Spring 2019

Structured Finance Bulletin Legal Insights and Trends in the Structured Finance Markets NOTES FROM THE EDITORS JAMES ANTONOPOULOS LINDSAY O’NEIL ANGELA ULUM

In this inaugural edition of our Structured Finance Bulletin, we discuss some trending issues that began impacting the structured finance and asset-backed and mortgage-backed securities spaces in late 2018, which will play a more prominent role in the execution and marketing of securitization transactions in 2019.

We also discuss the impact of new European Union securitization regulations on US securitizers, the do’s and don’ts of investor meetings and road show presentations, issues that securitization sponsors and servicers may face in M&A transactions, and asset valuation considerations in mortgage loan and real estate warehouse transactions.

Finally, we discuss the impact of recent statutory amendments in Delaware that enable a Delaware limited liability company to be divided into two or more LLCs.

Please visit Mayer Brown’s new structured finance blog, Retained Interest, designed to provide clients updates and analysis on legal and regulatory developments impacting the structured finance industry. Our lawyers provide insights related to developments and innovations in the structured finance industry and concise and timely briefings on current issues affecting financial asset transactions. retainedinterest.com

Additionally, the Consumer Financial Services Review blog provides insights from an industry-leading group of lawyers within Mayer Brown’s global Financial Services Regulatory & Enforcement practice. For more than 20 years, the Consumer Financial Services group has been recognized for its thought leadership and for providing high-caliber regulatory counseling, enforcement defense and transactional advice to a broad range of consumer financial services providers, including mortgage and auto lenders, consumer finance companies, payment companies, credit card issuers and investment banks. cfsreview.com Structured Finance Bulletin

TABLE OF CONTENTS

Securitization – What to Expect in 2019 5

Q&A: The Impact of the EU Securitization Regulation on US Entities 10

Certain Securities Law Considerations for ABS Investor Presentations 17

A Brief Overview of the Top 10 Issues in M&A for Securitization 28 Sponsors and Servicers

Asset Valuations in the Mortgage Loan and Real Estate Warehouse Contexts 40

Divisive Mergers: Hazards and Opportunities 44

MAYER BROWN | 3

Securitization – What to Expect in 2019

JAMES ANTONOPOULOS ANGELA ULUM LINDSAY O’NEIL LANCE WORKMAN SUSANNAH SCHMID

This article summarizes some of the key trends to watch in 2019 in the consumer asset-backed securities (non-mortgage) space, the mortgage and residential securitization space, and with respect to the Customer Due Diligence Requirements for Finance Institutions issued by the Financial Crimes Enforcement Network.

Consumer ABS Space 2019, pursuant to Regulation (EU) 2017/2402 (the “EU Securitization Regulation”). The EU Unlike in years past, there are no new Securitization Regulation revises and significant laws or rules in the United States consolidates the existing rules relating to that are taking effect in 2019 and that are securitizations, including risk retention, targeted at the United States (“US”) disclosure and credit-granting standards. consumer asset-backed securities (“ABS”) space. There are, however, a few items and Consistent with the old regulatory regime, trends to watch that will have an impact on the EU Securitization Regulation does not the consumer ABS markets in the United directly require compliance by US States including: (i) the recently effective EU originators or sponsors (except in certain Securitization Regulation, (ii) the adoption of cases where they are subject to supervision contractual provisions for LIBOR successor on a consolidated basis under the Capital and replacement benchmark rates and (iii) Requirements Regulation with an EU the SF-3 renewal process. banking entity). However, the EU Securitization Regulation may indirectly EU SECURITIZATION REGULATION result in US entities providing additional The next phase of the European Union’s (the disclosures in order for certain EU investors “EU”) new regulatory regime for to be able to invest in US securitizations. securitizations took effect on January 1,

MAYER BROWN | 5 Of particular note are the new transparency subject to the transparency requirements of requirements on originators, sponsors and the EU Securitization Regulation. Ultimately, it securitization special purpose entities, will be the individual EU investors that will requiring that investors obtain specified need to make the determination that the information and transaction documents, applicable US-sponsored securitization is including the requirement to provide investors eligible for investment. The differing views on with regular reports, including, among other this interpretative issue could have a items, loan-level information regarding the marketing and pricing impact on US underlying assets provided on specified securitizations offered to EU investors, and we reporting templates. could see the pool of potential EU investors shrink to the extent they are not provided with These transparency requirements raise a key loan-level information. interpretive issue for US originators and sponsors, since the disclosures required under See “Q&A: The Impact of the EU the new transparency rules, specifically with Securitization Regulation on US Entities” in respect to loan-level information, vary from this newsletter for a more detailed description those required under the US Securities and of the EU Securitization Regulation and its Exchange Commission’s (“SEC”) Regulation impact on the US securitization market. AB disclosure regime. The EU Securitization SUCCESSOR AND REPLACEMENT LIBOR Regulation does not specify the jurisdictional BENCHMARK RATES scope of these detailed transparency requirements. So, the key question for US In 2017, the chief executive of the United originators and sponsors is, are they obligated Kingdom’s Financial Conduct Authority to provide the information required under the (“FCA”), which regulates LIBOR, indicated that transparency rules, including loan-level the United Kingdom FCA expects to cease information, when selling securitization taking steps aimed at ensuring the continuing exposures to EU institutional investors. availability of LIBOR by no later than the end Moreover, will those EU investors be able to of 2021. satisfy their due diligence obligations under Prior to that announcement, it was common the EU Securitization Regulation in connection practice in auto and equipment loan and with a US-based securitization where loan- lease, credit card and other non-mortgage level information meeting the new ABS transactions that, upon the unavailability transparency requirements is not provided. of published LIBOR, the relevant interest Although we are aware of different views in calculation would first revert to the average of the marketplace, we believe that originators, quotes obtained by a number of reference sponsors and securitization special purpose banks and, if such quotes were not made entities that are not established in an EU available, a fall back to the last published member state should not generally be directly value of LIBOR. Given the relatively short

