules issued by SEC and federal banking agencies in March 2011

• Require securitizers to retain not less than 5% of credit risk of assets

collateralizing ABS issuance whether vertical, horizontal, L-shaped, cash

reserve account, or representative sample

• Transaction specific risk retention options for revolving master trusts, CMBS,

ABCP conduits, and agency ABS

• Exemptions for govt. guaranteed ABS, certain resecuritizations, QRMs (as

defined in the proposed rule), and certain auto loans, commercials loans and

commercial real estate

• Foreign transaction safe harbor for transactions predominantly outside the

US

• Prohibition on hedging or transferring required risk retention

• Comment period expired in August 2011

• Final rule still pending – 2013?

23

Dodd-Frank Section 621: Conflicts of Interest Rules

• Adds section 27B to 33 Act – proposed Rule 127B prohibits certain

persons involved in structuring, creating and distributing ABS from

engaging in transactions within 1 year after date of first closing of

sale of such ABS that would involve or result in a material conflict of

interest with respect to any investor in such ABS

• SEC proposed Rule 127B in September 2011

• Comment period was extended to, and expired in, February 2012

• Exceptions

• Risk-mitigating hedging activities

• Liquidity commitments

• Bona fide market-making

• Conditions: ABS transaction that involves covered persons, covered

products, a covered timeframe, a covered conflict, and a “material

conflict of interest”

24

Dodd-Frank Section 621: Conflicts of Interest Rules – Cont’d

• Covered persons include underwriters, placement agents, initial

purchasers, sponsors, and any affiliate or subsidiary of any such

entity

• Covered products is any ABS as defined in section 3 of the ‘34 Act

and covers both private and registered deals, as well as synthetic

ABS

• Covered timeframe is any transaction engaged in prior to the date

that is 1 year after the closing of the sale of the ABS

25


• Covered conflict is any material conflict of interest between an entity

that is a securitization participant and an investor in such ABS that

arises as a result of or in connection with such ABS transaction

• Expressly excluded are

• conflicts that arose exclusively between securitization participants, or exclusively

between investors,

• conflicts that did not arise as a result of or in connection with the ABS transaction,

and

• conflicts that did not arise as a result of or engaging in connection with “engaging

in any transaction,” such as issuing investment research by a securitization

participant

26


• Material conflict is a two-prong test:

• (1) securitization participant would benefit directly or indirectly from actual,

anticipated, or potential

• (a) adverse performance of the asset pool,

• (b) loss of principal, monetary default or early amortization event on the ABS,

or

• (c) decline in markets value of the ABS; or

• (2) securitization participant who directly or indirectly controls the structure of the

ABS or selection of assets in ABS would benefit directly or indirectly from fees or

other forms of remuneration as a result of allowing a third party, directly or

indirectly, to structure the relevant ABS; and there is a “substantial likelihood” that

a “reasonable” investor would consider the resulting conflict important to his or her

investment decision

• Status of proposed Rule 127B: final rule expected in 2013

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Regulation

General Financial Crisis Rule Changes that

Impact ABS and Covered Bonds

28

Volcker Rule

• Volcker Rule is found in D-F Section 619, and is to be implemented

through regulations to be issued by the SEC, CTFC, FRB, FDIC and

OCC

• Volcker Rule limits proprietary trading by banks and prohibits banks

from holding more than 3% of a covered fund

• Meant to keep banks from owning hedge funds

• Definition of covered fund is broad and includes any entity that is exempt from

registration as Investment Company under ’40 Act based on exemptions set forth

in 3(c)(1) or 3(c)(7) which would apply to most securitizations

• Would conflict with securitization risk retention requirements

• D-F provides that the Rule becomes effective in July 2012 even if

regulations not adopted

29

Volcker Rule - Cont’d

• Initial regulations proposed in October 2011

• In February 2012, the agencies issued guidance allowing banks until

July 2014 before the agencies enforce the Rule

• In June, Chairman Bernanke said he expects regulations to be

adopted by end of 2013

30

Establishment of CFPB

• Consumer Financial Protection Bureau was established under the

Dodd-Frank Act and began operation on July 21, 2011

• The jurisdiction of the bureau includes banks, credit unions, securities

firms, payday lenders, mortgage-servicing operations, foreclosure

relief services, debt collectors and other financial companies, and its

most pressing concerns are mortgages, credit cards and student

loans.

