Securitization Regulatory Update Paul Jorissen Partner +1 212 506 2555 [email protected] Jason Kravitt Partner +1 212 506 2622 [email protected]

Stuart M. Litwin Partner +1 312 701 7373 +1 212 506 2389 [email protected] 3 June 2015

Regulatory Update

• GSE Reform and the Future of Mortgage Finance • Due Diligence/Rating Agency Rules • Regulation AB Proposals (“Reg AB II”) • Risk Retention • Money Market Fund Reform • Conflicts of Interest • Swaps • Regulatory Capital Changes • Liquidity Coverage Ratio

GSE Reform and the Future of Mortgage Finance

• Conservatorship now 7 years • GSEs remain dominant • Incremental Reform (not Receivership) • FHFA has released "strategic plans" • Senate Bill "The Financial Regulatory Improvement Act“

GSE Strategic Plans for 2015

• “Maintain” – flow of product with rep and warranty reform and dispute resolution procedures to reduce seller risks – new product: 3% down payment mortgages to creditworthy borrowers – standing of existing borrowers through foreclosure prevention – P&L through sale of NPLs and REO

"Reduce" taxpayer risk

• $270 billion credit risk transfer via securities and insurance transactions • Portfolio reduction goal $250 apiece currently over $850 total • Strengthen PMI providers who cover LTV risk over 80.

“Build”

• Common Securitization Platform (CSP) for both GSEs and private label • Develop "Single Security" to maintain liquidity, availability of hedging for rate locks and pipeline and reduce $400 million subsidy

Soliciting Input on Long Run Policies

• Guarantee fees: suspend increases • Housing Trust Fund: reverse 2008 funding suspension • 3 year housing goals through 2017

Financial Regulatory Improvement Act

• Prohibit use of guarantee fees to fund budget • Mandatory risk sharing increase volume by 50% • No sale by US Treasury of preferred stock in GSEs • GAO study on availability mortgage credit and banking agencies on reg treatment of servicing assets • Qualified Mortgages include loans held in portfolio if consumer protection and financial stability criteria met • Reverse FHFA rule restricting FHLB membership

Regulatory Update

• GSE Reform and the Future of Mortgage Finance • Due Diligence/Rating Agency Rules • Regulation AB Proposals (“Reg AB II”) • Risk Retention • Money Market Fund Reform • Conflicts of Interest • Swaps • Regulatory Capital Changes • Liquidity Coverage Ratio

Rules 15Ga-2 and 17g-10; Form ABS-15G

• Effective June 15, 2015, these rules apply to all rated asset-backed securities offerings –

Both public and private

–

Regardless of whether the NRSRO uses the third-party diligence report to determine its rating

• “Due Diligence Service” –

–

Means a review of the assets underlying an asset-backed security, for the purpose of making findings with respect to: •

Accuracy of information or data about the assets provided by securitizer or originator

•

Whether assets conform to stated underwriting criteria

•

Value of collateral securing the assets

•

Whether originator complied with law

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Any other factor or characteristic material to likelihood of payment by issuer of principal and interest

Explicitly includes the comparison of a sample of asset files to the data tape, which is commonly performed by accounting firms in an agreed-upon procedures report

• Issuer or underwriter must file Form ABS-15G with SEC at least 5 business days prior to the first sale in the offering (Rule 15Ga-2) –

Contains the findings and conclusions of any third-party due diligence report, including interim reports, obtained by the issuer or underwriter

–

If applicable to the due diligence performed, must include a description of the criteria against which underlying assets were evaluated, how assets compared to those criteria and the basis for including any assets not meeting the criteria

Rule 17g-10 and Form ABS Due Diligence-15E

• Rule 17g-10 requires third-party due diligence providers to deliver Form ABS Due Diligence-15E promptly following completion of services to: – Delivered to issuer or underwriter for posting on the related Rule 17g-5 Website and any NRSROs that deliver a written request. – Signed by an individual duly authorized to make the certifications on behalf of the due diligence provider

