The Federal Reserve Board on October 5, 2009 issued a press release announcing proposed changes to its Regulation A to provide for a method by which the Federal Reserve Bank of New York may screen credit rating agencies' capacity to rate securities eligible for participation in the Term Asset-Backed Securities Loan Facility (TALF).
The TALF was created to provide liquidity to securitized asset markets covering a range of asset classes from auto ABS, student loan ABS, to commercial mortgage-backed securities (CMBS). The proposed rule would address concerns that only a limited number of credit ratings agencies are currently permitted to rate collateral pledged to the TALF.
The proposed rule would apply only to the following four categories of ABS: 1) auto loans, floorplan loans, and equipment loans, 2) credit card and insurance premium finance loans, 3) mortgage servicing advances, and 4) student loans. Small business loans eligible for the TALF would not be subject to the proposed rule because they are fully backed by the U.S. government and thus need not be rated. Similarly, CMBS will not be subject to the proposed rule due to the special considerations that apply to this class of securities.
According to the proposed rule, the Federal Reserve Bank of New York may accept the ratings of a credit rating agency if: 1) the agency is registered as a NRSRO with the Securities and Exchange Commission to rate ABS, 2) the agency has a current and publicly available rating methodology for a specific category of TALF eligible ABS, and 3) the rating agency demonstrates the requisite experience to aid the Federal Reserve Bank of New York's risk assessment process regarding TALF collateral. The rule states that the experience must consist of rating the most senior classes of newly issued ABS within one of the four TALF ABS categories publicly or to paid subscribers in at least ten transactions since September 30, 2006.
The supplemental information included with the proposed rule explains that the ten transaction rule was selected because the transaction features within the four TALF ABS categories are "homogenous" such that experience with one type of ABS within a category may serve as experience for other types of ABS within the same category. Also, ten transactions within a three year period would be sufficient to demonstrate experience in rating a particular type of ABS. In the case of mortgage servicing advances, a rating agency may satisfy the ten transaction rule by including ratings of residential mortgage-backed securities (RMBS) (It should be noted that RMBS currently is not eligible collateral for TALF loans). However, ratings agencies would not be allowed to leverage experience in one TALF ABS category to other TALF categories because of the significant differences across categories.
Under the proposed rule, a credit rating agency seeking to rate TALF eligible ABS collateral would be required to provide written notice and other information regarding their qualifications to the Credit, Investment, and Payment Risk group at the Federal Reserve Bank of New York. A decision on the agency's eligibility would be made within five business days following submission of all required information. The proposed rule would mandate that a credit rating agency also discuss with the Federal Reserve Bank of New York the credit risk of eligible transactions on which the agency has consulted with an issuer and provide any additional information about its qualifications that may be requested.
The Fed's proposal lists numerous specific items for which the Fed is soliciting comment from the public. Comments on the Fed's proposed rule are due in writing no later than 30 days after the proposal has been published in the Federal Register.
I thank my esteemed colleague Mark Nelson for this post.