November 12, 2010
COMMENTS OF THE MINNESOTA HOUSING FINANCE AGENCY ON
PROPOSED RULE 15GA-1 REQUIRING DISCLOSURE FOR ASSET-BACKED SECURITIES
Need for Clarification of the Municipal Securities Subject to Rule 15Ga-1
We understand that the Securities and Exchange Commission (the SEC) in promulgating proposed rule 15Ga-1 believed that it could not grant a general exemption for municipal securities, given the breadth of the definition of asset-backed security in Section 941 of the Dodd-Frank Act. We appreciate that the SEC is seeking comments on the need for further guidance on the application of the rule to municipal entities. (75 Federal Register 62720) Even if the SEC cannot recognize the exemption for municipal securities granted under the Securities Act of 1933 and the Securities Exchange Act of 1934 for purposes of this Section of Dodd-Frank, distinctions among municipal securities can still be made by the SEC for purposes of the proposed rule. For the reasons that follow, we strongly urge that the proposed rule be clarified to provide that municipal securities to which the issuer has pledged its general obligation or other assets not financed by the securities be exempt from the rule.
Mortgage revenue bonds issued by state or local governments may be secured by residential single-family mortgage loans, and so may in a sense be asset-backed securities, but those bonds may also secured by the general obligation of the issuer or by additional reserves or other assets of the issuer. For example, the Minnesota Housing Finance Agency, like many state housing finance agencies, issues single family mortgage revenue bonds that are secured by residential single-family mortgage loans but also are secured by the general obligation of the Agency. The bonds are issued under an open parity bond resolution, under which the Agency has substantial flexibility, subject to certain covenants, to sell loans or withdraw loans or other assets. The Agency has its own issuer credit rating which recognizes the creditworthiness of its general obligation pledge and its general obligation pledge has supported the issuance of a series of single family mortgage bonds even when specific loans were not pledged to pay the bonds.
Under its single family lending program, the Agency purchases mortgage loans for first-time homebuyers meeting the requirements of Section 143 of the Internal Revenue Code and that are originated by private lenders. In participation agreements with the Agency relating to the Agencys single family lending program and not specific bond issues, the private lenders originating the mortgage loans make general representations and warranties regarding compliance with industry underwriting standards and legal and program requirements (including Section 143 requirements) and agree to repurchase loans if such representations or warranties prove false. Because these participation agreements may be considered underlying transaction agreements with a repurchase covenant, without clarification the Agency may be regarded as a securitizer in respect of its single family mortgage bonds and subject to the rule.
This result is not warranted for several reasons. First, Section 943(2) of Dodd-Frank provides that the SEC shall prescribe regulations that require any securitizer . . . to disclose fulfilled and unfulfilled repurchase requests across all trusts aggregated by the securitizer (emphasis added). To our knowledge, trust as used in this Section is not defined in Dodd-Frank. Given its ordinary meaning in the context of asset-backed securities, trust would not be interpreted to include an issuer that pledges its general credit to securities also secured by a stand-alone or open portfolio of mortgage loans. This is implicitly acknowledged by the SEC itself in the proposing release. In note 17 at 75 Federal Register 62720, the SEC advises readers to consult a treatise by Robert A. Fippinger for a discussion of municipal ABS. The section of the treatise cited makes precisely this distinction. Mr. Fippinger states: A structured financing is an obligation secured by the cash flow capability or the collateral value of a specified asset or pool of assets. The credit analysis is shifted from the creditworthiness of the issuer-obligor and its revenues to the quality of assets assembled to secure the transaction. Robert A. Fippinger, THE SECURITIES LAW OF PUBLIC FINANCE vol. 1, Section 1:62B, 1-70 to 1-71 (2d ed. Practicing Law Institute 2010) Consequently, the SEC should exempt from the rule securities to which the issuer has pledged its general credit or other assets.
Second, the text of the proposed rule itself excludes at least certain municipal securities from its application since the rule requires disclosure of information concerning all assets originated or sold by the sponsor. (Proposed Rule Section 229.1104(e)(1)) Minnesota Housing neither originates single family mortgage loans, since it purchases them from originating lenders, nor sells the loans, since it owns them (or mortgage-backed securities backed by such loans) subject to the pledge in favor of the Agencys bondholders. While this may appear to be a wooden interpretation of the rule, it arises in part from the substantive distinction described in the preceding paragraph, because the Agency does not convey the assets to a trust. So that an exemption from the rule for municipal securities secured at least in part by the creditworthiness of the issuer does not depend on whether the issuer originates the loans, the rule should provide for a clear exemption for such securities.
Third, the distinction between municipal securities issued by issuers who pledge their general credit or other assets and asset-backed securities issued by trusts also is relevant to the policies behind the rule. Section 943 was enacted to address the situation where poor underwriting standards coupled with unenforceable representations and warranties by securitizers exacerbated investors losses in ABS. (75 Federal Register 62732) But in the context of municipal securities backed by the issuers general credit or other assets, it is the issuer, and not investors, who suffer loss if repurchase obligations are not honored. The issuer has a substantial interest in enforcing the repurchase obligations, and investor demands for enforcement (which is one of principal concerns of the SEC in the proposing release) are nonexistent. Furthermore, the representations and warranties made by originating lenders in the context of municipal single family mortgage bonds are more general than the representations and warranties made in respect of asset-backed securities issued by trusts, because the quality of the loan portfolio, while still important, ordinarily is not as critical to investors in municipal bonds. Consequently, applying the rule to these municipal securities will not further the purpose of the Dodd-Frank legislation.
Fourth, under the proposed rule the disclosures are to be made on EDGAR, noted to be a central repository for such information. (75 Federal Register 62732) But the central information repository for municipal securities is EMMA, operated by the MSRB, pursuant to SEC Rule 15c2-12. If investors in municipal asset-backed securities are intended to be beneficiaries of the rule, it makes little sense for the disclosure information to be filed on EDGAR. Evidently, investors in municipal securities are really not the intended beneficiaries of the rule but perhaps municipal issuers should nonetheless disclose this information because if their originating lenders default in their repurchase obligations, that information may be material to investors in asset-backed securities issued by trusts in which the same originating lenders have repurchase obligations.
But, finally, even this purported rationale makes little practical sense. Single family mortgage loans financed with tax-exempt bonds issued by municipal issuers must comply with the first-time homebuyer requirements set forth in Section 143 of the Internal Revenue Code. Those requirements are technical and many, and do not relate to the security afforded by the loan. In the experience of Minnesota Housing, most of the repurchase obligations that have been triggered in its single family mortgage portfolio relate to violation of those tax requirements, and not general underwriting criteria. Consequently, the incidence of repurchase obligations in the municipal context is not directly relevant, and may be misleading, to investors in asset-backed securities in the taxable market.
For all of the foregoing reasons, the SEC should exempt from application of the rule municipal asset-backed securities to which the issuer has pledged its general credit or other assets. The further policy reason for doing so is to honor the principle of intergovernmental comity that is also embodied in the Tower Amendment (Section 15B(d)(1) of the Exchange Act), even if the SEC believes that that statutory provision is not directly applicable to Section 943 of the Dodd-Frank legislation.