• Form ABS Due Diligence-15E must: – Identify the due diligence provider – Identify the person who paid for the due diligence – If applicable, identify any NRSRO rating criteria that the services are intended to satisfy – Describe in detail the scope and manner of the due diligence performed – Summarize the findings and conclusion of the due diligence review

Due Diligence Rules Compliance Checklist for AUP

• Get and Review Accountant’s AUP Engagement Letter –

Accountants intend to have two letters, one with the file review, the other on the numbers in the offering memo or prospectus

• Review changes to rating agency engagement letter forms • Get CIK code from SEC • Underwriters to approve Access Letter • Draft and signoff on Form ABS-15G • Accountants to prepare, sponsor and its counsel to review and sign off on, Form ABS-15E • Add reference in offering memo or prospectus to the filed Forms • Expect a new representation in Underwriting Agreement (and in due diligence questions on co-manager call) that there were no other due diligence services performed • Expect underwriters to request indemnity for false statements in or omissions from the new forms • Make sure accountants complete their file review sufficiently in advance • Review AUP report to confirm it contains no personally identifiable information • Timely file the forms at least five business days prior to first sale/pricing

Rating Actions/Rule 17g-7

• “Rating Action” includes an affirmation or withdrawal of an existing credit rating if: – the affirmation or withdrawal is the result of a review of the credit rating – The rating agency uses its applicable procedures and methodologies for determining credit ratings

• If a rating agency takes a “Rating Action,” Rule 17g-7 requires the agency to publish a report in the same manner as the original rating • It’s helpful to have amendment provisions that do not require the rating agencies to do reports: – Never require rating “confirmations,” which trigger the reporting requirement – Rating agencies take the position that “No Downgrade” letters don’t trigger the reporting requirement – Even better for issuers to have “satisfaction of the Rating Agency Condition,” which typically requires written notice to the rating agencies and no action in the following 10 days to downgrade or withdraw the rating

Regulatory Update

• GSE Reform and the Future of Mortgage Finance • Due Diligence/Rating Agency Rules • Regulation AB Proposals (“Reg AB II”) • Risk Retention • Money Market Fund Reform • Conflicts of Interest • Swaps • Regulatory Capital Changes • Liquidity Coverage Ratio

Important Regulation AB II Dates

• New public deals after Nov. 23, 2015 require compliance with new Reg AB forms, including new registration statement • Asset-level data required after Nov. 23, 2015 for RMBS, Nov. 23, 2016 for everything else – Required in the prospectus and in ongoing reports

Immediate Reg AB II Topics to Worry About

• Integrated Prospectus and New Shelf

• Planning for Depositor CEO Certification

• Asset Representations Reviewer Provision

• Planning for Asset-Level data.

Integrated Prospectus and New Shelf

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New public deals after Nov. 23, 2015 require compliance with new Reg AB forms – Asset-level data not required until Nov. 23, 2016

•

Working backwards to be effective by Nov 23: – File Form SF-3 Registration Statement in May or June – Initial Pilot Program filings won’t be publicly available in time – Good idea to coordinate timing with this year’s deals to avoid getting comments just before a deal launch

•

Shelf should continue to have spaceholders to permit flexibility in future takedowns

•

Fees: Apply outstanding fees and “pay as you go” thereafter

New Requirements for Shelf Eligibility

•

Removal of investment grade rating requirement

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New shelf eligibility transaction requirements (in addition to all prior shelf eligibility requirements): – Depositor CEO Certification – Asset Representations Reviewer Provision – Dispute Resolutions Provision – Investor Communication Provision

•

Registrant Requirements: Timely filing of Exchange Act Reports, Depositor CEO certifications and transaction documents with specified provisions as required by Form SF-3 – Includes annual compliance check of all timely filings 90 days after the end of the Depositor’s fiscal year – Now it will be even more important to have a process to assure timely filings

•

Pre-funding limit lowered to 25% from 50%

Depositor CEO Certification

•

Certification by Depositor’s CEO in each offering that: – To knowledge, prospectus has no false statements of material facts or material omissions – To knowledge, prospectus “fairly presents” asset characteristics, deal structure and risks of owning the securities, including risks affecting cash flows – To knowledge, reasonable basis to conclude that securitization is structured (but not guaranteed) to produce expected cash flows at times and in amounts to service scheduled interest and ultimate principal on the securities

Planning for Depositor CEO Certification

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Some companies may just do AAA/Aaa bonds publicly to avoid certification for subordinated bonds – Some companies may do 144A deals to avoid Depositor CEO certification • Is 144A market big enough? How much will pricing suffer?

