The Federal Deposit Insurance Corp. (FDIC) approved an advanced notice of proposed rule-making regarding safe harbor protection of failed institutions' assets being transferred for securitization. The new rule-making comes after a move in mid-November to grandfather securitization or participations in process through March 31, 2010 through a transitional safe harbor. Under this safe harbor, assets being transferred for securitization cannot be seized by the FDIC if the issuing firm fails or is taken over in receivership. "The misalignment of incentives in securitizations has contributed to massive losses to insured institutions, to the [deposit insurance fund] DIF, and to our financial system," said FDIC chairman Sheila Bair. "Fostering a sustainable securitization market that emphasizes transparency, loan quality, risk retention, and appropriate incentives and authorities for restructuring troubled loans will restore investor confidence and help banks diversify their funding sources while managing interest rate risk for longer dated assets." Bair added: "The sample regulatory text for conditions to a FDIC safe harbor would, I believe, go far towards correcting the weaknesses in securitization that contributed to the crisis and is very consistent with the direction of legislation in the House and Senate." With Financial Accounting Standards (FAS) 166 and 167 taking effect Jan. 1, 2010, most securitizations will not meet off-balance-sheet standards for sale treatment, the FDIC said in a statement Tuesday. In a statement on the FDIC's advance notice of proposed rule-making on securitizations, Comptroller of the Currency John Dugan said the suggested 5% credit risk retention would make sales treatment more difficult to achieve under FAS 166 and 167, with capital and credit constriction implications. He indicated that limiting securitization transactions to no more than six credit tranches could inhibit the flexibility of issuers to meet differing cash flow needs of various investors. He also said it might restrict investor interest if this structure is not deemed as liquid as competing alternatives. Dugan said the suggested requirement that all residential mortgages in a securitization comply with all regulatory standards as well as supervisory guidance in effect at the time of origination would complicate the assessment of the loans for qualification. He asked: "How would compliance with this standard be evaluated? And what if a very minor portion of a securitization did not qualify?" In an interview Monday with the Institutional Risk Analyst (IRA), Michael Krimminger, special advisor for policy to the chairman of the FDIC, said the advance notice of proposed rule-making will set new requirements on future securitizations established after March 31st. "The conditions we will be proposing to our Board focus on residential mortgage backed securitizations because we have seen the clearest evidence of the problems created by the misalignment of incentives in that asset class," he said. "These conditions focus on key issues that investors, banks and many others have been asking about -- greater transparency, simpler capital structures, clearer terms defining the roles and responsibilities of parties to the transaction, strengthened standards for loss mitigation, and risk retention." Krimminger added: "Fundamentally, what we are hearing is that investors will not return to RMBS, particularly, without greater transparency throughout the deal and about the securitized assets. That is also crucial to safer securitization for banks and the DIF." The IRA's interview with Krimminger will appear in an upcoming issue of HousingWire, due to hit mailboxes in January. Write to Diana Golobay.