6 | Structured Finance Bulletin 2019 maturity dates of the LIBOR-based securities Events,” or triggers upon which the that have been issued in these asset classes, benchmark rate would be automatically this methodology has continued to be used in transitioned from LIBOR to a specified ABS transactions even after the United replacement benchmark. Some of these Kingdom’s FCA announcement. Lack of triggers include: (i) a public statement by the contractual provisions providing for the administrator of the benchmark or a selection of a successor or replacement regulatory supervisor, central bank or other benchmark could have the effect of authority announcing that such administrator converting floating rate securities to fixed rate has ceased or will cease to provide the instruments referencing the last published benchmark permanently or that the value of LIBOR. benchmark is no longer representative or may no longer be used; (ii) the benchmark rate not Toward the end of 2018, a few new issuances being published for five consecutive business of credit card ABS transactions built on the days; and (iii) more than 50 percent of the historical methodology discussed above, by underlying securitized assets being indexed to giving the servicer authority to select a the replacement benchmark. successor or replacement benchmark that the servicer determines is the industry-accepted The ARRC proposal sets forth a detailed substitute or successor base rate without the “waterfall menu” for designating the need to obtain securityholder consent or replacement benchmark, beginning with follow the rigid amendment standards under SOFR and, if SOFR is not available, moving to the transaction documents. a substitute rate recommended by a relevant governmental body, among other specified In December 2018, the Alternative Reference options. Rates Committee (or “ARRC”) released a consultation for public feedback on US dollar It is unlikely that ABS transactions closing in LIBOR fallback contract language for 2019, or at least early in 2019 prior to the securitizations. ARRC has previously selected issuance of ARRC’s final paper, will adopt the Secured Overnight Financing Rate (or ARRC’s rigid and structured methodology. In “SOFR”) as its recommended alternative fact, given the relatively short maturity dates reference rate to LIBOR. of consumer ABS, it is likely that many of these issuances will either (i) continue to follow the In its paper, ARRC proposed an approach to existing practice of locking in the last available fallback language for new LIBOR-based LIBOR rate should the benchmark cease to be securities issued in connection with published or (ii) adopt the flexible methodology securitizations that is much more detailed and implemented by the credit cards ABS issuers rigid than language that exists in current as maturity dates on issued securities extend securitizations. The ARRC proposal sets forth closer to the end of 2021. a number of “Benchmark Discontinuance

MAYER BROWN | 7 SF-3 RENEWAL PROCESS Bureau (“CFPB”). As acting director, Mick SEC registrants are required to renew Form Mulvaney took a lighter touch to regulation as SF-3 registration statements three years from compared to his predecessor, decreasing the the effectiveness of the existing SF-3 registration size of the staff and budget within which the statement. Many issuers filed SF-3 registration CFPB operates, and notably during his tenure statements in late 2015 and early 2016 only one enforcement action was issued. The following the implementation of the newly appointed Kathy Kraninger is largely Regulation AB II rules, and thus many renewal expected to follow this path. This will leave filings began in 2018 and will continue state-level enforcement action to continue to through 2019. Thus far, many issuers whose take greater prominence, but state resources registration statements were previously are often more constrained than the federal reviewed by the SEC staff have received either government and are unlikely to be able to a limited or no review and generally only new entirely fill the regulatory void left by the SEC-registered issuers are receiving a more CFPB. thorough review. CONTINUED GROWTH OF NONTRADITIONAL MORTGAGE Mortgage and Residential PRODUCTS

Securitization Space In 2019, we expect to continue to see a rise in In the mortgage and residential securitization Non-Qualified Mortgage securitizations (which space, there are a few trends to watch in 2019 have more than doubled since 2016). In including: (i) an increased push to use addition, while the demand for reverse technology, (ii) continued regulatory relief and mortgage loans will continue to exist and (iii) continued growth of nontraditional likely grow in 2019, we expect to see an mortgage products. increase in private label originations in this space and changes to the Home Equity INCREASED PUSH TO USE TECHNOLOGY Conversion Mortgage Program. Further, we With the growing space of financing have seen, and expect to continue to see, technology and the government advocating increased interest in “fix and flip” mortgage for modernization of the industry, we expect loans in 2019. We also expect to see a that an increasing number of originators will continued appetite for single family rental look to digitize their mortgage loan properties. Lastly, the origination of closed-end documentation and collateral. second lien home equity loans may pick up along with home price appreciation. CONTINUED REGULATORY RELIEF

A trend to watch in 2019 is additional reglatory relief from the Consumer Financial Protection

8 | Structured Finance Bulletin 2019 The CDD Rule The Customer Due Diligence Requirements for Finance Institutions (the “CDD Rule”) was issued by the Financial Crimes Enforcement Network (“FinCEN”) and requires covered financial institutions (including banks, US branches and agencies of foreign banks, federally insured credit unions, mutual funds and broker dealers) to identify and verify the identity of beneficial owners of its legal entity customers with respect to “accounts” that are opened on or after May 11, 2018. The definition of “account” is broad and includes many securitization transactions, subject to certain exceptions. FinCEN has clarified that the extension of a loan or warehouse facility will be considered the opening of a new account for purposes of the CDD Rule.

While not required under the CDD Rule, we have seen some financial institutions elect to collect information on beneficial owners at a level lower than 25 percent, as well as more than one individual with managerial control. We expect this trend to continue throughout 2019. Most financial institutions have elected to satisfy their due diligence requirement by obtaining a form certification from their customers that identifies their beneficial owners. Certain customers are excluded from the CDD Rule—however, notwithstanding such exclusion, we see some financial instutitions requesting a separate certification from customers that specifies the exemption that the customer is relying on under the CDD Rule. We expect the new CDD Rule to continue to influence the industry in 2019 and that additional clarity will develop as to certain open questions.