•

Who is the right person to sign the certification?

•

Due diligence procedures – Go through prospectus line-by-line to determine procedures to assure accuracy – He/she must read the prospectus and review cash flow runs – Some companies intend to use internal certificates – Beef up Rule 193 procedures – Some companies will have review by a Disclosure Committee – How to get comfortable on cash flows?

Asset Representations Reviewer Requirement

•

“Asset representations reviewer” must be appointed pursuant to the transaction documents – Hired up-front – an additional cost in the deal – Sponsor can select – Must be independent from other transaction parties and must not have done pre-closing due diligence on the pool assets or its affiliates

•

Prospectus disclosure of reviewer’s identity, duties, compensation, indemnification and process to obtain review

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Review of at least all 60+ day delinquent assets for compliance with representations upon trigger events

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Results of review must be delivered to trustee and filed with SEC on Form 10-D

Asset Representations Reviewer Requirement

•

Asset representations reviewer must conduct a review when both of the following occur: – delinquencies exceed a certain threshold • No definition of “delinquencies” for this purpose • Sponsor can designate the threshold but must disclose in the prospectus how the threshold was determined to be appropriate and include a comparison of the threshold against the delinquencies disclosed for prior securitized pools of the sponsor for that asset type • Simple percentage as of a date, not a rolling average – requisite number of investors vote to conduct the review • If there is a minimum investor demand percentage for triggering a vote, it must be no more than 5% of the total investor interests outstanding • Once vote is triggered, no more than a simple majority of voting investors required to trigger the review

Planning for Asset Representations Reviewer Requirement

•

Who will provide asset representations reviewer services (must be independent of all transaction parties and due diligence providers)? – Pentalpha, Clayton, IAR, FTI, NewOak are some possible candidates

• Now is a good time to review reps and make them more “testable” – We have provided a draft of possible changes

•

How will we set the delinquency trigger? –

It’s important to assure that it’s not going to be hit

–

Need a justification for trigger in the Prospectus

•

Specify the review procedures (and costs) upfront

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Who pays for review costs? –

SEC has made clear in comments on Pilot Program registration statements that they want the sponsor to pay

SEC Comments

• Lots of miscellaneous comments – SEC conducted full review, not just new Reg AB II items.

• Issuers received between 31 and 96 comments • SEC requested that all exhibits be submitted with Amendment No.1 • Risk Retention – SEC wants bracketed section titled “Credit Risk Retention” – Include material terms of retained interest – Need to state amount/percentage that depositor expects to retain at closing of the transaction – Need to commit to provide the monthly disclosure required under risk retention rules – Post-December 2016 Disclosure • SEC had initially asked orally for post-December 2016 disclosure • Comments do not clearly indicate SEC will insist on this level of detail today, but “space holders” are clearly required. • Ford stated that it included its EHRI/Fair Value disclosure, and received the comment that it can’t assume straight line prepayments (Ford had made this assumption)

SEC Comments

• Sponsors’ ability to repurchase – No issuers have included sponsor financial information – SEC asked sponsor to confirm that there is no material risk of inability to repurchase

• Rule 193 – SEC asked sponsors to confirm that the NRSRO due diligence rules do not apply to their Rule 193 review

SEC Comments

• Asset Representations Review – Must specify that reviewer will not be affiliated throughout the life of the transaction – SEC wants disclosure about how investors can enforce their rights and how the costs of investor communications will be incurred – SEC rejected prohibiting a second review 36 months after first review is conducted – SEC asked one sponsor to make clear who has obligation to determine breach of reps • Note: Nobody has this obligation in an auto deal

SEC Comments

• Delinquency Trigger

– No comments from SEC where trigger was based on historical peak of 60 day delinquency plus a multiple with the actual number left blank. – When issuers included potential adjustments to trigger, SEC wanted disclosure about how adjustment of the trigger would be communicated to investors. – SEC rejected some adjustments to triggers in the credit card space (for example, changes in the accounts over a 3 year period). – SEC wanted an explanation of why it’s appropriate for one issuer’s statement that trigger could be waived during a Force Majeure Event (e.g., a repeat of Hurricane Katrina) and asked if the sponsor will determine whether event has occurred – SEC asked issuers whether defaulted and charged-off receivables would be included in calculation.

