Securitization Disclosure and Document Updates for 2020 and 2021
The "Securitization Disclosure and Document Updates for 2020 and 2021" panel featured Structured Finance and Securitization partners Prachi Gokhale, Christina Burgess, Josh Yablonski and Joe Topolski and was moderated by partner John Keiserman. The discussion ranged from the effects of the COVID-19 pandemic on the structured finance industry, to the eventual cessation and replacement of the London Interbank Offered Rate (LIBOR), and concluded with an outlook to recent securities law changes that will affect offerings in 2021 and beyond. Here are the top five takeaways from the panel.
Impact of COVID-19 on Risk Factors
The COVID-19 pandemic has had a far-reaching impact on the disclosure for asset-backed securities offerings and has brought about several changes throughout the year, in particular to the disclosed risk factors. Most issuers prominently featured pandemic-specific risk factors in their disclosure documents, which focused on the uncertainty brought about by the pandemic. These risk factors were both general, covering macroeconomic trends such as unprecedented unemployment and an anemic economy, and industry-specific, covering legislation adopted to offset the effects of the COVID-19 pandemic on the underlying securitized collateral and obligors. In particular, the panel discussed challenges for servicers of the underlying assets. Servicers found their ability to collect on the underlying assets impaired by legislative moratoriums preventing repossession of the securitized assets for delinquent payments, and many implemented self-imposed obligor relief programs, including voluntary loan deferrals and other hardship extensions. The risk factors covering the macroeconomic implications of the pandemic will likely remain in the disclosure documents in the near term, as the country continues to grapple with additional waves of the virus and the uncertainty surrounding further federal relief plans. However, the industry-specific risk factors remain fluid and many have been removed altogether or updated to reflect the evolving legislative requirements and obligor relief programs.
Impact of COVID-19 on Business Continuity Plans and Force Majeure Clauses
The COVID-19 pandemic also has affected disclosure with respect to business continuity plans and force majeure clauses. At the beginning of the pandemic, issuers included broad disclosures about adjustments to their business continuity policies and the transition to working from home. Insofar as these disclosures are indicative of a long-term realignment of the issuer’s working arrangements, they may become a permanent “part of the furniture” as the panel suggested.
The pandemic also has affected force majeure clauses in securitization documents. Initially, the outlook was that COVID-19 was not an “act of God” but an event akin to prior, less invasive, public health emergencies, such as the Swine Flu epidemic or the Ebola outbreak. As the pandemic worsened, many financial institutions argued that the scope of COVID-19 was so encompassing that it should be considered a force majeure. Because New York courts construe force majeure clauses narrowly and require the party claiming a force majeure to show that the event was not reasonably foreseeable, we have now seen “pandemic,” “epidemic” and “acts of governmental authorities” explicitly included in the laundry list of items that are considered a force majeure.
Impact of COVID-19 on CMBS Transactions
The panel further discussed the impact of the COVID-19 pandemic in the context of commercial mortgage-backed securities (CMBS) securitizations. At the onset of the pandemic, there had been discussion surrounding where exactly to put the wide-ranging COVID-related risk factors for these securitizations. Issuers eventually settled on aggregating the separate COVID-related risks into a “COVID chart” where all of the related impacts on the underlying collateral were aggregated and prominently featured in the disclosure documents, all to prevent investors from having to search throughout the disclosure documents to find the COVID-related disclosures. In the context of loan level due diligence on CMBS securitizations, there was been a shift away from including hotel and retail loans in the pools of underlying assets, as those assets have been more negatively affected by the COVID-19 pandemic relative to industrial and office building loans, which have, as a result, become larger percentages of CMBS asset pools.
While disclosures and document terms that look forward to the cessation of LIBOR and its ultimate replacement were in place well before 2020, including via prominent risk factors since its initial announcement, specific replacement has yet to be implemented in most securitizations. Many issuers have adopted the Alternative Reference Rate Committee’s (ARRC) proposed fallback language as a replacement, which, in short, provides that once LIBOR is discontinued, the rate will switch to a forward-looking term Secured Overnight Financing Rate (SOFR) or to compounded SOFR, which is calculated in arrears. To date, the only issuers that have closed deals based on a SOFR rate directly, without any fallback language, are Fannie Mae and Freddie Mac. It is worth noting that the ICE Benchmark Administration has considered continuing to post LIBOR through June 2023 in order to provide more time for the wind-down of legacy transactions. In 2021, we expect that fallback language will continue to be added to those deals without such fallback language, and we may see more deals move straight to issuing SOFR-indexed floating rate securities. While there has been some discussion about federal legislation on the issue of LIBOR, there may be constitutional issues with such legislation (i.e., due process and takings issues) to consider.
Finally, the panel concluded by discussing changes to existing securities regulations by the Securities and Exchange Commission (SEC) that impact many securities offerings. These principal changes are:
updates to Regulation S-K, which are intended to rein in the lengthy generic risk factors in the offering documents, require a grouping of risk factors by category, and mandate the inclusion of a summary of risk factors if the overall risk factor section is more than 15 pages in length;
definitional changes that modestly expand the individuals or entities that qualify as "Accredited Investors," or AIs, for placements relying on the safe harbor provided by Rule 506 of Regulation D and "Qualified Institutional Buyers," or QIBs, for resales of securities that are made in reliance on Rule 144A; and
revised rules that expand the use of electronic, as opposed to "wet ink," signatures on documents that are filed with the SEC.