MAYER BROWN | 9 Q&A: The Impact of the EU Securitization Regulation on US Entities

MERRYN CRASKE CAROL HITSELBERGER JULIE GILLESPIE CODY LAWRENCE KEVIN HAWKEN JAN STEWART

What is the Securitization they are subject to supervision on a consolidated basis with an EU regulated Regulation, and does it institution). However, the Securitization apply to the US entities? Regulation may indirectly result in US securitization originators, sponsors and The next phase of the European Union’s (the securitization special purpose entities “EU”) new regulatory regime for (“SSPEs”) being required to provide securitizations became applicable from additional disclosure in order for EU January 1, 2019, pursuant to Regulation (EU) institutional investors to be able to invest in 2017/2402 (the “Securitization Regulation”). US securitization transactions. The Securitization Regulation revises and consolidates the existing rules relating to Who needs to comply with securitizations,1 including with respect to risk retention, disclosure and credit- the due diligence granting, and introduces a ban on requirements of the resecuritization. It also specifies criteria that Securitization Regulation in a securitization will need to satisfy if the parties want the transaction to be connection with a US- designated as a simple, transparent and sponsored transaction? standardized (“STS”) securitization. Like past phases of EU regulation regarding EU institutional investors, as defined in the securitizations, such as the Capital Securitization Regulation, will need to Requirements Regulation (the “CRR”), the comply with the due diligence requirements Securitization Regulation does not directly of the Securitization Regulation in order to require compliance by United States (“US”) invest in a securitization transaction with a entities participating in securitization US originator or sponsor. transactions (except in certain cases where

10 | Structured Finance Bulletin 2019 What are the due diligence substantially similar to (but not the same as) the CRR due diligence requirements. In obligations imposed on EU recent years, many US entities have already institutional investors? undertaken limited voluntary compliance with the CRR in order to make their securities The Securitization Regulation imposes both eligible for purchase by EU investors and initial and ongoing due diligence already provide disclosure with regard to requirements on EU institutional investors. underwriting standards and risk retention that Prior to investing in a securitization could be sufficient to allow an EU institutional transaction, an EU institutional investor must investor to meet the related due diligence carry out a due diligence assessment that requirements of the Securitization Regulation. considers risk characteristics, material structural features and, if applicable, What are the transparency compliance with the criteria for STS requirements? securitizations. An institutional investor must also verify compliance with credit-granting The Securitization Regulation establishes standards, EU risk retention requirements transparency requirements for originators, and, where applicable, the transparency sponsors and SSPEs, requiring that certain requirements of the regulation (i.e., the specified information and documentation be requirements regarding disclosure and provided to investors, supervisory authorities provision of certain information). After making and, upon request, potential investors in a an investment in a securitization transaction, securitization transaction. Originators, an EU institutional investor has an ongoing sponsors and SSPEs must make available obligation to monitor the compliance and all the underlying documentation that is performance of the transaction pursuant to essential for understanding the transaction, written procedures established by the together with a prospectus, or, where there is investor and to meet continued reporting and no prospectus, a transaction summary. They testing requirements. are also required to report certain significant events and to meet ongoing regular Currently, under the CRR, EU institutional reporting requirements, which require that investors that invest in securitization certain loan-level information regarding the transactions with US entities are already assets underlying a securitization transaction required to meet due diligence assessment be provided on specified reporting templates and monitoring standards. Other than the to be established pursuant to technical reference to the transparency requirements, standards.2 which are discussed below, the Securitization While there is some overlap between the Regulation due diligence requirements are transparency requirements and the

MAYER BROWN | 11 information required by Regulation AB for SSPEs,4 but the Securitization Regulation does publicly registered transactions in the US, not explicitly state that it only applies to such which is also typically included in offering parties if they are established in the EU.5 memoranda for unregistered US term However, in certain provisions of the issuances, providing the loan-level information Securitization Regulation, a distinction is specified in the reporting templates is beyond drawn between an originator or sponsor the scope of Regulation AB. Providing this “established in the Union” and one additional data may be costly and “established in a third country.” For example, burdensome for US entities. As a result, the the due diligence verification requirements in question of whether a US originator, sponsor Article 5(1) with respect to credit-granting and or SSPE will need to provide the loan-level risk retention6 provide one verification information on the specified templates when standard if the relevant entity is “established selling securitization exposures to EU in the Union” and a comparable but separate institutional investors is one of the most verification standard if the relevant entity is important interpretive issues raised by the “established in a third country.” Furthermore, Securitization Regulation for US originators related EU regulations like the CRR have and sponsors. similarly been interpreted as not imposing direct obligations on non-EU entities. Will EU institutional investors With respect to the obligation in the investor require US entities to comply due diligence requirements to verify with the transparency compliance with the transparency requirements, the phrase “where applicable” requirements? in the section that imposes the obligation While the jurisdictional scope for the suggests that the transparency requirements transparency requirements is not specified, we are not applicable in all instances.7 One believe that originators, sponsors and SSPEs interpretation of this language would allow EU that are not established in an EU member institutional investors to conclude that the state should not generally be directly subject requirement to verify compliance with certain to the transparency requirements.3 As of the transparency requirements (including discussed below, this interpretation is potentially burdensome loan-level data supported by certain provisions of the requirements) is not applicable with respect to Securitization Regulation and other principles US originators, sponsors or SSPEs because the of interpretation. Securitization Regulation does not directly apply to non-EU entities. If the market adopts The Securitization Regulation indicates that this interpretation, it is not likely that the the regulation applies to institutional investors, Securitization Regulation will result in a originators, sponsors, original lenders and

