Iowa Banking Law Blog

Seeking Safe and Sound Securitization

In a recent speech given before the American Securitization Forum, John C. Dugan, the Comptroller of the Currency, discussed how the securitization market might be reformed and revived.  Some highlights of his remarks are set forth below: 

• A properly functioning securitization market “helps consumers and businesses by increasing the availability of credit on terms that might otherwise be unavailable.
• A revival of securitization must guard against abuses, “such as creating inventive for lax underwriting of underlying assets; opaque and complex asset pools; credit rating failures; inadequate risk capture in both accounting standards and regulatory capital and breakdowns in disclosure.”
• There are limitations associated with proposals for mandatory risk retention (“skin in the game”). New accounting standards (FAS 166 and 167) create uncertainty about the extent to which securitized assets involving risk retention will qualify as true sales and must remain on the securitizer’s balance sheet. To the extent that such assets do not qualify for true off-balance sheet accounting treatment, they would increase required regulatory capital levels.
• There are advantages to an approach based on “establishing minimum underwriting standards directly by regulation.” Such standards should apply uniformly and should be made equally applicable to “unregulated mortgage originators and brokers.” Such standards should require effective verification of income and financial information, meaningful down payments, reasonable debt-to-income ratios, and qualifying borrowers based on the highest monthly payment required by the terms of the loan.

Another perspective on the path to safe and sound securitization is provided in a speech given before the Mortgage Securities Association Annual Conference by FDIC Chairman Sheila C. Bair.  Some highlights of her remarks are set forth below:

• Among the factors that caused the recent financial crisis was an approach to securitization that encouraged a focus on “deal production and fee generation at the expense of consumer protection and sound underwriting.”
• Changes in accounting standards required the adoption by the FDIC of a transitional safe harbor rule under which “all securitizations or participations in process through March 31, 2010 would be permanently grandfathered” and thereby protected against the risk that the FDIC as conservator or receiver might try to reclaim loans transferred in connection with a securitization or participation or delay access to securitized assets.
• The FDIC has issued an Advance Notice of Proposed Rulemaking (the “Advance Notice”) providing 35 questions and a sample regulatory text and “seeking public comment on what standards should be applied for safe harbor treatment for transactions created after March 31st.”
• To correct weaknesses in securitization, the FDIC’s sample regulatory text contained in the Advance Notice “outlines four fundamental requirements for a well-structured securitization process in which risks can be properly evaluated and managed.” Those four fundamental requirements are (1) simpler and more transparent structures, (2) loan level disclosures with an adequate due diligence period and updates, (3) compensation tied to performance, and (4) origination standards and some retention of interest in the transaction.

 

The 35 questions and sample regulatory text contained in the Advance Notice provide some insight into the standards the might be included in a future rule protecting securitized assets in situations in which the FDIC has power over the underlying assets as conservator or receiver.  Among other things, the 35 questions and sample regulatory text suggest that the following standards might be included in a future rule:

• Limitations on permissible capital structures (e.g., limits on external credit support, leveraged tranches, re-securitizations, and other such features).
• Detailed disclosures concerning the structure of the securitization and credit and payment performance of the obligations, underwriting standards, and compensation and risk retention provisions.
• A periodic reporting requirement.
• Required provisions authorizing modification of loans and other actions to mitigate losses and governing the timing of such actions and the allocation of responsibility for such decisions.
• Provisions limiting the amount and timing of compensation and providing for appropriate alignment of incentives to promote actions that maximize value and mitigate losses.
• Risk retention requirements, seasoning requirements (e.g., origination of obligations more than one year before securitization), and verified representations and warranties with recourse.

 

If you have questions, please contact Howard O. Hagen at 515-246-4543 or hhagen@dickinsonlaw.com.

Update on Community Development Financial Institution (CDFI) Initiative

Yesterday the Treasury Department released additional details regarding enhancements to the Community Development Financial Institution initiative that was announced last October.  Under the CDFI program, institutions the Treasury has certified as targeting underserved communities in more than 60 percent of their small business lending and other economic development activities would now be eligible to receive capital investments at a dividend rate of 2 percent, compared to the 5 percent rate that was offered under the Capital Purchase Program (CPP).  Key enhancements to the program that were announced yesterday include the following:

• An Increase in the Maximum Amount of Capital Available to CDFIs: The program as outlined in October 2009 limited the amount of capital for which CDFIs could apply to 2 percent of risk-weighted assets. The final terms will allow institutions to apply for Treasury investments of up to 5 percent of risk-weighted assets, significantly increasing the potential impact on lending in low-income communities. (Credit unions can apply for an equivalent amount of total assets.)
• The Program Will Expand the Number of Eligible Institutions by Allowing CDFIs to Receive Capital from the Treasury Matched to Private Investments: CDFIs will need approval from their regulator to participate in this program. For CDFIs that might not otherwise be recommended for participation by their regulator, the Treasury will offer matching capital investments, up to 5 percent of risk-weighted assets, against private investments on a dollar-for-dollar basis, provided that the combined amount would return the institution to a viable position. This enhancement will allow the program to reach a broader range of institutions serving vital needs in their communities while protecting taxpayer interests.