• Voting

– SEC rejected quorum requirement – SEC did not comment on voting time period with 90 days from reporting of breach of trigger to initiate the vote and required completion of vote in 150 days. – For another issuer, SEC asked why 60 days is appropriate and enough time for investors to communicate – SEC made clear that they think a 30 day voting period is too short

• Review

– SEC rejected sampling – SEC rejected sponsor proposals that the cost of review is paid by voting investors

SEC Comments

• Dispute Resolution • Staff did not like binding arbitration. Sounds like SEC won’t let you say you can’t both arbitrate and go to court • Note: Does this really mean that investors can get two bites out of apple and go to court if they don’t like the result in dispute resolution?

• General Theme: SEC is seeking to stop actions by issuers to put restrictions on investors exercising their new rights

Asset-Level Data

• Required in the prospectus and in ongoing reports – We expect this to be automatic in your systems – Difficult to handle on a “manual” basis each month

• New Schedule AL (Reg AB Item 1125) lists the assetlevel data requirements • Filings are to be on new electronic Form ABS-EE in XML format

Asset-Level Data and Related Privacy Concerns

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All asset-level data will be publicly available on an unrestricted basis

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SEC obtained guidance from CFPB that mitigates FCRA concerns for issuers – CFPB letter protects filings on EDGAR under regulatory requirements • May not protect a 144A deal or disclosure of anything not explicitly required by SEC rules, including disclosure under FDIC Safe Harbor

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Re-identification risk still exists, so potential liability under GLB and state privacy laws not completely eliminated

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Re-identification may also present potential reputation and customer relationship concerns

Planning for Asset-Level Data

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Is this a reason to do 144A rather than public deals?

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Need to start getting systems people in the loop to focus on the details now. There will be some “head scratchers” and programming changes.

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You’ll need to make some judgment calls, and may want to discuss some of those judgment calls with industry participants

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What AUP letters will be required? How much?

Timing Changes Related to Filing Requirements

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Final Reg AB II and Due Diligence Rules change the timeline for filings and delivery in connection with shelf offerings:

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Preliminary prospectus must contain all information other than price-related information and underwriting syndicate

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New structural feature or type of credit enhancement requires a post-effective amendment

Other Changes to Reg AB Disclosure Requirements

• Financial Information Regarding a Party Obligated to Repurchase Assets • Risk Retention (applies even before Risk Retention Rules become effective) • Beefed up Summary • Graphical presentation of Static Pool Data (if doing so would aid in understanding)

Regulatory Update

• GSE Reform and the Future of Mortgage Finance • Due Diligence/Rating Agency Rules • Regulation AB Proposals (“Reg AB II”) • Risk Retention • Money Market Fund Reform • Conflicts of Interest • Swaps • Regulatory Capital Changes • Liquidity Coverage Ratio

Risk Retention

• Compliance required for new deals beginning Dec. 24, 2016 (RMBS begins Dec. 24, 2015) • Sponsor of a securitization transaction generally must retain at least 5% of fair value as of the closing date of all “ABS Interests” in the transaction • Applies to asset-backed securities as defined in the Securities Exchange Act –

May see more private transactions intentionally structured as loans that are not Exchange Act ABS

• Forms of Risk Retention: –

Eligible vertical interest, •

Can be either: –

A single vertical security or

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An interest in each class of ABS Interests issued as part of the securitization transaction

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Eligible horizontal residual interest (or reserve account), or

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Any combination of the above

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Special rules for specific types of deals

• Requires description of methodology used to calculate fair values, including key inputs and assumptions like default rate and loss given default • Exceptions/0% Risk Retention if securitization consists entirely of Qualifying Auto Loans –