12 | Structured Finance Bulletin 2019 significant increase in the amount of requirements, including the provision of information requested from US entities by EU loan-level data, is applicable with respect to institutional investors. However, we are aware US originators, sponsors and SSPEs. that different views on this point are currently being taken by certain market participants Will the Securitization and law firms. Regulation impact EU In addition, it is also worth noting that there may be a different interpretation of this point investor participation in in the United Kingdom (the “UK”) following pre-2019 transactions? Brexit. On December 19, 2018, a draft of the Securitisation (Amendment) (EU Exit) The Securitization Regulation will not apply to Regulations 2019 (the “Proposed UK transactions entered into before January 1, Securitization Regulation Amendment”) was 2019, unless new securities are issued or a new published in the UK, the purpose of which is securitization position is created on or after to amend the Securitization Regulation (which that date. Therefore, the Securitization is directly applicable in the UK) to ensure that Regulation is not expected to impact the it can operate in a UK-only context from the liquidity of previously issued transactions as date that the UK leaves the EU. The Proposed long as they remain grandfathered; an EU UK Securitization Regulation Amendment institutional investor can still invest in adds a new subsection to the article relating securitizations issued prior to January 1, 2019, to the diligence requirements, which says that even if those transactions do not comply with an institutional investor must verify that an the Securitization Regulation. The originator, sponsor or SSPE “established in a Securitization Regulation does not make clear third country” has “where applicable” how its provisions should be applied to master provided information that is “substantially the trust structures where different series of same” as the information it would have securities may be issued before and after the provided under the transparency Securitization Regulation becomes effective. requirements if it had been established in While it could be argued that each series the UK. issued by a master trust is a separate securitization, we understand that the Each EU institutional investor will need to prevailing market view is that the master trust make its own assessment regarding its constitutes a single securitization such that the compliance with the due diligence issuance of a new series after the requirements under the Securitization Securitization Regulation becomes effective Regulation, and some EU investors may will subject the entire master trust to the determine that the requirement to verify Securitization Regulation. While not made compliance with the transparency clear in the Securitization Regulation, the

MAYER BROWN | 13 market view appears to be that, in that its own obligations as a sponsor under the instance, an EU institutional investor’s existing transparency requirements, the EU ABCP investment in a pre-2019 series would be sponsor may require its US counterparty to considered compliant even if not in provide certain information that the ABCP compliance with all aspects of the sponsor could aggregate for use in its Securitization Regulation. However, an EU program-level disclosure to ABCP investors institutional investor investing in a pre-2019 (depending on what is required to be series of a master trust that issued a series in reported by the ABCP sponsor in the final 2019 or at a later date would potentially need form of the reporting templates for ABCP to assess compliance with the Securitization securitizations). Loan-level data also may need Regulation. to be made available to the ABCP program sponsor. 8 US originators should discuss with What is the potential impact their EU bank lenders and ABCP sponsors of the Securitization what data they will require for compliance. Regulation on warehouse Can a US-sponsored facilities and conduit transaction qualify as an arrangements with EU STS securitization? banks? A transaction cannot qualify as an STS An EU bank or other institutional investor that securitization under the Securitization is a lender to a US originator or SSPE in a Regulation unless the originator, sponsor and warehouse facility or through a variable SSPE are all established in the EU. There will funding note will be required to comply with be a separate STS regime in the UK after the Securitization Regulation if the transaction Brexit, which based on the Proposed UK falls within the definition of a securitization. If Securitization Regulation Amendment, will that EU entity is funding its advances directly, require the originator and sponsor (in the case then it will be subject to the due diligence of non-ABCP securitizations) or the sponsor requirements of the Securitization Regulation only (in the case of ABCP programs or as discussed above, and the disclosure of transactions), to be established in the UK, loan-level data by the US originator or SSPE provided that securitizations that meet the using the applicable reporting templates STS requirements under the Securitization could be required. If the advances are being Regulation and that are notified to ESMA prior funded through an asset-backed commercial to Brexit or during the two-year period paper (“ABCP”) program for which an EU bank thereafter will still be considered STS in the acts as sponsor, then that EU bank will itself UK. It is possible that certain EU or UK be subject to the transparency requirements institutional investors will have more interest in imposed on sponsors. In order to comply with investing in securitizations that meet the STS

14 | Structured Finance Bulletin 2019 requirements under the Securitization particularly with respect to the templates for ABCP securitizations. See https://www.esma. Regulation or those under the UK regime, as europa.eu/document/european-commission-let- applicable (“STS Securitizations”) than those ter-esma-draft-rts-and-its-securitisation-disclosures. that do not. Institutional investors may find A revised version of the technical standards is expected to be submitted by ESMA to the STS Securitizations more attractive due to Commission shortly. If approved by the lower regulatory capital requirements Commission, the technical standards will need to be approved by the Council of the European compared with non-STS Securitizations, or Union and the European Parliament. they may take the view that an investment in The Securitization Regulation requires that, in the an STS Securitization would be more liquid. event the new technical standards were not in Therefore, transactions with US entities may place by January 1, 2019, the reporting templates established pursuant to Article 8b of the Credit be less marketable than STS Securitizations. It Rating Agencies Regulation be used in the interim is not yet clear what proportion of period. See Regulation (EC) No 1060/2009 on securitization transactions will be STS credit rating agencies, as amended, including by Regulation (EU) No 462/2013. It is anticipated that Securitizations, but it is expected that there national supervisors will exercise their powers in a will still be a market with EU and UK proportionate and risk-based manner during that period, taking into account the type and extent of institutional investors for non-STS information already being disclosed by reporting Securitizations, including non-STS entities, on a case-by-case basis. See the joint Securitizations with US entities. statement of the European Supervisory Authorities at https://esas-joint-committee.europa.eu/ Publications/Statements/JC_Statement_ Securitisation_CRA3_templates_plus_CRR2_final.pdf. 3 Note that certain non-EU subsidiaries of EU Endnotes banking entities that are subject to consolidated supervision under the CRR could become subject 1 The Securitization Regulation defines “securiti- to the requirements of the Securitization sation” broadly to mean any “transaction or Regulation directly. It is expected that the rules scheme, whereby the credit risk associated will be amended to limit the application of these with an exposure or a pool of exposures is requirements with respect to these non-EU tranched,” having certain enumerated entities to the due diligence requirements. EU characteristics. See Article 2(1). competent authorities are expected to take this 2 The European Securities and Markets Authority pending amendment into account when assessing (“ESMA”) published its final draft of the compliance with the Securitization Regulation. See technical standards with respect to the the joint statement of the European Supervisory detailed reporting requirements and the Authorities at https://esas-joint-committee.europa. associated templates in August 2018. However, eu/Publications/Statements/JC_Statement_ market participants have expressed a number Securitisation_CRA3_templates_plus_CRR2_final.pdf. of concerns about the templates. The 4 See Article 1(2) of the Securitization Regulation. European Commission (the “Commission”) has 5 notified ESMA that it intends to endorse the The term “institutional investor” is defined in draft technical standards only once certain Article 2(12) by reference to entities that are amendments are introduced and has defined in or fall under certain EU regulations that requested ESMA to consider whether certain are only applicable to EU investors. Therefore, “No Data” options could be available for only institutional investors that are established or additional fields of the draft templates, located in the EU will be directly required to comply with the Securitization Regulation (except

