Many supply chain finance programs are structured on what is called a “buyer-led” or “buyer-focused” basis. In certain of these types of programs, although the bank or other financier providing the program (the “Finance Provider”) may purchase accounts receivable represented by invoices or otherwise provide funding to a number of suppliers, the true customer of the Finance Provider is a single corporate buyer of goods and services (the “Buyer”) for whom the program has been arranged (a “payables finance program”). In certain other programs, a Finance Provider does not purchase the accounts receivable but instead relies only on a promise from the Buyer to make payment to the Finance Provider on supplier invoices the Finance Provider has funded (a “corporate payment undertaking program” and collectively with payables finance programs, “buyer-focused programs”). Whatever method is used, the Buyer’s active support of the program is the key to making the program marketable. Although the Buyer does not typically have any involvement in the relationship between the Finance Provider and suppliers directly, the Buyer will often have considerable control over which suppliers may be approached for participation in the program and what invoices will be made available for funding (the “Approved Invoices”).
In late December 2020, New York Governor Andrew Cuomo signed S.B. 5470 into law, which will impose a range of Truth in Lending Act-like disclosure requirements on providers of commercial financing in amounts of $500,000 or less. The law will have a significant impact on providers beyond traditional commercial lenders, as it broadly defines “commercial financing” to include the providers, and third-party solicitors, of sales-based financing, closed-end commercial financing, open-end commercial financing, factoring transactions and other forms of commercial financing as the New York Department of Financial Services may provide. S.B. 5470 will impact a broad range of nonbank and fintech companies offering smaller balance commercial financing, following in the footsteps of a similar law enacted in California in 2018.
Read more in Mayer Brown’s Legal Update.
I was only 9 years old when Jan and Dean in 1963 released their hit song “Dead Man’s Curve.” I thought about this song when I read the Conference of State Bank Supervisors’ (“CSBS”) Proposed Regulatory Prudential Standards for Nonbank Mortgage Servicers (the “Proposal”). Published for comment on September 29 with comments due by the end of the year, the Proposal seeks to impose on US nonbank mortgage servicers many of the safety and soundness or prudential standards required of insured depository institutions by federal banking regulators. The goal, it appears, is to “get ahead of the curve” of the potential for mortgage servicer failures resulting from widespread mortgagor delinquencies. While that objective is reasonable in principle, the question is whether a state-imposed “one size fits all” financial strength requirement could cause the very mortgage servicer failures that the standards are designed to prevent.
We previously wrote a Legal Update describing the Proposal. The focus of this Legal Update is the financial strength requirements specified in the Proposal. CSBS seems to recognize that bank safety and soundness standards might not be a comfortable fit for nonbank mortgage servicers when CSBS asks interested parties, among other questions, to provide comments on a fundamental “gating” issue—namely, is the need for state prudential standards sufficiently established?
The Proposal includes minimum net worth and capital ratio requirements that in part track FHFA (the conservator and regulator of Fannie Mae and Freddie Mac) requirements, and the Proposal requirements are designed automatically to adjust as FHFA’s requirements are modified. One of the questions it asks is whether its financial strength standards should be tied to FHFA requirements.
Specifically, the Proposal would require nonbank mortgage servicers to maintain the higher of (1) $2.5 million net worth plus 25 basis points of owned unpaid principal balance for total 1–4 unit residential mortgage loans serviced or (2) FHFA eligibility requirements. The Proposal would apply this methodology to all owned residential servicing rights, without regard to the terms of the servicing agreement, such as whether the servicer is contractually obligated to make monthly advances of principal and interest if the borrower does not pay. With respect to capital requirements, nonbank mortgage servicers would be required to maintain the higher of (1) net worth/total assets equal to or greater than 6% or (2) FHFA eligibility requirements. These align with FHFA’s current requirements.
The liquidity requirements in the Proposal also track FHFA requirements. Under the Proposal, nonbank mortgage servicers would be required to maintain liquidity at an amount that is the higher of (1) 3.5 basis points of aggregate unpaid principal balances of agency and non-agency servicing or (2) FHFA eligibility requirements. CSBS explained that because servicing loans in forbearance, delinquency, or foreclosure imposes additional costs on servicers, the Proposal includes additional liquidity requirements for non-performing loans. This additional requirement would equal the higher of (1) an incremental 200 basis points charge on non-performing loans for the portion of agency and non-agency non-performing loans greater than 6% of total servicing or (2) FHFA eligibility requirements. This tracks FHFA’s existing requirements, although FHFA discounts the size of the outstanding balances of loans in CARES Act forbearance. Also, the Proposal would require servicers to maintain sufficient allowable assets to cover normal operating expenses in addition to the amounts required for servicing expenses.