Criteria for Qualifying Auto Loans are completely unusable, including (i) DTI of less than or equal to 36%, verified through payroll stubs and the borrower’s credit report; and (ii) down payment 10% plus title, tax and registration fees and other add-ons

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Reduced risk retention (not lower than 2.5%) for “blended” pools of qualifying and non-qualifying loans

Risk Retention

• Many funding transactions are not “34 Act ABS”, so these rules don’t affect those deals • Unfortunately, the rules add greater disclosure and therefore greater potential liability – Includes disclosure of your expected loss assumptions

Regulatory Update

• GSE Reform and the Future of Mortgage Finance • Due Diligence/Rating Agency Rules • Regulation AB Proposals (“Reg AB II”) • Risk Retention • Money Market Fund Reform • Conflicts of Interest • Swaps • Regulatory Capital Changes • Liquidity Coverage Ratio

Money Market Fund Reform

• Most important changes (which greatly affect the MMF market, but don’t specifically affect ABS) in July 2014: –

Floating NAV

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Liquidity Fees and Redemption Gates

• Changes to ABS Diversification Requirements (for new ABS purchases by MMFs on and after April 14, 2016) –

Aggregation of Affiliates (majority ownership test) for Issuer Diversification Rules •

Limited to 5% of Fund’s assets –

•

–

Note: Exception for ABCP conduit ownership by SPE service companies

Also aggregated for determining 10% Obligors (except Restricted SPEs)

Treatment of ABS Sponsors as guarantors unless Fund’s Board has determined (and maintains a written record) that Fund is not relying on: •

Sponsor’s financial strength

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Sponsor’s ability or willingness to provide liquidity, credit support, or other support –

•

Will MMFs ever determine that a sponsor/servicer does not provide “support”?

Limited to 10% of Fund’s assets

• Proposed Changes (Comment Period for Proposed Rules expired October 14, 2014) –

In definition of “eligible security,” proposal to replace rating requirement with a board finding that a security’s issuer has “exceptionally strong capacity to meet its short-term financial obligations ”

–

Intended to comply with Dodd-Frank Section 939 which requires federal agencies to eliminate ratings references

Regulatory Update

• GSE Reform and the Future of Mortgage Finance • Due Diligence/Rating Agency Rules • Regulation AB Proposals (“Reg AB II”) • Risk Retention • Money Market Fund Reform • Conflicts of Interest • Swaps • Regulatory Capital Changes • Liquidity Coverage Ratio

Conflicts of interest

• Dodd-Frank Section 621 prohibits “material conflicts of interest” with ABS investors for year after closing – Both public and private deals • SEC Rule was broad and vague, with only very narrow exceptions – But Release made clear that only short transactions were intended to be prohibited • Synthetic securitizations might be completely prohibited • Final Rules could be adopted at any time • Porsche’s transactions are likely to be affected, but not in material respects

Regulatory Update

• GSE Reform and the Future of Mortgage Finance • Due Diligence/Rating Agency Rules • Regulation AB Proposals (“Reg AB II”) • Risk Retention • Money Market Fund Reform • Conflicts of Interest • Swaps • Regulatory Capital Changes • Liquidity Coverage Ratio

Clearing and Margin for SPE Swaps

• Mandatory Clearing – standardized and uniform swaps • “Securitization" swaps: – Idiosyncratic provisions – Conditional notionals

• Margin Requirements currently apply to cleared swaps • Discuss current status of clearing for SPE swaps • Margin proposals for uncleared swaps – How would we get margin into an SPE consistent with bankruptcy-remoteness? – Industry groups have asked for securitization exceptions

New CFTC No-Action Letter – Captive Finance Companies • Captive Finance Companies have an exemption from the swap clearing requirements under Dodd-Frank – Primary business is providing financing; – Uses derivatives for the purpose of hedging commercial risks related to interest rate or FX exposure; – 90 percent or more of which arise from financing that facilitates the purchase or lease of products; and – 90 percent or more of such products are manufactured by the parent company or another subsidiary of the parent company