MAYER BROWN | 15 as discussed in the previous footnote). The definitions of “securitization special purpose entity,” “originator,” “sponsor” and “original lender” contained in Article 2 are not limited to entities in the EU. 6 The credit-granting and risk retention require- ments are similar (but not identical) to the requirements in the CRR. 7 See Article 5(1)(e): “Prior to holding a securitisa- tion position, an institutional investor, other than the originator, sponsor or original lender, shall verify that:… the originator, sponsor or SSPE has, where applicable, made available the information required by Article 7 in accordance with the frequency and modalities provided for in that Article.” (emphasis added). 8 See Article 7(1): “In the case of ABCP, the information described in points (a), (c)(ii) and (e)(i) of the first subparagraph shall be made available in aggregate form to holders of securitisation positions and, upon request, to potential inves- tors. Loan-level data shall be made available to the sponsor and, upon request, to competent authorities.”

16 | Structured Finance Bulletin 2019 Certain Securities Law Considerations for ABS Investor Presentations

JAMES ANTONOPOULOS JULIE GILLESPIE

Some common questions raised by issuers in circumstances, so it is important for issuers connection with ABS conferences are: what to discuss their issuance and marketing plans legal rules and issues should we consider with counsel before jumping on the plane to when meeting with investors, can written the conference. investor presentations be used and what can This article is intended to highlight certain be included in those written materials and, securities law considerations that may arise more specifically, can such presentations be in connection with investor meetings, the left behind with investors? Questions about distribution of written materials to existing investor presentations arise in connection and potential investors, road shows for ABS with different types of investor meetings, offerings, and potential Securities and and the context, content and timing of the Exchange Commission (“SEC”) filing investor presentations will give rise to requirements.1 different legal considerations. For example, certain meetings are not conducted in Registered Offerings: Free connection with particular offerings of securities but may include attendees that are Writing Prospectus representatives of existing or potential Requirements investors. Other meetings and presentations are conducted as part of the offering FWP FILING REQUIREMENT process for specific ABS programs and may Written materials that are distributed to be conducted as part of a registered offering potential investors and some electronic road or as part of a private placement or other shows may constitute free writing unregistered offering. An investor meeting at prospectuses (commonly referred to as an ABS conference may fall under any of “FWPs”). The term “free writing prospectus” these categories depending on the

MAYER BROWN | 17 generally includes any written communication Is the communication an FWP that (other than a statutory prospectus2) that constitutes an offer to sell or a solicitation of needs to be filed? an offer to buy securities relating to a Is the communication an “offer”? registered offering that, in the case of an ABS issuer, is used after the registration statement in respect of the offering is filed.3 Oral communications are not FWPs. Rules 163 and NO YES 164 under the Securities Act of 1933, as amended (the “Securities Act”), generally require FWPs to be filed with the SEC no later Not an FWP Written? than the day of their first use (the “FWP Filing Requirement”)4 and to contain specific legends.5 There are three important questions Not Written Written to ask when determining whether a (e.g., traditional live (e.g., live telephone communication constitutes an FWP and, if so, road shows, slides/ calls, videos or whether the communication is subject to the handouts that are webcasts that are FWP Filing Requirement: (1) is the used as a part of a live recorded, emails, communication a “road show,” (2) is the road show (only if they facsimiles and postings communication an “offer” in connection with are collected), live on websites, slides and a registered offering and (3) is the telephone handouts that are communication a “written communication?” conversations, distributed during live The answers to these questions will determine webcasts and video road shows but not whether the investor presentation or meeting conferences (only if collected, radio or constitutes an FWP and whether the issuer originate live and television broadcasts must satisfy the FWP Filing Requirement. real-time) (whether or not live))

Not an FWP FWP

No FWP Filing Road Show? Requirement

YES NO

No FWP Filing FWP Filing Requirement Requirement

18 | Structured Finance Bulletin 2019 The FWP Filing Requirement, the legend ask, and the issuer to address, any questions requirement and other rules relating to FWPs or concerns regarding the issuer, the ABS discussed below do not apply to unregistered program or the specific transaction. offerings. Many of the practices observed with Any presentation by management involved in investor meetings in connection with SEC the securitization or servicing function, registered offerings (such as collecting copies regardless of the number of participants, can of presentation slides provided to investors be considered a road show under SEC rules. during the meeting), however, have carried Traditionally, road shows have taken the form over and are applied to investor meetings in of in-person presentations scheduled in connection with unregistered private offerings. multiple locations across the country wherever 1. IS THE COMMUNICATION A ROAD institutional investors are located. Road shows SHOW? have also commonly taken an electronic form, as pre-recorded presentations posted to a In the ABS context, a road show is a password-protected website. Individual presentation by management involved in the meetings or a series of meetings at a securitization or servicing function that conference can be considered a road show if includes a discussion of the issuer, the presentation involves members of management and/or any securities being management involved in the securitization or offered.6 Road show presentations can be servicing function and the content of the done in-person or by telephonic or graphical meeting covers the areas described above. A means and are usually accompanied by presentation or meeting is considered a road presentation slides. A road show can allow for show for securities law purposes, however, a more personal and interactive conveyance only if it involves an offer of securities. We will of information to investors, allowing for a discuss what constitutes an “offer” in more back-and-forth exchange between the issuer detail below. and potential investors. So, why does it matter whether a presentation In the ABS context, these presentations or meeting is considered a “road show” under typically cover, among other items, the issuer’s SEC rules? We will discuss the implications origination and servicing practices, portfolio and considerations in more detail below, but a characteristics and loss and delinquency key consideration for SEC-registered offerings trends, any prior securitization experience and is whether the road show constitutes a “free prior transaction performance and, if in writing prospectus” that necessitates a filing connection with a specific transaction, a with the SEC. A road show for an offering that discussion of key terms of such transaction is a written communication is an FWP and, and any offered securities. The meeting may generally, use of an FWP triggers the FWP also include the opportunity for investors to Filing Requirement. But in the context of the