Allowable assets to satisfy these liquidity requirements include unrestricted cash and cash equivalents and unencumbered investment grade assets held for sale or trade. Allowable assets do not include unused or available portions of committed servicing advance lines of credit or other unused or available portions of credit lines such as normal operating business lines; prior to this month, this exclusion was part of the revisions to Fannie Mae’s and Freddie Mac’s financial strength requirements that FHFA proposed in January 2020 and later rescinded in June 2020 pending further rulemaking. To the surprise of the industry, Fannie Mae and Freddie Mac each announced the adoption of this exclusion on December 16, 2020, effective March 31, 2021.
In addition to these requirements, the Proposal would apply enhanced standards to servicers that are deemed to be “Complex Servicers.” Complex Servicers are servicers that own whole loans plus servicing rights with aggregate unpaid principal balances totaling the lesser of $100 billion or representing at least 2.5% of the total market share. These servicers would be required to meet enhanced capital and liquidity standards that require the servicer’s management and board of directors to develop a methodology to determine and monitor its capital and liquidity needs.
Our prior Legal Update identifies the genesis of the Proposal. While not explicitly stated in the Proposal, there appear to be two types of major regulator concerns relating to the financial strength of nonbank mortgage servicers. The first is whether mortgage servicers can meet their contractual obligations to advance principal and interest to whole loan or mortgage-backed securities holders under the terms of the relevant servicing agreements, if a substantial percentage of borrowers go delinquent and do not soon reinstate. COVID-19 exacerbated this concern this year by virtue of the statutory right of eligible borrowers to seek mortgage forbearance under either the CARES Act for government-related mortgage loans or the laws of some states for other loans.
Luckily, in light of the continuing refinancing boom, the ability of servicers under their servicing agreements to use excess custodial funds from full prepayments as an interim source of funds to make principal and interest advances materially reduced the potential hardship on mortgage servicers to meet these advance obligations. But an increase in interest rates could diminish the availability of excess custodial funds to pay for principal and interest advances. What happens if a mortgage servicer cannot come up with the funds it needs to make required advances?
The second concern is whether mortgage servicers can meet their contractual obligations under their borrowing facilities that they obtained to finance the making of advances and the acquisition and holding of mortgage servicing rights. These facilities often are secured by the mortgage servicer’s interest in all or a portion of its mortgage servicing rights, based on a prescribed loan-to-value ratio. If the value of the servicing rights declines, the servicer either has to provide additional collateral or partially prepay the loan in order to maintain the required loan-to-value ratio—a so-called “margin call.” In a worst case scenario, the creditor could declare the mortgage servicer in default under the loan agreement and seek to seize the mortgage servicing rights, which most likely would result in a default under the agency servicing agreements. While the Proposal’s (and FHFA’s) financial strength requirements do not directly account for the financial covenants in a mortgage servicer’s borrowing facilities, the existence of the debt and the impact of margin losses would be reflected in the calculation of net worth.
In either case, a mortgage servicer’s default, under either a servicing agreement or a commercial loan agreement, theoretically could result in a mortgage servicer failure with resulting harm to borrowers. The fact that this “parade of horribles” could occur does not mean that it is reasonably likely to occur—that either a servicer would fail or, if it did, the failure would cause widespread harm to borrowers. Indeed, Fannie Mae, Freddie Mac, and Ginnie Mae have subservicers in place to take over the servicing functions on an interim basis for servicers terminated with cause. They have utilized these arrangements for years without reports of material consumer harm.
But that does not mean that state regulators want to wait until the risk of a servicer failure eventuates to find out for sure that the likelihood and severity of consumer harm is low; it understandably wants to get “ahead of the curve.” The Proposal is designed to minimize the likelihood of a mortgage servicer’s financial failure. Yet the good faith pursuit of a worthy public policy objective does not mean the Proposal as constituted makes sense.
A key issue under the Proposal is whether there should be prescriptive, state-mandated financial strength requirements, and, if so, what should they be and how will they be enforced? There is nothing unique or outlandish about a state licensing authority wanting to impose financial strength standards on a licensed entity. Many state mortgage banking licensing laws already do that, although there is little history of state requirements comparable to those in the Proposal.