• New CFTC No-Action Letter clarifies that securitization SPEs that are subsidiaries of “captives” get the benefit of the “captive” exemption

Regulatory Update

• GSE Reform and the Future of Mortgage Finance • Due Diligence/Rating Agency Rules • Regulation AB Proposals (“Reg AB II”) • Risk Retention • Money Market Fund Reform • Conflicts of Interest • Swaps • Regulatory Capital Changes • Liquidity Coverage Ratio

Securitization Regulatory Capital Rules

• Comments Accepted or Rejected by Basel III • Effect of Basel III on U.S. Risk-Based Capital Rules

Predicted Effect of Basel III on US Risk-Based Capital Rules Key Features of US Rules & Predictions on How Basel III & HQS May Change Them US Rule

Basel III Affect

• Removal of Risk Weight based on ratings

• No change

• 20% Risk Weight Floor

• Likely Change to Basel III 15% Floor

• Increased Due Diligence Requirements

• No Change

• Formulas for SFA

• Likely to be affected by IRBA & SSFA

• Definition of Securitization Focus: Credit risk transferred to third party; underlying are financial assets; outcome primarily relies on underlying; tranching; exclusion of commercial or industrial companies and hedge funds and print equity companies but not SIVs or CDOs

• No change

Predicted Effect of Basel III on US Risk-Based Capital Rules US Rule

Basel III Affect

• Operational Requirement - GAAP transfer - Real credit risk transfer - Eligible Clean-Up Call - Hold capital if on balance sheet - Deduct gain on sale from Tier One capital - One reason ABCP Conduits are disappearing - Can take synthetic securitizations off balance sheet if meet all synthetic requirements for eligibility

• No change

• Eligible Clean-Up Calls - Not structured to provide credit enhancement - 10% cap - Special Master Trust rules by tranche

• No change

• Determining RBC - Advanced Approach - SSFA & Gross Up - No RBA

- Probably some change – higher - Probably some change – higher - No change

Predicted Effect of Basel III on US Risk-Based Capital Rules US Rule • Determining RBC (continued) - 1250% vs. deduction - IO’s 100% RW - ABCP notional assessment of liquidity if off balance sheet (limited by amount of underlying pool (calculated without credit quality of pool)) - no use of IAA - no overlapping RW exposure - Senior Advances, if eligible, no capital; otherwise as if senior position with SSFA - SSFS, further simplied to replace RBA • 1250% up to Kirb • 20% RW floor • more capital if hold all tranches than if all assets on balance sheet

Basel III Affect - No change - No change - No change - No change - No change - No change • No change • Possible change to 15% • Possible change if held by Originator or Sponsor (but not investor)

Predicted Effect of Basel III on US Risk-Based Capital Rules US Rule

Basel III Affect

• Determining RBC (continued) - Relevant factors: underlying exposures Kg attachment point detachment point adjustments for correlation (.5 x W parameter)

- Possibly change as to formula with regard to affect of maturity and tranche maturity - May increase to 1.0

• Credit Risk Mitigation

• No likely change

• Enhanced Disclosures risks, policies on monitoring, mitigation policies, SPEs, accounting policies

• No likely change

HQS • US Agencies have no definitive unified position other than being generally negative/lukewarm - improve capital - self-monitored and disclosed - no harm to existing market

• Trying to build consensus to use as tool to improve RBC results - unclear; I don’t think FDIC enthusiastic - EU favors third party monitor - scarlet letter affect

Regulatory Update

• GSE Reform and the Future of Mortgage Finance • Due Diligence/Rating Agency Rules • Regulation AB Proposals (“Reg AB II”) • Risk Retention • Money Market Fund Reform • Conflicts of Interest • Swaps • Regulatory Capital Changes • Liquidity Coverage Ratio

LCR outflows – Commitments to SPEs – US rules US banking agencies’ final rule §__.32(e)

