Issue 5: What Consents Are Required?

Consent Issues

As discussed in the previous part of this article, M&A transactions involving financial assets that are subject to securitization may require the consent of numerous third parties. The consents required to transfer these financial assets, regardless of whether a buyer is proposing to acquire an entire loan origination and/or servicing business or just certain financial assets, is often driven by the transaction structure. Generally, if the transaction is structured as an asset sale, which would trigger the various assignment provisions in the operative servicing agreements, the consent process is more time-consuming and complicated because the transaction will entail a complicated third-party consent process. If the transaction is structured as a merger or a sale of stock (or, in some instances, as a sale of substantially all of the seller's servicing platform assets), however, the transfer process is generally less complicated and timeconsuming because the third-party consent provisions may not be triggered (although there may be other requirements that the parties must satisfy before closing).

Consent Issues in an Asset Sale. If a buyer and a seller structure a securitization M&A transaction as an asset sale, nearly all of the operative servicing agreements involved will contain an assignment provision that sets forth extensive requirements that must be satisfied prior to the transfer/ assignment. Because servicing is such a critical component of any financial asset financing, third-party stakeholders in the financing will want to confirm that a proposed M&A transaction involving the transfer of servicing to a new servicer will not weaken the performance of the financing. In nearly every instance, therefore, various third-party deliveries will typically need to be obtained prior to closing.

  • Rating Agencies. Some of the more important third parties in a securitization that the buyer and the seller will need to work with during the M&A transaction process are the rating agencies. Under the operative servicing agreements, the identified rating agencies may have to confirm prior to transfer that the proposed transaction will not result in a reduction of credit ratings, which requires the parties to obtain a "no downgrade" letter from each of these agencies prior to closing. Similarly, servicing agreements in the mortgage context will often require that the new servicer be Fannie Mae- and/or Freddie Mac-approved and that each of Fannie Mae and Freddie Mac provide written consent to the transfer. The buyer may need to complete the relatively complicated and time-consuming Fannie Mae and/or Freddie Mac qualification process prior to servicing the assets. Obtaining written consent from the GSEs can also be time-consuming, and this process, along with the qualification process (if applicable), should be initiated as soon as practicable in the deal timeline.
  • Master Servicer, Trustee, Trust Administrator, Depositor. Generally, prior written consent of the master servicer, trustee, trust administrator, depositor, purchaser and owner (in each case, as applicable) is also required under servicing agreements prior to a transfer of servicing. Although time-consuming, obtaining these third-party consents is typically not problematic, except in cases where security holder consent is required.
  • Security Holders. Some servicing agreements will expressly require the consent of security holders (typically, the noteholders of asset-backed securities) holding a certain percentage (often a majority or 66%) of the outstanding securities prior to the transfer of servicing. In addition, even though trustees may have discretionary powers under servicing agreements as to whether security holder consent should be obtained prior to a servicing transfer, trustees may be more likely to seek security holder consent following the credit crisis in an attempt to insulate the process from potential liability. Soliciting security holder consent is generally undesirable for a buyer and a seller in a M&A transaction because of the inherent difficulty of attempting to obtain consent from a wide pool of public security holders. The time and expense required to properly stage a security holder consent and the potential unpredictability of the results makes it a very onerous process. As such, the parties should work with the trustee as soon as possible in the transaction process to determine whether security holder consent is needed (if it is not expressly required under the servicing agreements). Trustees will typically take into account the experience and creditworthiness of the proposed servicer and the extensiveness of other security holder protections, such as rating agency confirmation and master servicer consent, when determining whether security holder consent is needed. Understanding what a trustee needs to consent to a servicing transfer without obtaining security holder consent in the early stages of the transaction can save the parties considerable transaction costs.

Consent-Based Price Adjustments. A purchase price variation seen in securitization-related M&A transactions arises from consent-based price adjustments. Where the primary assets of the business are securitization or customer agreements and multiple consents are needed to transfer ownership, the buyer may only be willing to close on assets for which consents have been received. In this case, each contract is assigned a price and the buyer closes and pays for that contract only when consent is obtained.