MAYER BROWN | 19 typical ABS offering,7 a road show is not but rather with the intent of providing subject to the FWP Filing Requirement.8 information about the issuer and its ABS program to investors. If an issuer’s meeting 2. IS THE COMMUNICATION AN OFFER with investors or potential investors is in fact a IN CONNECTION WITH A REGISTERED non-deal road show (i.e., not in connection OFFERING? with an offering), then any communication in FWPs only include those “written connection with such meeting is not an offer communications” (which we will discuss in and is not an FWP subject to the FWP Filing more detail below) that are offers to sell or Requirements. Issuers should be careful in solicitations of offers to buy securities relating taking this position, however, because of the to registered offerings. Section 2(a)(3) of the broad view of when an offer of securities has Securities Act defines “offer to sell” in terms occurred. Communications to potential of any activity that is reasonably calculated to investors before an offering is officially solicit or generate a buying interest. As a announced, even if the communication does general matter, a determination as to whether not mention specific securities, may be viewed a communication constitutes an offer to sell in as conditioning the market and part of the connection with a registration statement selling effort of an upcoming offering. In the entails a fact-intensive analysis, the outcome instance where an offering has not yet been of which will depend on the specific announced or where presentation materials circumstances of such communication. do not make reference to a specific offering, an ABS issuer that is considering taking the SEC releases and relevant case law suggest position that a meeting or presentation is a that the scope of the definition of “offer to non-deal road show should consider where sell” is indeed very broad. For instance, the they stand in relation to the initiation of any SEC has indicated that it is possible to upcoming offering and, for frequent issuers, generate a buying interest and therefore have where they stand in relation to their an offer to sell in promotional material that programmatic funding plan. Although a does not even mention the upcoming bright-line does not exist as to when a offering, especially where the materials are communication is in connection with an used as part of a plan to prepare the market in offering or when a communication is in fact a advance of a dissemination of offering non-deal road show, issuers should consider materials.9 Similarly, courts have held that the following factors, among other factors, dissemination of information in the ordinary that may be present at the time of the investor course of business becomes questionable meeting or presentation: when the timing of such activities seems to be gearing up to an impending public offering.10 • Does the issuer have an effective shelf registration statement on file; An issuer may engage in a non-deal road show that is not intended to offer securities, • Has the issuer selected a pool of assets to be securitized or begun other internal work

20 | Structured Finance Bulletin 2019 on an upcoming offering; facsimiles, CD-ROM, electronic mail, • Has the issuer engaged legal counsel or Internet Web sites, substantially similar an investment bank to begin structuring messages widely distributed (rather than a transaction or hired a rating agency to individually distributed) on telephone begin reviewing proposed structures or answering or voice mail systems, asset characteristic and performance data; computers, computer networks and other and forms of computer data compilation.” • If the ABS issuer is a frequent and pro- Except for the live, real-time road grammatic issuer, how close in proximity communications (including, in certain is the meeting or presentation to the circumstances, when transmitted electronically closing of its prior offering, and when has in real-time, as will be discussed below), all the issuer historically begun work on or communications made through electronic announced its subsequent offering? means are graphic communications and therefore considered to be written Because the SEC and relevant case law have communications. For example, presentations taken such a broad view on what constitutes that are recorded and posted on Internet an offer, many issuers have taken a websites are considered graphic conservative approach when engaging in communications that are written meetings, even when a specific transaction is communications and should be treated as not discussed, and have operated under the FWPs. assumption that any meeting or presentation with investors and potential investors could be Graphic communications do not include deemed to be an offering of securities under communications that, at the time of SEC rules. communication, originate live, in real-time to a live audience and do not originate in recorded 3. IS THE COMMUNICATION A form or otherwise as a graphic “WRITTEN COMMUNICATION”? communication, even if the communication is Only written communications are FWPs; transmitted through graphic means.11 For however, what constitutes “written example, a live road show presented via communications” under Securities Act Rule videoconference from a conference room in 405 may not be entirely obvious. For purposes New York and transmitted real-time to a live of the FWP definition, written communications audience in a conference room in London include any communication that is written, would not be a graphic communication and printed, a radio or television broadcast, or the would therefore not be a written following forms of “graphic communications”: communication and, consequently, would not be an FWP. Likewise, an in-person road show “[a]ll forms of electronic media, including, at a conference would not be an FWP and not but not limited to, audiotapes, videotapes, subject to the FWP Filing Requirements. Live,

MAYER BROWN | 21 in-person road shows are treated as oral In contrast, a recorded electronic road show communications. would be a graphic communication; therefore, any materials, such as slides or handouts used The notes to Rule 433 provide an exception in connection with the presentation, would be that would allow certain communications that written materials and would therefore be would otherwise be written communications FWPs. As noted above, although such road to be deemed not to be written shows are FWPs (and should include a communications if they are used required FWP legend as described below), simultaneously in connection with a live road they are not subject to the FWP Filing show. The notes to Rule 433 provide: Requirement. “A communication that is provided or The notes to Rule 433 also clarify that “a transmitted simultaneously with a road written communication that is an offer show and is provided or transmitted in a contained in a separate file from a road show, manner designed to make the whether or not the road show is a written communication available only as part of the communication, or otherwise transmitted road show and not separately is deemed to separately from a road show, will be a free be part of the road show. Therefore, if the writing prospectus subject to any applicable road show is not a written communication, filing conditions of paragraph (d) of this such a simultaneous communication (even section.” For this reason, it is advisable for an if it would otherwise be a graphic audio presentation and slides to be combined communication or other written in one file rather than transmitted as separate communication) is also deemed not to be files. Also, investors viewing a recorded road written.” show through an Internet website should not An example of such a communication would be able to separately download or print any be a written presentation handed out in accompanying presentation slides. connection with a live, in-person road show FWP LEGEND REQUIREMENT and collected at the end of the road show presentation. Because the road show (i.e., the A legend substantially similar to the following in-person presentation) is not a written is required to be included in any FWP in communication, the slides or handouts used in connection with a registered offering of an connection with the road show would also be ABS issuer: deemed to be part of the non-written road “The issuer has filed a registration show and would therefore not be FWPs and statement (including a prospectus) with the not subject to the FWP Filing Requirements. SEC for the offering to which this Any written materials left with investors would communication relates. Before you invest, nevertheless be FWPs and would be subject you should read the prospectus in that to the FWP Filing Requirements.