• Consolidates responsibilities from various federal regulatory bodies,

including the Federal Reserve, the Federal Trade Commission, the

Federal Deposit Insurance Corporation, the National Credit Union

Administration and the Department of Housing and Urban

Development.

• It writes and enforces bank rules, conducts bank examinations,

monitors and reports on markets, as well as collects and tracks

consumer complaints.

31

Consumer and Mortgage Lending Reform

• In January 2013, the Consumer Financial Protection Bureau issued the

Ability-to-Repay and Qualified Mortgage rule

• Amends Reg Z to require lenders to account for a borrower’s ability to repay

• Reg Z applies to all persons extending consumer credit to U.S. residents

• Final rule takes effect in January 2014

• Ability-to-Repay Requirement

• For residential mortgages, creditors must make a “reasonable and good faith

determination at or before consummation that the consumer will have a reasonable

ability to repay the loan according to its terms”

32

Consumer and Mortgage Lending Reform – Cont’d

• Eight enumerated underwriting factors for creditors to consider, including:

• Borrower’s income or assets (excludes assets securing the loan)

• Borrower’s employment status

• Borrower’s expected monthly payment for the loan

• Borrower’s debt obligations

• Borrower’s credit history

33

• Qualified Mortgage (“QM”) definition

• Residential mortgage loan that meets the following criteria:

• No excess upfront points and fees

• No negative amortization

• Term not exceeding 30 years

• Consumer cannot defer repayment of principal

• No balloon payment (with a very narrow exception)

• Income and financial resources must be verified and documented

• Limits on debt-to-income ratios

• QMs provide compliance safe harbor or rebuttable presumption that ability-to-repay

requirements satisfied


34

• Consequences of the Ability-to-Repay and QM rule

• Complexity may create compliance challenges and litigation risks

• Restrictions may tighten access to credit

• Non-U.S. issuers not subject to these requirements may have an advantage over

other market participants


35

• In January 2013, the Consumer Financial Protection Bureau issued new mortgage

servicing standards focused on helping troubled borrowers

• Final rules take effect in January 2014 and apply to all U.S. servicers

• Among other items, the new standards:

• Forbid servicers from “dual-tracking” (i.e. evaluating a consumer for loan

modifications at same time as preparing to foreclose)

• Require servicers to provide delinquent borrowers with direct and continuous

access to servicing personnel

• Prevent servicers from making a first foreclosure notice or filing until a mortgage is

at least 120 days delinquent

• Require servicers to provide written notice of loss mitigation options to borrowers

• Servicers that service less than 5,000 loans that they or an affiliate either own or

originated are exempted


36

Credit Ratings

• Dodd-Frank Act eliminated certain safeguards against strict liability

for credit rating agencies rating securities offered and sold pursuant

to a US registration statement

• Issuers must obtain consent from such credit rating agencies in order

to include such ratings in the registration statement or prospectus

• Because credit rating agencies now face strict liability for that portion

of any registration statement or prospectus they have in essence

“expertised,” they have routinely declined to provide the necessary

consents

• Applies only to registered deals; not applicable to Rule 144A or Reg

S offerings

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Regulation

CFTC as Regulator of Securitizations

38

Definitional Changes

• Dodd-Frank’s inclusion of swaps as commodity interests means that

pooled investment vehicles trading in swaps (and their operators or

advisors) must consider whether they may be subject to regulation as

a Commodity Pool, a Commodity Pool Operator or a Commodity

Trading Advisor

39

Commodity Pool Definition

• As amended by Dodd-Frank, the Commodity Exchange Act (“CEA”)

now defines the term “commodity pool” to include any investment

trust, syndicate, or similar form of enterprise operated for the purpose

of trading in commodity interests, including any—

• (i) commodity for future delivery, security futures product, or swap;

• (ii) agreement, contract, or transaction described in section 2(c)(2)(C)(i) of the

CEA or section 2(c)(2)(D)(i) of the CEA;

• (iii) commodity option authorized under section 6c of the CEA; or

• (iv) leverage transaction authorized under section 23 of the CEA

• In addition, the CFTC, by rule or regulation, may include within, or

exclude from, the term “commodity pool” any investment trust,

syndicate, or similar form of enterprise if the CFTC determines that

the rule or regulation will effectuate the purposes of the CEA

http://www.law.cornell.edu/uscode/text/7/2

http://www.law.cornell.edu/uscode/text/7/usc_sec_07_00000002----000-







http://www.law.cornell.edu/uscode/text/7/6c


40

Commodity Pool Operator Definition

• As amended by Dodd-Frank, the CEA now defines the term

“commodity pool operator” to include any person:

• (i) engaged in a business that is of the nature of a commodity pool, investment

trust, syndicate, or similar form of enterprise, and who, in connection therewith,

solicits, accepts, or receives from others, funds, securities, or property, either

directly or through capital contributions, the sale of stock or other forms of

securities, or otherwise, for the purpose of trading in commodity interests,

including any—

• (I) commodity for future delivery, security futures product, or swap;

• (II) agreement, contract, or transaction described in section 2(c)(2)(C)(i) of the

CEA or section 2(c)(2)(D)(i) of the CEA;

• (III) commodity option authorized under section 6c of the CEA; or

• (IV) leverage transaction authorized under section 23 of the CEA; or

• (ii) who is registered with the CFTC as a commodity pool operator

• In addition, the CFTC has the authority to include within, or exclude from, the CPO definition

any person if such inclusion or exclusion will effectuate the purposes of the CEA





http://www.law.cornell.edu/uscode/text/7/6c


41

Why should you avoid CPO status?

• A CPO:

• Is de facto a “financial entity” and not able to avail itself of the end-user exemption

• Must register itself, and register its principals and associated persons, as

members of the NFA

• Requires filing of a Form 7-R for the entity, and an 8-R for each AP/principal

• A principal will be understood to include a director, officer, or anyone with

decision-making authority

• A holder of 10% or more of the equity of the entity also is considered a principal

• An AP must take a Series 3 exam, required ethics training, and subject itself

to fingerprinting and other registration obligations

• Is subject to ongoing compliance obligations

42

Compliance obligations of CPOs

• A CPO will be subject to oversight and examinations by the NFA

• A CPO must be prepared to comply with various initial and ongoing

reporting, recordkeeping and other requirements, including:

• The requirement to appoint a CCO

• The obligation to file with, and have approved by, the NFA a disclosure document,

and comply with regulations relating to information disclosures

• A requirement to maintain compliance policies and procedures to

provide for appropriate custody of client assets; secure privacy of

client information; comply with anti-money laundering requirements;

prevent manipulative or disruptive trading practices, ensure business

continuity, maintain accurate records, etc.

• File certain annual and other reports, such as Forms CPO-PQR and

CTA-PR

43

Exclusions from Definition of “Commodity

Pool” – No-Action Relief

• The CFTC has issued no-action relief to the effect that certain

vehicles that trade in swaps need not be considered as a “commodity

pool”

• In no-action letters relating to securitization vehicles (each, an “SV”)

and equity real estate investment trusts (each, an “equity REIT”), the

CFTC has applied a fact-intensive analysis to determine whether or

not an SV or equity REIT constitutes a commodity pool

• A primary inquiry is the extent to which such a vehicle’s entering into

swaps actually drives (or could actually drive) the investment returns

of investors in the vehicles, as opposed to being used for certain

limited permitted uses (e.g. credit enhancement and altering rates or

currency flows from underlying assets)

44

Securitizations – No-Action Relief

• CFTC No-Action Letter 12-14 (October 11, 2012) provides that a

securitization vehicle will not constitute a commodity pool if it

conforms to the following criteria: • the issuer of the asset-backed securities is operated consistent with the conditions set forth in

Regulation AB, or Rule 3a-7, whether or not the issuer’s security offerings are in fact regulated

pursuant to either regulation;

• the entity’s activities are limited to passively owning or holding a pool of receivables or other

financial assets (either fixed or revolving) that by their terms convert to cash within a finite time

period plus any rights or other assets designed to assure the servicing or timely distributions of

proceeds to security holders;

• the entity’s use of derivatives is limited to the uses of derivatives permitted under the terms of

Regulation AB, which include credit enhancement and the use of derivatives such as interest

rate and currency swap agreements to alter the payment characteristics of the cash flows from

the issuing entity;

• the issuer makes payments to securities holders only from cash flow generated by its pool

assets and other permitted rights and assets, and not from or otherwise based upon changes in

the value of the entity’s assets; and

• the issuer is not permitted to acquire additional assets or dispose of assets for the primary

purpose of realizing gain or minimizing loss due to changes in market value of the vehicle’s

assets.