Consent Issues in a Merger or Stock Sale. If a buyer and a seller structure a securitization M&A transaction as a merger or a stock sale (or, in some instances, as a sale of substantially all of the servicer's assets), the transfer process can be less difficult, because the transfer provisions in servicing agreements are generally more relaxed in the case of a merger or stock sale. Typically, under these transaction structures, third-party consents are not needed, but the buyer's proposed servicer must satisfy several regulatory and financial requirements. For example, in a mortgage transaction the buyer's servicer must generally be Fannie Mae, Freddie Mac and/or HUD approved and its deposits must be FDIC-insured. In addition, the buyer's servicer may be required to satisfy certain financial thresholds (e.g., have a GAAP net worth of at least $25 million) and the proposed transfer cannot result in a reduction of credit ratings (i.e., a "no downgrade" letter must be obtained from the relevant rating agencies). Given the complex language of servicing agreements and ambiguities that may arise, each relevant agreement should be carefully analyzed by the parties to ensure that the transfer process outlined in the agreements is correctly interpreted.

Approval of State and/or Federal Mortgage Regulators. Finally, because of the heightened scrutiny that governmental authorities have placed on the consumer finance industry, a mortgage M&A transaction may require the approval of state and/or federal mortgage regulators. These regulators may want to confirm that the buyer will adequately manage the financial assets that it is proposing to acquire. These regulatory concerns may lead to detailed preand post-closing covenants for the buyer and the seller.

Amendments to Servicing Agreements. In addition to the often lengthy and complicated consent process, the proposed transfer of a securitization sponsor's platform or certain of its assets (in particular, servicing rights) also generally requires that each of the operative servicing agreements be amended in order to effect the proposed transaction. This process is typically document intensive involving numerous parties, which can essentially require a mini-closing for each of the amendments. This process normally involves a negotiation with the trustee and depositor that are parties to the relevant servicing agreement with respect to the language of the amendment, obtaining a "no downgrade" letter from each of the relevant rating agencies (the rating agencies typically provide one "no downgrade" letter that covers the consent to the amendment and the transfer of servicing rights), obtaining legal opinions with respect to the authorization of the amendment and tax matters and obtaining miscellaneous third-party consents (e.g., consent from a collection agent if a collection agent agreement is in place).

Issue 6: Should the Seller Engage in Reverse Due Diligence?

A new issue arising for bank and non-bank sellers that are regulated by the CFPB is what level of due diligence sellers must engage in with respect to their buyers. Nonbank servicers that are owned by private equity or hedge funds have become very common bidders. A seller should be concerned with the regulatory and litigation history of its bidders as well as their licensing status, including whether a prospective bidder has taken aggressive positions relating to compliance matters. These compliance issues can impact a bidder's ability to close a transaction and may present potential liability for the seller. Buyer representations and covenants relating to its pre-closing and post-closing conduct have become much more common and assist the seller in completing its due diligence of the buyer.

The Office of the Comptroller of the Currency (the "OCC") and the CFPB have made it clear that a seller cannot just walk away from a consumer loan portfolio without some assurances that the portfolio will be handled properly after the closing. For example, 2014 CFPB regulations impose affirmative obligations on transferors of servicing to mitigate servicing disruptions when loans are transferred, and provide that examiners will consider the steps taken by the transferor servicer to minimize disruptions, including transferring loan information and identifying loss mitigation in process. In addition, in 2013 the OCC issued best practices for national banks and federal savings associations involved in consumer debt sales, including requiring that national banks have risk management policies in place and take a number of steps prior to selling any debts to a third party, which include establishing initial and ongoing due diligence of third-party debt buyers and minimum criteria for approving debt buyers. Consent decrees issued by the OCC, the CFPB and states regulators provide strong warnings to banks reselling distressed debt (e.g., a bank cannot sell debts that have been paid, settled, discharged or do not

have the required documentation and must not use robosigned affidavits). Even if the seller is not directly regulated by the OCC or the CFPB, it should consider whether the seller or the buyer may be swept within OCC or CFPB supervision, or similar federal or state supervision, in the future and whether the seller should diligence the buyer as if their rules and guidance applied.

Finally, the bank seller may need to address OCC and FRB guidance regarding outsourcing and third-party vendors. While the outsourcing guidance may not typically apply in a sale context, where a transaction contemplates future loan sales on a flow basis or a subservicing agreement for certain assets not transferred, this guidance should be considered. Covenants addressing third-party risk management issues (audit, compliance, indemnity, etc.) may be needed for the seller.