22 | Structured Finance Bulletin 2019 registration statement and other into the registration statement and not documents the issuer has filed with the superseded or modified.13 SEC for more complete information about Although Rule 433 permits an FWP to include the issuer and this offering. You may get information that is not included in the these documents for free by visiting registration statement, as discussed below, it EDGAR on the SEC Web site at www.sec. is advisable not to include information that gov. Alternatively, the issuer, any goes materially beyond the information in the underwriter or any dealer participating in prospectus, which could call into question the the offering will arrange to send you the adequacy of the information included in the prospectus if you request it by calling prospectus. toll-free 1‑8[xx‑xxx-xxxx].”12 In addition, an FWP may not contain The legend may also provide an email address disclaimers of responsibility or liability that are at which the documents can be requested and impermissible in a registration statement or may indicate that the documents are also statutory prospectus. available by accessing the issuer’s website and provide the Internet address and the particular location of the documents on the Examples of impermissible legends for website. an FWP are:

RESTRICTIONS ON CONTENT FOR FWPS Disclaimers regarding accuracy or completeness or reliance by investors; An FWP may include information the substance of which is not included in the Statements requiring investors to read registration statement or in the prospectus or acknowledge that they have read or included in the registration statement, but understand the registration statement or such information may not conflict with: (i) any disclaimers or legends; information contained in the registration Language indicating that the statement, including any prospectus or communication is neither a prospectus prospectus supplement that is part of the nor an offer to sell or a solicitation of an registration statement and not superseded or offer to buy; and modified; or (ii) information contained in the issuer’s periodic and current reports filed or With regards to information that must furnished to the Commission pursuant to be filed with the SEC, statements that section 13 or 15(d) of the Securities Exchange the information is confidential. Act of 1934 that are incorporated by reference

MAYER BROWN | 23 Regulation FD the applicable exceptions to Regulation FD apply. In the context of an ABS offering, there Regulation FD generally requires that when a are two exceptions that are particularly reporting issuer, or any person acting on its relevant. behalf, discloses any material nonpublic First, in the case of an unregistered offering information regarding that issuer or its by a reporting issuer, Regulation FD will not securities to certain categories of persons apply to disclosures made to a person who described below, the issuer must expressly agrees to maintain the disclosed simultaneously14 publicly disclose that information in confidence. So, an issuer may information as described below. In the ABS avoid compliance with Regulation FD in context, Regulation FD applies to ABS issuers connection with an investor presentation for that file 10-Ds, 10-Ks and other reports under an unregistered offering by first obtaining a Section 15(d) of the Exchange Act. The confidentiality agreement from the recipient sponsor of an ABS issuer may also be a of the information. reporting issuer subject to Regulation FD, so it may be necessary to consider whether Second, in the case of an ABS offering information disclosed in connection with an registered under the Securities Act, ABS offering, for example, information Regulation FD will not apply if the disclosure is regarding the sponsor’s business, may be by a registration statement, prospectus or considered material nonpublic information FWP used after filing of the registration relating to the sponsor or its securities. statement for the offering or an oral communication made in connection with the Regulation FD only applies to a disclosure registered securities offering after filing of the made to certain categories of persons that registration statement for the offering under include brokers, deals, investment advisors, the Securities Act institutional investment managers, and holders of the issuer’s securities, under Additional Information Not circumstances in which it is reasonably Included in the Prospectus or foreseeable that the person will purchase or sell the issuer’s securities on the basis of the Offering Memorandum information. As noted above, an FWP may include Given that investor meetings typically involve additional information that is not included in persons falling within the above categories, the registration statement or in the reporting issuers should consider whether any prospectus as long as such information does presentation materials or road shows contain not conflict with the registration statement, any material nonpublic information regarding prospectus or the issuer’s periodic and current that issuer or its securities, or a sponsor that is reports that are incorporated by reference subject to Regulation FD, and whether any of into the registration statement and not

24 | Structured Finance Bulletin 2019 superseded or modified.15 However, in all presentation as discussed in the following offerings—whether registered or paragraph. unregistered—issuers and sponsors should Second, issuers and other offering nevertheless carefully evaluate information participants may mistakenly believe that contained in an investor presentation that is information delivered to investors in a road not included (or expected to be included) in show, whether orally or in any related the offering memorandum or prospectus for presentation slides—rather than an offering an offering to determine whether such memorandum or prospectus—is subject to a information is material. So, members of the lower standard in terms of assuring that such deal team should evaluate the information in information is accurate or that such the investor presentation to confirm that, if information does not give rise to potential such information is material, it is contained in liability under the securities laws. Rule 10b-5 the offering memorandum or prospectus, and, under the Exchange Act provides that it is if such information is not material, that it does unlawful for any person to employ any device, not conflict with the issuer’s other filings. scheme or artifice to defraud, to make any Although it is not uncommon for investor untrue statement of a material fact or to omit presentations to include some additional to state a material fact necessary in order to information that is not in the offering make the statements made, in light of the memorandum or prospectus or to present circumstances under which they were made, information from the offering document in a not misleading or to engage in any act, more detailed fashion or in a different format practice or course of business which operates in the investor presentation, such practice may or would operate as a fraud or deceit upon give rise to a number of potential concerns. any person in connection with the purchase or First, investor presentations will often not be sale of any security. Any material misstatement delivered to all investors that ultimately in a road show or other investor presentation, receive an offering memorandum or used in connection with the purchase and sale prospectus for an ABS offering. As a result, of a security, can give rise to potential claim questions may arise as to whether material under Rule 10b-5 if the investor is able to information has been selectively disclosed to establish the requisite elements for a cause of some, but not all, potential investors. In action, including scienter or intent. Therefore, addition to causing potential relationship care should be taken to confirm the accuracy issues with investors who have not received of all information contained in investor the investor presentation, selective disclosure presentations, including that the presentation can also raise questions as to whether failure does not conflict with the prospectus or other to include such information constituted a offering materials and does not include material omission under the securities laws in information, the omission of which from the connection with the purchase of a security by prospectus or offering memorandum could an investor that did not receive the investor call into question the sufficiency of the