The bigger issue is what should those standards be? Should they equal FHFA standards for Fannie Mae or Freddie Mac approved servicers? Should they be higher than these standards? Should FHFA standards even apply for servicers who only service non-agency loans? Is there another approach to address the same concerns?
Agency Financial Strength Requirements
As noted above, agency servicers already have to meet agency financial strength requirements on net worth, capital, and liquidity. Requiring an agency servicer to meet the financial strength requirement of the agencies for which it services has a simple logic to it. But converting a contractually imposed continuing eligibility requirement into a law or regulation could cause a problem in state enforcement. Each of Ginnie Mae, Fannie Mae, and Freddie Mac has the discretion to waive or alter these financial strength requirements based on its evaluation of the relevant circumstances. This flexibility to act quickly when necessary or appropriate may take many forms and is informed by their “hands-on” knowledge of the servicer’s performance and profile to support a judgment to take a less drastic alternative than declaring default.
Depending on the final form that the Proposal might take for any particular state, state regulators may not have the same flexibility when administering fixed laws and regulations. This difference between fixed and discretionary standards could create the anomalous result of a state or states imposing administrative sanctions on a mortgage servicer for failing to meet agency financial requirements when the agency itself determined in its informed judgement not to declare a default and exercise remedies. These state sanctions could create a series of cross-defaults resulting in the failure of a mortgage servicer even though the agency itself elected initially not to declare a default under the servicing agreement.
It is hard to fathom a compelling reason for state regulators to prescribe financial strength requirements that are higher than those of Fannie Mae, Freddie Mac, and Ginnie Mae for agency servicers. One of the primary risks about which the state regulators seem to be most concerned—meeting principal and interest advance requirements in a time of high borrower delinquencies—is the very risk to which these agencies manage because they bear the direct risk of loss if a servicer fails to meet this advance obligation. Moreover, Fannie Mae and Freddie Mac are subject to their own federal supervision and examination and are subject to regulatory safety and soundness standards, and Ginnie Mae is part of a federal agency, the Department of Housing and Urban Development. Where is the data-driven analyses to support the states’ exercise of different judgments about the required financial strength of mortgage servicers in connection with federally related servicing agreements?
Similarly, why would state regulators require non-agency servicers to meet the financial strength requirements of Fannie Mae and Freddie Mac, if the non-agency servicing agreements do not require servicers to advance principal and interest and servicers may not have financed their mortgage servicing portfolio? There should be a rational relationship between the state financial strength requirements and the contractual obligations and financial profile of the mortgage servicer. Such a relationship is not readily apparent in the non-agency servicing world under the Proposal. As non-agency approved servicers tend to be smaller than their approved counterparts, a “one size fits all” approach pegged to agency financial strength requirements also could have a particular adverse impact on smaller mortgage servicers, again perhaps needlessly resulting in a smaller mortgage servicer’s failure by virtue of the imposition of state administrative sanctions.
An Alternative Approach
An alternative approach is to abandon a fixed quantitative formula for determining financial strength requirements and instead utilize a pure “principles-based” regulatory perspective—namely, that a mortgage servicer must meet in all material respects the financial strength requirements under the servicing agreements to which it is subject. Under this approach, a state could not impose its judgement on how much net worth, capital, or liquidity is enough or not enough or how to calculate these metrics; it could not question the determinations of the counterparties to a mortgage servicer’s servicing agreements. A decision by an investor under a servicing agreement to waive a potential breach of its financial strength requirements automatically would pass-through to the state standard. A principles-based approach recognizes that the risk of a mortgage servicer’s financial failure would be the direct the result of a contractual counterparty declaring a default and exercising remedies based on a servicer’s inability to meet material contractual obligations.
As noted above, aside from the risk of servicer licensees failing to make principal and interest advances, state regulators also are particularly concerned about the potential for a mortgage servicer’s material losses resulting from margin calls on loans secured by mortgage servicing rights. But the impact of margin calls on a servicer’s financial strength is reflected in its financial statements through a reduction in indebtedness and a reduction in cash, with any resulting changes in the servicer’s net worth and liquidity. In any event, while the Proposal links a mortgage servicer’s financial strength requirements to those of FHFA, secured creditors have their own financial strength requirements for their mortgage servicer borrowers. In many respects, the financial risk profile of mortgage servicers under commercial loan agreements is very much like their profile under servicing agreements with the agencies and thus serve as a “second set of private eyes” to monitor a mortgage servicer’s financial profile.