While the OCC guidance only applies to national banks and federal savings associations, the CFPB guidance and regulations are applicable to all residential mortgage and other servicers. The OCC bulletins are generally applicable to national banks, which includes most of the largest issuers of credit cards. However, the CFPB has also expressed some similar concerns about these types of practices and has viewed its UDAAP provisions as applicable to both firstand third-party debt collection. Given the focus by the New York Department of Financial Services and banking regulators on MSR and other financial asset sales to non-bank finance companies, reverse due diligence will continue to be a hot topic.

Issue 7: What SEC Disclosure Issues Arise?

Both the buyer and the seller must be aware of what SEC disclosure requirements will be triggered in connection with an M&A transaction involving a securitization sponsor or servicer. Potential SEC disclosures could be triggered by (i) events or circumstances that occurred prior to the M&A transaction and (ii) any ongoing or future deals after the M&A transaction closes. These potential SEC disclosure requirements are very fact-specific and will heavily depend on the structure of the M&A transaction. A non-exhaustive list of some common disclosure requirements for sponsors and servicers in public securitization transactions during and after M&A transactions is contained below.

Regulation AB

Sponsor: Rule 1104(c) of Regulation AB ("Reg AB") provides that a description of the sponsor must be provided and that the description must include "to the extent material, a general discussion of the sponsor's experience in securitizing assets of any type. . .." In addition to the general description, a more detailed discussion of the sponsor's experience should be included when securitizing assets of the type included in the current transaction. An example of a material instance that should be disclosed includes "whether any prior securitizations organized by the sponsor have defaulted or experienced an early amortization triggering event." Even though no clear time period for this disclosure requirement is provided in Rule 1104(c)(1), the materiality qualifier makes it clear that, if it is determined the experience is material, it should be disclosed no matter how long ago it happened. The buyer should diligence the sponsor's securitization history and anticipate the need to make these disclosures.

Rule 1104(e) of Reg AB provides that the issuer must disclose the information required by Rule 15Ga-1(a) (17 CFR 240.15Ga-1(a)) concerning "all assets securitized by the sponsor that were the subject of a demand to repurchase or replace for breach of the representations and warranties concerning the pool assets for all asset-backed securities" for a period of three years. Therefore, the buyer must obtain information from the seller as to whether any assets it is buying were subject of a demand during this time frame.

Static Pool: Rule 1105(a)(1) of Reg AB requires that static pool information, to the extent material, should be provided for either (i) the previous five years or (ii) "[f]or so long as the sponsor has been either securitizing assets of the same asset type. . .if less than five years." Static pool information should include delinquencies, cumulative losses and prepayments for prior securitized pools of the sponsor (for the same asset type). Since this potentially ongoing disclosure could affect how investors view current and future transactions, the buyer should diligence this information for at least the relevant time period mentioned above.

Depositor: Rule 1106 of Reg AB contains the same disclosure requirements for the depositor as included in Rule 1104(c) for the sponsor.

Servicer: Rule 1108(b)(2) of RegAB requires disclosure, to the extent material, of "a general discussion of the servicer's experience in servicing assets of any type as well as a more detailed discussion of the servicer's experience in, and procedure for the servicing function it will perform in the current transaction for assets of the type included in the current transaction." Similar to the sponsor's disclosure requirement, Reg AB only requires a "general" discussion of all other asset types and requires more detail when the current transaction includes the same assets. Rule 1108(b)(3) states that any material changes to the servicer's policies or procedures in the servicing function it will perform in the current transaction for assets of the same type should be disclosed for the previous three years. Since policies and procedures may change when a servicer is purchased by a buyer, it is important to have a clear understanding of the previous policies and procedures and know the differences that will be implemented as a result of the M&Atransaction. Finally, Rule 1108(d) provides that the "material terms" of the servicer's removal, replacement, resignation or transfer be disclosed. A buyer may need to provide this information if a servicer is actively servicing one or more of the seller's outstanding deals and will no longer be doing so after the M&A transaction.