45

Securitizations – More No-Action Relief

• CFTC No-Action Letter 12-45 (December 7, 2012) provides further

detail with regard to securitization vehicles that may or may not

constitute commodity pools: • “certain securitization vehicles that do not satisfy the operating or trading limitations contained in Regulation AB

or Rule 3a-7 may be properly excluded from the definition of commodity pool, provided that the criterion with

respect to the ownership of financial assets continues to be satisfied and the use of swaps is no greater than

that contemplated by Regulation AB and Rule 3a-7, and such swaps are not used in any way to create an

investment exposure”

• Examples:

• A “standard asset-backed commercial paper conduit”

• Even if not falling within the letter of the 12-14 letter, “an investment in this securitization is not unlike

an investment in a traditional securitization that satisfies Regulation AB or Rule 3a-7 in that the

investment is essentially in the financial assets in the vehicle and not in the swaps”

• A CDO using swaps to convert fixed rate assets into floating rate assets and FX swaps to convert a

foreign currency into dollars

• Similarly, such an investment “is not unlike an investment in a traditional securitization that satisfies

Regulation AB or Rule 3a-7 in that the investment is essentially in the financial assets in the vehicle

and not in the swaps”

• A covered bond transaction

• The collateral pool (and any special purpose vehicle) “would not be a commodity pool if it contains no

commodity interests other than any swaps which are used only for purposes permitted by Regulation

AB, and covered bond holders are only entitled to receive payments of accrued interest and

repayment of principal of their covered bonds, without any condition to payment based upon any

derivative exposure”

46

Securitizations (further cont.)

• However, if investors in an SV have exposure to swaps which are used to create

investment exposure (e.g., the payment to investors is affected by swaps in a way

other than to enhance credit (within reason) or to swap interest rates or currencies,

each as permitted by Regulation AB), then the securitization vehicle may be a

commodity pool

• Examples:

• CDO holding a 5% bucket for synthetic assets consisting of swaps rather than

having 100% of its holdings in financial assets

• Repackaging vehicle that issues credit-linked or equity-linked notes where the

repackaging vehicle owns high quality financial assets, but sells credit

protection on a broad based index or obtains exposure to a broad based stock

index through a swap (SV may be a commodity pool because investors in the

SV are obtaining a significant component of their investment upside or

downside from the related swaps)

• Repackaging vehicle that acquires a three-year bond, issues a tranche of

notes, and uses swaps to extend investment experience of the bond (and

notes) to four years

• “Commercially unreasonable” use of swaps as credit support in a securitization

(e.g., to raise “CCC” rated underlying assets to “AA” rating level, thereby

making the swap “a significant aspect of the investment”)

47

Legacy Securitizations

• CFTC No-Action Letter 12-45 also contains no-action relief for certain

legacy securitization issuers of fixed-income securities

• The relief applies if: • the issuer issued fixed income securities before October 12, 2012 that are backed

by and structured to be paid from payments on or proceeds received in respect of,

and whose creditworthiness primarily depends upon, cash or synthetic assets

owned by the issuer;

• the issuer has not issued and will not issue new securities on or after October 12,

2012; and

• issuer agrees, upon request, to provide disclosure documents and other

information

48

Other Relief

• CFTC No-Action Letter 13-07 (March 29, 2013) provides securitizations not

meeting the 12-14 or 12-45 letters partial relief from the limitations of Part 4

of the regulations until June 30, 2013, if CPO registration is initiated by

March 31, 2013.

• CFTC No-Action Letter 13-09 (April 5, 2013) provides reporting relief for

between affiliated counterparties if neither are SDs or MSPs; for 100%-

owned counterparties, transaction information must be retained; for majority-

owned counterparties, aggregate transaction data may be reported quarterly.

• ASF requested an explicit exemption in a May 16, 2013 letter from the

clearing requirement for swaps with limited recourse and non-petition

clauses; it was reported that the DCR staff stated in a telephone call that it

could not provide a written response before the June 10, 2013 effective date.