First, commercial lenders impose sophisticated affirmative and negative financial covenants on its mortgage servicer borrowers in their credit agreements, including the continuing covenants to comply with state licensing laws and agency eligibility standards for financial strength. These agreements provide the creditor with robust remedies it may elect to exercise if the mortgage servicer defaults under the credit agreement.
Second, in each case, the investor under the servicing agreement and the commercial lender under the credit agreement bears the direct credit risk of loss if the mortgage servicer defaults on its contractual obligations and has a broad array of risk management controls and contract remedies to address this risk.
Third, federally insured depository institutions often serve as commercial credit providers to mortgage servicers and are themselves subject to safety and soundness standards and supervision and examination by their federal regulators. Fourth, commercial lenders have the discretion to waive, modify, or vary any of their contractually imposed affirmative and negative covenants, or elect not to declare a default and accelerate the outstanding indebtedness, based on their evaluation of the totality of the circumstances; if a state were to impose administrative sanctions on a mortgage servicer for failing to meet financial covenants in a loan agreement as to which the creditor elected not to declare a default, a series of cross-defaults could follow, resulting in the failure of a mortgage servicer.
The one problem with this approach is timing. Mortgage servicers annually upload their audited financial statements to the NMLS. A lot can happen in a year, and state regulators likely do not want to be caught “flat footed” if a licensee suffers a material adverse financial effect during the year. But that concern is easily resolved through the supervisory powers of a state mortgage regulator to request interim financial results to assess a licensee’s continuing compliance with the financial strength requirements of its servicing agreements.
Collective State Action
Financial strength requirements, regardless of how formulated, could wreak havoc if the states do not act in unison. As drafted, the Proposal seemingly would permit any single state regulator to restrict or terminate a license of a servicer that allegedly is in violation of that state’s financial requirements. Such a unilateral act likely would set in motion a series of parallel state actions, even though the investors under the servicing agreements or the commercial creditors under loan facilities formulated their own action plans to address the financial issues without declaring a default. This makes no sense and again could cause the result that the Proposal is designed to limit.
One should not blame CSBS and state regulators for wanting to get “ahead of the curve” in monitoring for a potential collapse of a mortgage servicer. But imposing prescriptive, mandatory financial strength requirements in a “one size fits all” manner may have an unintended material adverse effect on mortgage servicers—a regulatory “dead man’s curve”—particularly if the states either disregard a servicer’s contract counterparties election not to declare a default or fail to act in unison in response to a servicer’s financial hardship.
The Consumer Financial Protection Bureau (“CFPB”) issued two relatively welcome surprises yesterday. First, along with ditching a debt-to-income ratio (“DTI”) ceiling, the agency expanded its proposed general Qualified Mortgage (“QM”) to include loans up to 2.25 percentage points over the average prime offer rate. Mortgage lenders can opt in to the new QM as early as 60 days after the rule is published (so, likely by late February 2021), although compliance becomes mandatory July 1, 2021. Second, the CFPB will begin allowing loans to season into a QM after 36 months of timely payments, so long as the loan is not sold more than once (and is not securitized) during that time.
The CFPB otherwise recently issued a separate final rule, confirming once and for all that the GSE Patch – a temporary QM category for loans eligible for purchase by Fannie Mae or Freddie Mac – would expire on the mandatory compliance date of the agency’s rule revising the general QM definition. Since 2014, in general terms, a closed-end residential mortgage loan could only constitute a QM if the borrower’s DTI did not exceed 43%, or if the loan were GSE-eligible. As the GSE Patch’s expiration date (January 10, 2021) loomed, the CFPB promised to rethink the 43% DTI requirement and provide for a smooth and orderly transition to a post-Patch QM. In considering the public comments it received, the CFPB decided to loosen up on a couple of its proposals.
Specifically, the new general QM and its compliance protection will apply, under the final rule, to a covered transaction with the following characteristics:
- The loan has an annual percentage rate (“APR”) that does not exceed the average prime offer rate (“APOR”) by 2.25 or more percentage points;
- The loan meets the existing QM product feature and underwriting requirements and limits on points and fees;
- The creditor has considered the consumer’s current or reasonably expected income or assets, debt obligations, alimony, child support, and DTI ratio or residual income; and
- The creditor has verified the consumer’s current or reasonably expected income or assets, debt obligations, alimony, and child support.