(e) Commitment outflow amount. (1) A [BANK]’s commitment outflow amount as of the calculation date includes: … (iii)-(iv) [10 / 30] percent of the undrawn amount of all committed [credit / liquidity] facilities extended by the [BANK] to a wholesale customer or counterparty that is not a financial sector entity or a consolidated subsidiary thereof, including a special purpose entity (other than those described in paragraph (e)(1)(viii) of this section) that is a consolidated subsidiary of such wholesale customer or counterparty; (vi)-(vii) [40 / 100] percent of the undrawn amount of all committed [credit / liquidity] facilities extended by the [BANK] to a financial sector entity or a consolidated subsidiary thereof, including a special purpose entity (other than those described in paragraph (e)(1)(viii) of this section) that is a consolidated subsidiary of a financial sector entity, …; … (viii) 100 percent of the undrawn amount of all committed credit and liquidity facilities extended to a special purpose entity that issues or has issued commercial paper or securities (other than equity securities issued to a company of which the special purpose entity is a consolidated subsidiary) to finance its purchases or operations, and excluding liquidity facilities included in paragraph (b)(2) of this section [provided by bank sponsor to non-consolidated conduit]; and (ix) 100 percent of the undrawn amount of all other committed credit or liquidity facilities extended by the [BANK].

US Banking Agencies Final Rule § __.32(b)

• Commitment outflow amount to a structured transaction involving an off-balance sheet issuer is the greater of: 1. 100% of all issuer obligations maturing within 30 days plus all issuer commitments to purchase assets within 30 days; and 2. The maximum contractual amount required to be provided to issuer within 30 days through a funding agreement.

US LCR Trade Receivables Securitization Illustration

Originator

SPE 1

Bank

On Balance Sheet ABCP Conduit 2

Bank

Off Balance Sheet ABCP Conduit (independent) 3

Bank

Off Balance Sheet ABCP Conduit (sponsored) 4

Bank

Facts: • Originator sells Trade AR to SPE on an ongoing basis under a working capital facility (clearly a credit facility) –

Note that liquidity vs. credit is no longer determined by what the documents “express”

• SPE obtains a revolving credit facility (“VFL”) from Bank directly and through one on and two off balance sheet conduits. Each VFL has an outstanding balance of 50 million and an undrawn commitment of 50 million. • No ABCP conduit has a commitment under its VFL for the undrawn commitment amount, but the Bank has a commitment to the SPE instead.

Results: 1

• Bank’s 50 million outstanding does not impact LCR directly. • Its undrawn commitment limits LCR denominator with an outflow rate of 10%. • Total LCR denominator: 5 million

2

• On balance sheet conduit 50 million is funded with CP. 100% of CP maturing within 30 days is included in LCR denominator. (Options to extend, put, etc. do not impact this result.) • Bank’s committed parallel purchase facility to SPE treated same as ① above. • Bank’s liquidity and credit to conduit are eliminated through consolidation. • Total LCR denominator: 5 million plus CP < 30 days (50 million) = 55 million

3

4

• • • •

Independent off balance sheet conduit’s outstanding CP does not hit Bank LCR directly. Bank’s committed parallel purchase facility to SPE treated same as ① above, if it exists. Bank’s structured liquidity to conduit has a 100% outflow rate to entire undrawn amount. Total LCR denominator: 5 million plus 100 million = 105 million

• Sponsored off balance conduit’s outstanding CP does not hit Bank LCR directly. • Bank’s committed parallel purchase facility to SPE treated same as ① above. • Bank’s liquidity/credit to conduit equals greater of (x) outstanding CP maturing within 30 days plus conduit commitment (0); and (y) maximum amount that may be drawn in 30 days. IF Bank support is limited to conduit CP, this will equal CP maturing in 30 days or less. • Total LCR denominator: 5 million plus CP < 30 days (50 million) = 55 million • Therefore ② and ④ treated equally.

Bank Regulatory Changes

• The “Frightful Five”: – Higher capital charges – Future leverage ratios – Liquidity Coverage Ratio – Net Stable Funding Ratio – CCAR

• These elements create incentives for banks to get assets off balance sheet and to fund with liabilities longer than one year • ABCP/warehouse funding will likely be less attractive and less available in the future • Solutions: – Warehouse funding in capital markets (i.e., Ford 2014-REV) – More term ABS – Banks will increasingly try to get their assets off balance sheet – Exit businesses that can’t work in the future environment

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