49

Exemptions from CPO Registration

• CFTC Regulation 4.13(a)(1) – closely held pool – not required to register as

CPO if • does not receive any form of compensation;

• operates only one pool at a time;

• not otherwise required to register with the CFTC; and

• does not advertise

• CFTC Regulation 4.13(a)(2) – small pool – not required to register if • no pools have more than 15 participants (not including pool’s operator, CTA and certain other related

persons); and

• total gross capital contributions in all pools do not exceed $400,000

• CFTC Regulation 4.13(a)(3) – de minimis exemption • exclusion from CPO registration for entities that engage in a de minimis amount of derivatives trading

activity

50

The 4.13(a)(3) Exemption

• CFTC Regulation 4.13(a)(3) exempts pools with investors that are

either non-US persons or that meet an “accredited investor”- like

standard provided that the pools trades only a de minimis amount of

commodity interests, whether or not for bona fide hedging purposes

• Limitations are similar to those in new Rule 4.5:

• aggregate initial margin, premiums and required security deposit for commodity

positions cannot exceed 5% of the liquidation value of the fund’s portfolio (after

taking into account unrealized profits and losses), OR

• the aggregate net notional value of commodity positions will not exceed 100% of

the liquidation value of the fund’s portfolio (after taking into account unrealized

profits and losses)

• Commodity positions include commodity options, certain swaps,

certain forex transactions and futures (including security futures)

51

Regulation 4.5 Exclusion

• CTFC Regulation 4.5 excludes from the definition of a CPO

“qualifying entities” that operate pools regulated by some other

regulatory authority

• Qualifying entities include

• Registered investment companies (that comply with restrictions)

• Insurance companies with respect to separate account

• Bank, trust company or financial depository institution with respect to trust or

custodial assets while acting in fiduciary capacity

• Trustee or named fiduciary of, or employer maintaining an ERISA pension plan

• February 9, 2012 – CFTC amended Rule 4.5 to sharply limit the

ability of advisers to registered investment companies that use

derivatives to rely on the exclusion

52

Swaps - Clearing

• Dodd-Frank Act provides that the CFTC or the SEC—in consultation

with the US Treasury Secretary—may prohibit an entity domiciled in a

non-US jurisdiction from participating in any swaps activities in the

US if it determines that the regulation of swaps markets in that

country undermines the stability of the US financial system

• Dodd-Frank Act’s provisions apply only to swaps activities in the

United States, except where activities outside the United States have

a “direct and significant” connection to activities in, or effect on, US

commerce, or contravene any rules designed to prevent the evasion

of US derivatives laws.

• If issuer is not a dealer or major participant and enter into swaps in

the US for purposes of hedging or mitigating commercial risk, issuer

may be eligible to utilize the “end-user” exemption from mandatory

clearing

53

Swaps – End User Exemption

• Mandatory centralized clearing of swaps unless one of the

counterparties:

is (i) not a dealer, major participant, commodity pool, private fund, employee benefit plan,

or entity that predominantly engages in financial or banking activities, (ii) using the swap

to hedge or mitigate commercial risks, and (iii) notifies the CFTC or the SEC how it

generally meets its financial obligations associated with non-cleared swaps

• This exemption is also available to an affiliate of an entity that meets

the criteria above (a “Qualifying Entity”) so long as such affiliate: is (i) not a dealer, major participant, commodity pool, private fund or bank holding company

with over US$50 billion in consolidated assets, (ii) acts on behalf of the Qualifying Entity

and as an agent, and (iii) uses the swap to hedge or mitigate the commercial risks of the

Qualifying Entity or other affiliate of the Qualifying Entity

Swaps entered into in the US for purposes of speculation, trading, or

investing are not eligible for the end-user exemption.

©

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Covered Bonds in

the United States

55

Foreign Bank Issuance into U.S.

• Some tranches of European offerings were sold into the U.S. prior to

2008

• Post-crisis issuance resumed in 2010 with $25 billion of offerings

• 2011 followed with more than $35 billion of issuance and 2012

provided almost $50 billion of issuance

• 2013 has started somewhat slowly at a time when European

issuance is at historic lows

• Currently we have more than $110 billion of covered bonds

outstanding

56

Foreign Bank Issuances

• Foreign banks issuing into the US market have been relying on their domestic covered

bond framework and have been using cover pool assets that are foreign (not in the

United States).

• Issuances into the United States have been structured as program issuances (or

syndicated takedowns) conducted on an exempt basis; that means that the foreign

issuer is relying on exemptions from the U.S. securities laws requiring registration of

public offerings of securities.

• As a result, offerings have been targeted at U.S. institutional investors and generally

conducted in reliance on Rule 144A.

• On May 18, 2012, Royal Bank of Canada obtained a no-action letter from the SEC that

permitted RBC to register its covered bond program on Form F-3.