The final rule removes the 43% DTI threshold and the troublesome Appendix Q. However, the rule retains the distinction between safe harbor and rebuttable presumption QMs, with the same 1.5 percentage point threshold.
The final rule provides creditors significant flexibility and room for innovation in considering and verifying the factors described above. However, the CFPB provides for a safe harbor if the creditor follows the verification standards in specified single-family underwriting manuals of Fannie Mae, Freddie Mac, the Federal Housing Administration, the Department of Veterans Affairs, or the Department of Agriculture. A creditor even may pick-and-choose among those agency standards. If an agency updates its standards from the versions in the final rule, a creditor still may rely on the updated standards so long as they are substantially similar. Determining what constitutes a “substantially similar” version may lead to future headaches. However, a creditor does not have to follow those safe harbor agency standards, so long as it complies with the rule’s obligation to verify the amounts on which it relies.
The CFPB had proposed to use an APR rate spread of 2.0 percentage points over APOR. However, the agency apparently looked closely at rate spread and delinquency data and determined that a 2.25 percentage point spread “strikes the best balance between ensuring consumers’ ability to repay and ensuring continued access to responsible, affordable mortgage credit.” The final rule provides different thresholds for relatively small loans and/or subordinate-lien loans.
The final rule maintains the proposed rule’s approach of not prescribing any particular underwriting standard. Under the final rule, a creditor must maintain written policies and procedures for how it takes into account, pursuant to its underwriting standards, income or assets, debt obligations, alimony, child support, and monthly DTI or residual income in its ability-to-repay determination. The creditor also must retain documentation showing how it considered those, including how it applied its policies and procedures. The rule’s commentary clarifies that the required documentation may consist of the creditor’s underwriting standards, plus an underwriter worksheet or a final automated underwriting system certification for each loan, along with any applicable exceptions.
As mentioned above, in addition to the expiration of the GSE Patch and the newly-revised general QM definition, the CFPB issued a final rule to allow for a loan to become a safe harbor QM after 36 months of timely payments. The CFPB had proposed that a loan could only become a so-called seasoned QM if the originating creditor held the loan in portfolio during that 36-month period. While timely payments for 36 months may indicate that the borrower had the ability to make the payments, that portfolio requirement would have restricted access to the seasoned QM category to a relatively narrow set of mortgage lenders.
However, the CFPB heeded the pleas of certain commenters by providing, in its final rule, that a loan may still become a seasoned QM if it is sold, assigned, or otherwise transferred once before the end of the seasoning period, provided the transaction is not securitized before the end of that period. That means that a loan’s status as a QM could change if the loan is subsequently resold or securitized. To emphasize the requirement that the creditor still must diligently underwrite the loans, the final rule requires that in order for a loan to become a seasoned QM, the creditor must have complied with the same consider and verify requirements that will apply to general QM loans as summarized above.
The final rule also provides that high-cost mortgages (otherwise known as HOEPA or Section 32 loans) cannot season into QM status, and thus can never achieve more than a rebuttable presumption of ability to repay. Otherwise, even if the loan is a higher-priced mortgage loan (but not a HOEPA loan), it can season into a safe harbor QM if it otherwise meets all the requirements.
As a reminder, the seasoned QM status is available only for a first-lien, fixed-rate mortgage loan that satisfies the product-feature requirements and limits on points and fees under the general QM loan definition. With certain exceptions, the loan must not have had more than two delinquencies of 30 or more days or any delinquencies of 60 or more days at the end of the seasoning period. While the servicer may choose not to treat a payment as delinquent if it is deficient by only $50 or less, the servicer generally may not do so more than three times during the seasoning period. The final rule contains significant criteria and certain exceptions for determining whether payments are timely. The rule will kick in for loans for which creditors receive an application on or after the rule’s effective date (which will be 60 days after publication in the Federal Register).