Legal Proceedings: Rule 1117 of Reg AB emphasizes a point that should already be taking place in an M&A transaction—a buyer should diligence legal proceedings pending against the sponsor, depositor or servicer, as applicable. This information should be disclosed if it is, or will be, deemed "material to security holders." Once again, there is no clear time period provided in Reg AB. Therefore, as long as the proceeding is pending or active against a relevant entity, it should be disclosed to investors, if material.

Compliance with Applicable Servicing Criteria: Rule 1122(c)(1) of Reg AB includes additional disclosures that should be included in Form 10-K. For example, material instances of noncompliance with the servicing criteria, otherwise known as "MINCs," should be disclosed on Form 10-K. Whether the identified instance involved assets of the same type or different type should be disclosed in the Form 10-K. This is another reason why the buyer should ensure it receives an acceptable data tape and thoroughly review the data tape for diligence reasons. There is no time period included in Rule 1122(c)(1).

Instruction 1 to Rule 1122 clarifies that the "assessment should cover all asset-backed securities transactions involving such party that are backed by the same asset type backing the class of asset-backed securities which are the subject of the SEC filing." For example, if the buyer is purchasing both the mortgage and auto businesses of the seller, MINCs arising in servicing the mortgages will not need to be disclosed in the public auto securitizations. This has created an incentive for parties to actively separate its platforms, especially when dealing with a sponsor that securitizes multiple asset types. A buyer may want to keep the newly purchased platforms and assets separate to limit the scope of the required assessment.

Form SF-3: Any registrant that meets the eligibility requirements of Form SF-3 may use Form SF-3 for the registration of asset-backed securities. To be able to use Form SF-3, the transaction and registrant requirements must be met. The transaction requirements specify that the registrant must timely file (i) a certification in accordance with Item 602(b)(36) of Regulation S-K signed by the CEO of the depositor and (ii) all transaction agreements containing Reg AB's asset review, dispute resolution and investor communication provisions. The registration requirements specify that, during the 12 calendar months (and any portion of a month) prior to filing, the depositor and all affiliated depositors of the same asset class must have timely filed (i) all 1934 Act Reports and (ii) all documents listed under the transaction requirements above. The buyer should carefully diligence the seller's compliance with these requirements.

There is an annual compliance check 90 days after the end of the depositor's fiscal year. Failure to timely file the 1934 Act reports will result in (i) the inability to file a new shelf registration statement and (ii) the inability to issue additional securities from the applicable shelf registration statement for a period of one year (starting on the date of the compliance check). However, note that the depositor would be able to complete takedowns from the date of the failure up to the date of the compliance check. This penalty is commonly referred to as the "death penalty" since there is no cure once the filing deadline is missed. Failure to timely file the documents related to the transaction requirements will result in the inability to file a new shelf registration statement. A filing failure in connection with the transaction requirements will be deemed cured 90 days after all required filings are filed. Note that, if the filing failure was corrected at least 90 days prior to the date of the compliance check, there would be no lapse in ability to issue.

However, Form SF-3 includes a carve-out for business combination transactions that states:

"Regarding an affiliated depositor that became an affiliate as a result of a business combination transaction during such period, the filing of any material prior to the business combination transaction relating to asset-backed securities of an issuing entity previously established, directly or indirectly, by such affiliated depositor is excluded from this section, provided such business combination transaction was not part of a plan or scheme to evade the requirements of the Securities Act or the Exchange Act."

Therefore, assuming the business combination transaction was not completed with the intention of evading SEC requirements, a buyer may be able to avoid liability and/or penalties in connection with missed filing deadlines by the seller. However, the buyer typically seeks a representation from the securitization seller that it has timely filed all of its securities filings in any event.

Form 8-K: Section 6 of Form 8-K provides that, even though many of the disclosure requirements in Form 8-K exclude asset-backed issuers, a change in servicer will still need to be disclosed. If a servicer, as contemplated by Rule 1108 of Reg AB, has "resigned or has been removed, replaced or substituted, or if a new servicer has been appointed," the date of the event and the circumstances surrounding the change must be disclosed in Form 8-K. Therefore, if a seller sells a servicer with outstanding deals, it will have to report the date and circumstances. Similarly, if a buyer is replacing a servicer with a newly purchased servicer for its outstanding deals, it will also have to report the date and circumstances.

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