• On July 30, 2012, RBC obtained SEC approval for a registration statement for its

covered bond program (333-181552): • On September 19, 2012, RBC issued $2.5 B of 5 year covered bonds under this registration statement.

• On December 6, 2012, RBC issued $1.5 B of 3 year covered bonds.

57

Issuance Alternatives

• In a private placement in reliance on U.S. private placement exemptions (generally

Section 4(a)(2)).

• In an offering structured as a private placement, with resales under Rule 144A (to

qualified institutional buyers, or QIBs).

• In an offering by a bank that is excepted from registration under Section 3(a)(2) (a

3(a)(2) offering).

• In an SEC registered offering, public offering without restrictions.

59

Covered bonds in the United States

• Historically, housing finance in the United States has depended on other sources

(instead of covered bonds). For example,

• the GSEs. The GSEs were essential to the growth of the securitization market in

the United States.

• Securitization. U.S. banks became dependent on securitization. There was a

significant market for securitization and securitization provided off-balance sheet

treatment for regulatory capital and GAAP accounting purposes.

• FHLB funding. U.S. banks had access to funding from the Federal Home Loan

Bank system.

60

Covered bonds in the United States

• Given a mix of the financial crisis, GSE financial circumstances, market forces,

accounting developments and regulatory changes, new housing finance alternatives

are becoming more important.

• Covered bonds have been in the news in the United States since 2006.

• In September 2006, Washington Mutual became the first North American

financial institution to offer covered bonds in an offering in Europe.

• In 2007, Bank of America followed with its own covered bond offering in Europe.

61

The Emergence of US Domestic CB Supply is Anticipated –

Subject to the Establishment of US Covered Bond Legislation

• In 2011, Covered Bond legislation was introduced in the House as H.R. 940 and passed the Financial Services

Committee by a strong bi-partisan vote of 44-7

• Covered Bonds legislation was introduced in the Senate on November 9, 2011 as S. 1835. No hearings were held.

• A new Congress begins in 2013, so the legislation must be reintroduced. Upon passage, it is our expectation that a

number of the US money center / super-regional banks will begin issuing covered bonds into the USD market

following a brief rule-making period.

• The passage of US covered bond legislation will resolve existing uncertainty around the ability of covered

bonds to survive an FDIC receivership and will allow US issuers to begin accessing this cost efficient funding

source soon thereafter.

• Key steps for US legislation are as follows:

• The United States Covered Bond Act of 2013 must be introduced in and passed by the House;

• A companion bill must be introduced in the Senate and passed by the Senate; and

• The House and Senate must then agree on a final bill, to be signed by the President.

2006

WaMu issues first North American covered bond into Euro market

2006

WaMu issues first North American covered bond into Euro

2007

Bank of America issues first USD covered bond by a US bank

2007

Bank of America issues first USD covered bond by a US bank

March 2011 January 2010

CIBC issues the first USD 144A covered bond since 2007

CIBC issues the first USD 144A covered bond since 2007

2007

RBC launches the first Canadian covered bond program

2007

RBC launches the first Canadian covered bond program

2011 2012 2012/13

US Covered Bond Act introduced by Senators Hagan and Corker

US Covered Bond Act introduced by Rep. Scott Garrett

Anticipated completion of US covered bond legislation

No significant legislative developments – RBC first SEC registered covered bond

November 2011

The Development of US Domestic Covered Bonds in the USD Market

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Proposed Legislation in the U.S.

63

Essential legal elements

• Federal legislation.

• Creation of a separate insolvency estate

• Necessary to protect the maturity of the bond

• We have a ‘unitary’ insolvency system

• Only a single estate to meet the claims of creditors

• Priority claim for bondholders.

• Covered bond regulator

• Regulatory oversight of the quality of covered bonds

• Regulatory approval of issuance

• Regulatory oversight of the administration of the separate estate

• No tax on separate estate or its activities.

64

Proposed U.S. Structure

• Legislation enables direct issuance from the bank to investors while

ensuring the assets are segregated in the event of an issuer

insolvency

• The statute generally enables cash flow from the collateral to continue to pay

covered bonds as scheduled notwithstanding the insolvency of the issuer.