However, it appears that the QM status of a loan with points and fees that inadvertently exceed the limit (3% for most loans) cannot be salvaged. Currently, the CFPB’s regulations provide that if the creditor (or assignee) discovers after consummation that the total points and fees exceed 3%, the creditor/assignee may cure the loan’s QM status by paying the consumer the excess (plus interest) within 210 days after consummation (unless prior to that point the consumer had notified the creditor/assignee/servicer of the excess, or the consumer had become 60 days past due on the loan). The creditor or assignee also would have needed to have policies and procedures in place to review points and fees post-consummation. However, this points-and-fees cure provision is set to expire for loans consummated on or after January 10, 2021. The CFPB did not extend this provision in its final rules.
Mayer Brown intends to issue a full description of the CFPB’s final QM rules through a Mayer Brown Legal Update, as well as a discussion of the rules through our Global Financial Markets Initiative teleconference/podcast series.
In this Winter 2020 edition of our Structured Finance Bulletin, we provide updates on recent legal and regulatory developments in the consumer loan space as well asthe latest on the transition from LIBOR.
We also analyze the Federal Housing Agencies and GSE updates to COVID-19 relief measures for mortgage loan borrowers and US M&A considerations for Fintech Businesses during the COVID-19 pandemic.
Finally, we review recent Volcker Rule revisions and developments in the EU Securitisation Regulation and the EU securitization market as a whole and address legal issues in cross-border trade receivable securitizations and the CFPB QM proposal for the GSE Patch.
Learn more about Structured Finance practice and Get the Full Issue here.
Please visit us at mayerbrown.com.
Financial Statement Disclosure of Supply Chain and other Trade Payables Programs
Trade payables programs have in recent years increased greatly in popularity among both large and small companies. While originally the sole domain of the large global banks and firmly based on a fairly straightforward reverse factoring model, these programs are now offered by banks and many non-bank market participants using a variety of structures and funding sources.
As we discussed in our post on April 22, 2020, the “Big Four” accounting firms and the Office of the Investor Advocate of the SEC, among others, have recently been calling for guidance from the Financial Accounting Standards Board (“FASB”) on two distinct issues with respect to the financial reporting of trade payables programs: (i) the financial statement disclosure requirements for public companies utilizing such programs and (ii) whether such programs should be treated as trade payables on a company’s balance sheet or, instead, as short-term debt obligations. According to critics, the increased popularity of these programs, along with the relatively modest disclosures required currently under US GAAP are raising questions as to whether these trade payables programs potentially obscure the financial reality of companies from investors. In particular, critics have expressed a concern that these programs – which sometimes allow for longer terms for a company’s trade payables than the company would be able to negotiate in the absence of such a program – (i) could cause artificial improvements to a company’s cash flow that could evaporate overnight if the financier of its payables program decided to discontinue funding and (ii) could potentially obscure a company’s true leverage. However, proponents of these programs argue, among other things, that these programs serve a vital economic function by providing efficient working capital to a company’s supplier base without in any way distorting the underlying supplier/buyer commercial relationship or the trade payable nature of the company’s obligations.
Last Wednesday, FASB held a board meeting to discuss whether developing guidance with respect to trade payables programs should be added to their agenda. FASB made clear that this proposed agenda item does not include examination of supplier-led factoring, receivables purchase or receivables securitization arrangements. The scope of the proposal only includes buyer-led trade payables programs.
During the meeting, the Board members voted 5-2 in favor of adding the creation of guidance on disclosure requirements with respect to trade payables programs to their agenda. However, FASB declined, for now, to take up the issue of whether trade payables programs should be classified as trade payables or short-term debt on balance sheets, although some Board members acknowledged that this may be necessary at some point. Should this be the case, it is likely that the Board would need to delve into the legal substance of trade payables structures, which varies greatly from program to program.
FASB’s next steps will include the solicitation of feedback from companies and their accounting firms, the development of a draft proposal, a public comment process and the issuance of final guidance. The guidance that will eventually be provided by FASB should speak to the nature and extent of disclosure that will be required in financial statements with respect to these programs. Given the importance of these questions for the supply chain finance industry, we anticipate that, in the coming months, industry participants will be keen to convey to FASB the importance and durability of the payables product.
On Friday, October 9, 2020, the US Internal Revenue Service released Revenue Procedure 2020-44 (the “Revenue Procedure”), providing retroactive but limited relief for amending specific types of legacy contracts to add fallback mechanics for LIBOR or other IBORs. The fallback language included must rather strictly follow select model contract language recommended by the Alternative Reference Rate Committee (the “ARRC”) and the International Swaps and Derivatives Association (“ISDA”).
