The process of transforming 2,000 pages of Dodd-Frank into 25,000 pages of regulations is well under way. Front and center is Risk Retention. I assume you, like me, have been studying the 300 plus pages of the proposed Risk Retention rules (known to the cognoscenti as the Risk Retention “NPR”) for the past several weeks getting ready for the June 10th deadline for comments, right? Oddly, almost a full month passed before the government actually posted the NPR to the Federal Register, something which is usually done in a matter of days. (Tea leaf readers, thoughts?)

We have visited Risk Retention in this Blog before, but today we want to really focus on premium capture as it seems to capture all that is wrong with the NPR. My first reaction to reading the words on the page: Where the hell did this come from? On the fifth read, same reaction. There was nary a hint of the premium capture monstrosity in either Dodd-Frank or in the whispering about the rule-making process before the NPR came out.

On its face, and we absolutely have to start here, it says a securitizer who monetizes either an IO or earns a premium on the sale of P&I bonds, has to put that money in a box. That box serves as a first loss reserve for any losses on the loans for the life of the deal. The authors muse (they almost seem to chuckle) in the commentary that it’s unlikely that anyone will ever do this because it is onerous and therefore securitizations will be done without premium. Huh? Why, in Heaven, would a bank hire an origination team, build out technology, make loans, warehouse and hedge loans and assemble a pool for sale if it was not going to make a profit? I mean, we all know greed has a bad odor these days, but, good heavens, this is still a capitalistic economy, isn’t it?

Now, about the actual text of premium capture. In conversations following publication of the NPR, the regulators have told anyone who asks that the premium capture provisions were not properly drafted, and that what it really is all about is ensuring that the securitizer, who elects to satisfy risk retention with a horizontal first loss piece, retains 5% of the value of the underlying loans (the NPR curiously uses the term “par” to mean value). Regulators have gone on to say this is easy to achieve if securitizers would just stop their nefarious practice of stripping coupon and attach that interest to the first loss piece where it should always have been in the first place. Then, the bottom 5% would equal 5% of the value of the loans in the pool.

Disturbing, huh? And on so many levels.