Covered

Bond

Proceeds

Issuer

Covered Bondholders

Covered

Bonds

Cover Pool Security

Covered

Bond

Security

Trustee

65

Key Elements of the Legislation

Cover Pool Assets

• “Eligible Asset”

• complying first-lien residential mortgage loan

• complying commercial mortgage loan

• loans or securities of States or municipalities

• complying auto loans or leases

• complying student loans

• complying revolving credit receivable

• any loan made or guaranteed under a Small Business Administration program

• any other asset designated by the covered bond regulator in consultation with the primary financial regulatory agency of the issuer

• “substitute asset” – cash, overnight Federal funds, US Government obligations and GSE obligations ≤20% of pool

66

Key Elements of the Legislation (cont’d)

Legal Attributes of Statutory U.S. Covered Bonds

• Only one asset type permitted in a cover pool.

• The Issuer’s primary Federal financial regulator to be the covered bond regulator.

• The regulator is required to set a limit for each issuer on the amount of covered bonds an issuer may have outstanding based on total assets

• Cease and desist authority if program does not comply with legislation

• Upon insolvency of a bank issuer, 180 days for the FDIC to transfer the covered bonds to another bank.

• The cover pool becomes a separate “estate” if the covered bonds are not transferred or if the FDIC is not the receiver.

• Upon default prior to insolvency, the cover pool becomes a separate estate immediately.

67

Key Elements of the Legislation (cont’d)

Legal Attributes of Statutory U.S. Covered Bonds

• The covered bond regulator as the trustee of the pool.

• Appoints one or more servicers or administrators.

• Administers the estate for the benefit of the bondholders and other secured parties (e.g., swap counterparties).

• Authority for the cover pool to borrow for liquidity purposes.

• FDIC granted a residual interest in the cover pool.

• Covered bonds issued by a bank are deemed to be issued under Section 3(a)(2) of the Securities Act

• Covered bonds are not an “asset-backed security” and therefore should not be subject to SEC Regulation AB

68

Prospects for Legislation

Several factors favor U.S. Covered Bonds legislation in 2013

• Prices in the housing market are recovering

• Fannie Mae and Freddie Mac are being wound down

• Have been 95% of financing for new mortgage loans

• FDIC unlimited deposit account guarantee has terminated

• Presidential election behind us

• Ways and Means Committee cleared bill

• Steadily growing issuance by foreign banks into U.S.

• Currently there are more than $110 billion of covered bonds outstanding

• SEC approval of RBC registration statement

• RMBS market still has little traction

• Possible solution to FDIC concerns

70

SEC Registered Covered Bonds

• RBC obtained a no action letter from the SEC

• SEC link http://www.sec.gov/divisions/corpfin/cf-noaction/2012/rbc051812-f3.htm

• RBC filed its registration statement of Form F-3 (333-181552).

• A shelf registration statement.

• SEC link http://www.sec.gov/cgi-bin/browse-edgar?filenum=333-

181552&action=getcompany

• There are eligibility requirements for Form F-3, including at least 12 months of SEC

reporting history.

• Form F-9 or Form F-10 issuers generally would be eligible for Form F-3.

http://www.sec.gov/divisions/corpfin/cf-noaction/2012/rbc051812-f3.htm





http://www.sec.gov/cgi-bin/browse-edgar?filenum=333-181552&action=getcompany







71

SEC Registered Covered Bonds – Cont’d

• The covered bonds were not deemed to be ABS, although disclosure

consistent with Regulation AB was required.

• Disclosure about the cover pool assets is similar to a credit card or

UK RMBS master trust.

• No loan level disclosure for loans in the cover pool.

• No financial statements required for the Guarantor.

72

Canadian Covered Bond Architecture

• The structure first launched by RBC has been established as the market standard for Canadian issuers with CIBC, BMO, BNS, TD and NBC utilizing the same basic structure.

• The Canadian covered bond architecture below closely resembles the UK covered bond architecture:

• Covered bonds are issued to investors with full recourse to the Issuer and the cover pool.

• The issuer, as Seller, sells mortgage loan assets to the Guarantor, which uses proceeds from the Intercompany Loan to purchase the mortgage loans from the Issuer and provide a guarantee to the covered bond investors.

Covered Bond Guarantor Guarantor

Intercompany

Loan

Covered Bond

Proceeds

Trust Deed (incl Covered

Bond Guarantee) and

Security Agreement

Interest Rate Swap Provider

Mortgage Loans and

Related Security

Canadian Bank Issuer

Covered Bondholders

CB Swap Provider

Covered

Bonds

Repayment of

Intercompany Loan

Canadian Bank Seller

Consideration

Bond Trustee

73

Why a No Action Letter?