For further information, please contact L. Allyn Dixon, Jr. at 515-246-4520 or adixon@dickinsonlaw.com.

Update on Community Bank Lending Initiative

A comprehensive summary of the Obama Administration’s just-announced “Small Business Lending Fund” program that would recycle TARP funds to help banks with $1 billion to $10 billion in assets lend to small businesses is available online at http://www.whitehouse.gov/the-press-office/president-obama-outlines-new-small-business-lending-fund.

 

According to various news accounts, the Administration is considering whether to include weaker banks, and Administration officials have said that Congress must limit conditions on executive compensation in order for the new program to attract banks.  Furthermore, Treasury Secretary Geitner has publicly remarked that the new proposal is needed to help get growth back on track and repair some of the damage caused by the financial crisis.

 

If you have questions, please contact L. Allyn Dixon, Jr. at 515-246-4520 or adixon@dickinsonlaw.com.

Details of New Community Bank Lending Program Announced Today

Following up on remarks made in last week’s State of the Union address, President Obama today revealed plans for a new “Small Business Lending Fund," under which community banks with assets between $1 billion and $10 billion could receive funds to support small business lending. 

 

To avoid some of the stigma associated with the TARP program, this program would be a completely new program, funded with $30 billion paid back from TARP recipients.

 

The fund would provide capital investments with an incentive structure to support new lending.  As presented today by the President, banks with less than $1 billion in assets could receive capital investments of up to 5% of risk-weighted assets, while banks between $1 and $10 billion in assets could receive up to 3%.  Banks’ primary regulators will approve applications, and existing Capital Purchase Program participants with less than $10 billion in assets could convert their capital to the new program.

 

The dividend paid on the capital would start at 5%, but could be reduced to as low as 1% as a bank demonstrates increased lending compared to a 2009 baseline.  For every 2.5% increase in business lending over a two-year period, banks would receive a 1% dividend decrease down to a minimum of 1%.  After 5 years, the dividend would be increased to encourage timely repayment.

 

We will keep you posted as further details emerge.  If you have questions in the meantime, please contact L. Allyn Dixon, Jr. at 515-246-4520 or adixon@dickinsonlaw.com.

Iowa Appeals Court Rules in Case Involving Collection of Debt After More Than Four Years of Inaction by Lender

The Iowa Court of Appeals recently entered a ruling which should be of general interest to lenders.  The case of U.S. Bank v. Anna M. Weems, filed January 22, 2010, illustrates that long delays in the enforcement of a promissory note and mortgage can raise questions as to whether the lender is entitled to enforce the note and mortgage, even when the enforcement action is filed within the 10 year statute of limitations applicable to written agreements in general.  Anna Weems made her last regular payment on a note and second homestead mortgage held by U.S. Bank in March of 2004.  Between the time of that payment and U.S. Bank’s lawsuit against her on the note and mortgage over four years later, the Bank charged off the loan, quit assessing late fees and made no attempt to collect the note.  During that four year period Weems had regular contact with the Bank, both in connection with the administration of her first mortgage loan (she kept up the payments on her first mortgage during that time) and in connection with “numerous” volunteer training seminars Weems conducted for Bank personnel.  Based on the fact that the Bank said nothing to her during that time period regarding the delinquent second mortgage note, Weems argued that the Bank had by its conduct “abandoned” or “waived” its right to enforce the note and mortgage.  The District Court disagreed, granting summary judgment in the Bank’s favor.

 

Lenders should take note that, although the Court of Appeals upheld the District Court’s ruling in favor of the Bank, the decision was based on a close (2 -1) vote of the appellate judge panel.  One of the three judges who decided the case wrote a dissent in which he concluded that Weems was at the very least entitled to a full jury trial on the issue of whether the Bank had waived its right to enforce the note and mortgage in question.  He found that “a jury might find that U.S. Bank waived its rights to foreclose on the second loan when it coaxed payments from Weems to apply to her first mortgage for four years while making no effort to collect her debt on the second mortgage secured by the same home.”

 

Current public sentiment regarding what some pundits have described as “abusive” mortgage lending practices is reason enough for any Bank to be very cautious about engaging in conduct which could result in a jury, rather than a District Court judge, deciding the Bank’s right to foreclose a mortgage.  This lesson of this case, notwithstanding the final result, is that a lender can actually jeopardize its ability to foreclose a mortgage lien by its failure to start a  foreclosure proceeding or to take some other action to collect the underlying note within some reasonable time period following the borrower’s default.    

If you have questions, please contact Jon Sullivan at 515-246-4522 or jsullivan@dickinsonlaw.com.