The Securities Industry and Financial Markets Association sent a letter to federal regulators Thursday asking to clarify how risk retention will be calculated under the proposed rule. In March, major banking regulators including the Federal Deposit Insurance Corp., proposed a rule requiring lenders to retain 5% credit risk on a loan after securitization. Along with designating what loans will be exempted from the rule, regulators issued guidance for how the risk retention will be calculated. Under the proposed rule, an originator-seller of the loan can take either a horizontal- or vertical-shaped risk retention. Under the horizontal option, the lender takes a first-loss position, where it would take a surbordinate interest in the issuer, thereby facing losses before any other class of investor. Taking a vertical risk means the lender is exposed to 5% of the credit risk that each class of investors has to the underlying collateral on a pro-rata, or an equal portion, basis. A third option allows the lender to take an “L-shaped” risk, combining both the horizontal and vertical forms. To qualify for this option, the lender must retain at least a 2.5% stake in the issuer (the horizontal option) and a 2.564% stake of the “par value” of all of the security’s interests (the vertical option). When securitizing other products such as commercial mortgages or other paper, lenders are required to fund a premium capture cash reserve. It would be equal to the difference between the “par value” of the ABS being issued and the proceeds from the sale. SIFMA raised the question on how that slice, whether it’s horizontal, vertical or otherwise, and the fund would be calculated. Specifically, the trade group wanted clarification on how the regulators define “par value.” “Par value” is generally understood to be the stated value or face amount of the security, but SIFMA doesn’t believe that definition translates to the risk retention rule. “It has come to our attention that the Agencies may have conceived of par value as somehow related to or involving a calculation of the market value of an issuing entity’s ABS interests,” SIFMA said. “This is a crucial distinction which, we can assure you based on discussions with our members, is not well understood by those who have read the proposed rules and the accompanying commentary.” They requested the regulators publish an explanation of what “par value is intended to mean.” A spokesperson for the FDIC said the proposal is currently open for comment until June, and regulators will digest the comments before issuing a final rule. Write to Jon Prior. Follow him on Twitter @JonAPrior.

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