Required by Canadian/U.K. structure

Separate Guarantor deemed to be issuing a separate security, the guarantee

The guarantee needs to be registered with the SEC

The Guarantor is not an SEC reporting company

Nor is it a 100% owned subsidiary under Rule 3-10 of Regulation S-X

Not a “full and unconditional” guarantee under Rule 3-10 of Regulation S-X

So Guarantor does not qualify for a shelf registration statement

No action letter from SEC permits both Bank and Guarantor to register on a shelf

registration statement

This would not be a requirement for a Pfandbrief-type structure

74

Advantages of Registration

• No offering restrictions; no transfer restrictions.

• No investment restrictions; the bonds are not restricted securities.

• No requirement for the issuing bank to have a U.S. branch or agency;

no capital impact on a U.S. branch or agency.

• No discussion required with U.S. banking regulators.

• No private placement restrictions on communications.

• No limits on repatriation of proceeds.

75

Advantages of Registration

• Wider investor base

• State retirement funds

• ~ 200 investors compared to 75 in a typical 144A

• Attractive pricing

• 10 – 12 basis points savings compared to 144A

• RBC $2.5 billion 5 year

• Better secondary market

• Eligible for major bond indices – e.g., Barclays Aggregate Bond Index

• TRACE Reporting System

• Pricing transparency

Advantages of Registration - TRACE

77

Disclosure

• Bank disclosure

• Typical bank disclosure for MTN, plus

• Mortgage origination program.

• Mortgage servicing program.

• Statistical disclosure of servicing portfolio.

• Covered bonds

• Summary of fees and expenses of Guarantor.

• Characteristics of the Loans.

• Statistical disclosure of cover pool.

• Static pool disclosure of cover pool (by vintage year of origination).

• SEC filing of monthly investor report, including delinquency

information.

• Rule 193 disclosure of cover pool audit.

78

Ongoing Reporting Requirements

• The bank would file annual and interim reports and current reports.

• Form 40-F, Form 6-K and Form 8-K.

• The guarantor would file annual and interim reports.

• Annual reports on Form 10-K, including:

• Servicer’s assessment of compliance with servicing criteria in Item 1122

• Auditor’s attestation report on servicer assessment of compliance

• Monthly reports on Form 10-D related to distributions of proceeds from the cover

pool.

• Monthly investor report attached as an exhibit

• Current reports on Form 8-K.

79

GSEs

• Yesterday, Senators Corker (R-TN) and Warner (D-VA) introduced a draft of a bill in

the Senate to wind down the GSEs and create a new federal insurance program for

housing

• The bill was co-sponsored by Senators Johanns (R-NE), Tester (D-MT), Heller (R-NV),

Heitkamp (D-ND), Moran (R-KS) and Hagan (D-NC),

• Secondary Mortgage Market Reform and Taxpayer Protection Act of 2013

• The bill would create the Federal Mortgage Insurance Corporation and the

operations and personnel of FHFA would be transferred into the new entity

• The new entity would provide insurance to cover losses after a first loss

position held by private sector investors had been wiped out

• Establish and maintain a Mortgage Insurance Fund

• An “eligible mortgage” must satisfy the CFPB definition of Qualified Mortgage

• LTV must not exceed 80% unless the private mortgage insurance covers

an amount equal to 20% to 30% of the loan (depending on LTV)

• Minimum down payment of 5%

• HUD to establish a “Market Access Fund”

• The fund would be used to provide incentives for multi-family housing

80

GSEs (cont)

• The bill provides for the final dissolution of FNMA and FHLMC not later than five years

after passage of the bill

• The multi-family operations of the GSEs would be transferred to the Federal

Mortgage Insurance Corporation

• Proceeds from the winddown of FNMA and FHLMC would be applied first to pay

outstanding debt, second to preferred holders and lastly to common stock holders

81

Conclusion

• Structured finance markets are clearly on the rebound

• RMBS in particular appears poised to break out further

• Increasing interest rates may temporarily slow recovery, but shouldn’t be a long-

term issue

• Many regulatory uncertainties have been resolved

• Remaining uncertainties have been substantially narrowed by

outstanding proposals

• The final uncertainties should be lifted in 2013 or 2014

• Now is the time to map out an ABS strategy

the return of u.s. structured finance

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