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New financing structures for RMBS residuals raise red flags

Unless an exemption applies, “neither a retaining sponsor nor any of its affiliates may pledge as collateral for any obligation (including a loan, repurchase agreement, or other financing transaction) any ABS interest that the sponsor is required to retain with respect to a securitization transaction pursuant to subpart B of this part unless such obligation is with full recourse to the sponsor or affiliate, respectively. [emphasis added]”

For RMBS, the transfer and hedging restrictions expire on or after the date that is (1) the later of (a) five years after the date of the closing of the securitization or (b) the date on which the total unpaid principal balance of the securitized assets is reduced to 25 percent of the original unpaid principal balance as of the date of the closing of the securitization, but (2) in any event no later than seven years after the date of the closing of the securitization. A sponsor that retains a B-piece also may transfer it to a qualified third-party purchaser after five years from the closing date.

Sponsors of RMBS securitizations, where no exemption applies, seeking to pledge residual securities from RMBS transactions as collateral for non-recourse financing where they have a right, but not an obligation, to repurchase the collateral may be able to evade realizing losses under GAAP, as such transaction may not be deemed to be a “true sale” by their accounting firm; however, they do so at their own risk as this practice is expressly prohibited by Section 15G – and the potential consequences are severe.  Additionally, lenders who facilitate these transactions may incur regulatory liability unless they first confirm their non-recourse loans are not secured.

Section 15G includes a variety of exemptions including an exemption for asset-backed securities that are collateralized exclusively by residential mortgages that qualify as “Qualified Residential Mortgages” (“QRM”).  While Section 15G has been effective since February 23, 2015, it defines QRM to mean “Qualified Mortgage” as defined in Section 129C of the Truth-in-Lending Act (“QM”).

The Consumer Financial Protection Bureau (“CFPB”) amended the general definition of QM in the Truth-in-Lending Act’s implementing regulation (“Regulation Z”) which became mandatory  on October 1, 2022.  In doing away with the objective test (debt-to-income ratio < 43% calculated in accordance with Appendix Q) the CFPB clarified that both QM loans containing the mere presumption of compliance and Non-QM loans utilizing bank statements to verify income or assets must source deposits into the consumer’s bank account to confirm the deposits are income and not, for example proceeds from a loan.  Sourcing deposits poses an additional layer of risk and uncertainty when a consumer has a commingled bank account.  How can a creditor possibly differentiate and prove which portion of a deposit is income v. prepayment of expenses (such a building materials)?

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