The only permissible deviations from the prescribed ARRC or ISDA contract language are deviations (a) reasonably necessary to make the terms incorporated into the contract legally enforceable in a relevant jurisdiction or to satisfy legal requirements of that jurisdiction, (b) from the terms of an ISDA fallback that are reasonably necessary to incorporate the ISDA fallback into a contract that is not a “protocol covered document” as defined in the ISDA protocol, (c) to omit terms of an ARRC fallback or an ISDA fallback that cannot under any circumstances affect the operation of the modified contract (for example, for a contract that refers only to USD LIBOR, omission of the portions of an ISDA fallback that relate exclusively to contracts referring to another IBOR), and (d) from the terms of an ARRC fallback or an ISDA fallback to add, to revise, or to remove technical, administrative, or operational terms, provided that the addition, revision, or removal is reasonably necessary to adopt or to implement the ARRC fallback or the ISDA fallback
The Revenue Procedure applies to contracts entered on or after October 9, 2020 and before January 1, 2023. It is also retroactive, as taxpayers are permitted to rely on it for modifications to contracts occurring before October 9, 2020.
Mayer Brown will be releasing a Legal Update summarizing the Revenue Procedure in more detail in the coming days.
In what we understand to be the first state law to do so, California’s Assembly Bill 913 (AB913), which was enrolled on September 4, 2020, amends Section 850 of the Public Utilities Code to allow electrical corporations to apply for a required financing order from the California Public Utility Commission (CPUC) to use securitization to recover verified incremental undercollections in calendar year 20201 through authorized fixed recovery charges.
AB913 notes that securitization is a “proven method of stabilizing rates by smoothing rate increases over a longer period of time” and finds that, as a result of the COVID-19 pandemic, many customers have been unable to pay their electrical utility bills and, further, that electricity consumption has decreased. Consequently, the amount of revenue the electrical corporations, regulated by the CPUC, will recover is expected to be below authorized forecasts, so—in order to avoid otherwise likely rate increases in a time of economic stress and uncertainty—AB913 notes that the CPUC should be authorized to approve the securitization of these revenue shortfalls.
AB913 requires verification of either or both of the following incremental undercollection amounts for calendar year 2020:
(i) An incremental undercollection amount equal to the difference between the forecasted amount of billed revenues for that year, based on the authorized sales forecast, and the revenues actually billed by an electrical corporation with respect to all revenue balancing accounts if the incremental amount as a percentage of the forecasted amount of billed revenues for that year is at least 5 percent.
(ii) An incremental undercollection amount equal to the residential and small business customer bad debt expense recorded for that year that exceeds the bad debt expense for that year that was adopted by the CPUC in the general rate case if the incremental undercollection amount is otherwise eligible for recovery in rates.
AB913 defines a “revenue balancing account” to mean a balancing account reflecting the balance between the electrical corporation’s authorized revenue requirements relating to the volumetric sale of electricity and billed revenues associated with those sales. A revenue balancing account includes accounts reflecting the balance between the electrical corporation’s authorized distribution base revenue requirements and recorded billed revenues from authorized distribution rates, and accounts reflecting the difference between the amount of the discount provided to consumers enrolled in the California Alternative Rates for Energy (“CARE”) program and the CARE surcharge charged to non-CARE consumers, but shall not include amounts reflecting the balance between costs and expenses relating to fuel and purchased electricity by the electrical corporation.
AB913 also prohibits the recovery through any other cost recovery application, mechanism, or request by the electrical corporation of any incremental undercollection amounts subject to a CPUC-approved financing order and requires that the CPUC ensure that any costs included in incremental undercollections subject to a financing order are just and reasonable, consistent with the requirements of subdivision (a) of Section 850.1.
While, by focusing on revenue undercollections, AB913 may avoid some of the technical and other difficult issues2 in determining COVID-19 “costs,” this law may raise issues regarding the qualification of a related securitization for the preferential treatment provided by the Internal Revenue Service in its related revenue procedure 2005-62.
On 3 September 2020, two regulations were published regarding the detailed disclosure requirements under the Securitisation Regulation (the “Disclosure Technical Standards“). These consist of regulatory technical standards concerning the information and the details of a securitisation to be made available (the “Disclosure RTS“), and implementing technical standards with regard to the standardised templates (the “Disclosure ITS“). The Disclosure Technical Standards will enter into force 20 days after publication, i.e. on 23 September 2020.
Read the Legal Update here.