MAYER BROWN | 25 disclosure in the prospectus or offering established for all classes of the offering and the date of first use (Rule 433(d)(5)(ii)). This article memorandum. In particular, road show does not contain a detailed description of all materials may include financial and other applicable rules relating to the filings of FWPs numerical information that is not included in and the timing thereof. the prospectus or offering memorandum and 5 The required legend (and other content require- ments) for FWPs are discussed below. is not otherwise comforted by the issuer’s 6 Rule 433 under the Securities Act defines a “road accountants. Information may also be derived show” as “[a]n offer (other than a statutory from sources other than the issuer, such as prospectus or a portion of a statutory prospectus industry or rating agency market reports. filed as part of a registration statement) that contains a presentation regarding an offering by Issuers should be sure to obtain backup for one or more members of the issuer’s manage- any statements or projections included in the ment (and in the case of an offering of asset-backed securities, management involved in road show materials. the securitization or servicing function of one or more of the depositors, sponsors or servicers (as such terms are defined in Item 1101 of Regulation AB) or an affiliated depositor) and includes a discussion of one or more of the issuer, such Endnotes management and the securities being offered.” 7 1 This article does not address similar presentations Rule 433(d)(8) under the Securities Act does and road shows outside of the ABS context, and require filings of FWPs in cases of road shows a number of the rules discussed in this article, that are written communications for an offering of including the free writing prospectus filing common equity or convertible equity securities by requirements, would be different for equity an issuer that is, at the time of the filing of the offerings and other non-ABS debt offerings. registration statement for the offering, not required to file reports with the SEC pursuant to 2 The definition of free writing prospectus also Section 13 or Section 15(d) of the Securities excludes written communications used in reliance Exchange Act of 1934, unless the issuer of the on Rules 167 and 426 under the Securities Act securities makes at least one version of a bona (ABS informational and computational materials). fide electronic road show available without 3 Rule 405 under the Securities Act. restriction by means of graphic communication to any person, including any potential investor in the 4 Rule 433(d) under the Securities Act specifies a securities (and if there is more than one version of number of exceptions to the FWP Filing a road show for the offering that is a written Requirement, for example, for an FWP that does communication, the version available without not contain substantive changes from or additions restriction is made available no later than the to an FWP previously filed with the SEC (Rule other versions). 433(d)(3)), issuer information contained in an FWP 8 of an offering participant other than the issuer Rule 433(d)(8) under the Securities Act. Although that is included in a previously filed prospectus or road shows generally are not required to be filed, FWP and that relates to the offering (Rule 433(d) it is still important to determine whether the road (4)) and an FWP or portion thereof that contains a show is a “written communication” and therefore description of the terms of the securities or the an FWP because the legend (and other content) offering and that does not reflect the final terms requirements for FWPs and the retention require- (Rule 433(d)(5)(i)). In addition, certain FWPs that ments for FWPs will still apply to road shows that contain only a description of the final terms of the are FWPs. issuer’s securities or the offering are required to 9 SEC Release 33-3834 Example 1, 1957 WL 3605 be filed by the issuer within two days of the later (1957). of the date such final terms have been

26 | Structured Finance Bulletin 2019 10 See, e.g., Georgeson & Co., 1977 WL 13861 (SEC No Action Letter Feb. 3 1977). 11 See definition of “Graphic Communication” in Rule 405 under the Securities Act. 12 See Rules 164(a) and 433 under the Securities Act. 13 Rule 433(c)(i) under the Securities Act. 14 Information that is the subject of a non-intentional disclosure must promptly be disclosed. 15 Rule 433(c)(i) under the Securities Act.

MAYER BROWN | 27 A Brief Overview of the Top 10 Issues in M&A for Securitization Sponsors and Servicers

ELIZABETH A. RAYMOND1

Mergers and acquisition transactions for executed as a portfolio sale or a platform securitization sponsors and servicers present sale or both. The securitization sponsor’s unique issues that require in-depth “platform” includes the assets needed to knowledge of the underlying securitization operate the finance business, including structures and risks as well as related employees, facilities and real estate, financing, regulatory and technology issues. information technology and contracts. Many M&A lawyers and business teams should buyers are already in a finance company maintain a holistic view of how M&A affects business and do not need the facilities, past and future securitizations by both the people and information technology assets seller and the buyer, what financing plans are that may be offered as part of a platform likely for the buyer, what consents are sale along with the loans, leases or other needed and how the securitization receivables and related rights included as transactions and securitization systems will part of a loan portfolio. These buyers may be integrated post-closing. A summary of only be willing to purchase the platform some of the more prominent issues appears (other than the licenses) as a reduction to the below. purchase price for the portfolio or may view the platform as a very small part of a much Issue 1. Is It a Securitization? bigger asset play.

Is it a Whole Loan Deal? No, M&A Deal or Loan Portfolio Sale? If a It’s an M&A Deal! valuable operating platform is being sold along with loan assets, a traditional M&A Where the buyer’s primary goal is to structure, such as a merger or a stock or purchase a large portfolio of loans, leases or asset purchase, will typically be used, and other receivables, a threshold issue for the the purchase agreement will likely contain acquisition of a securitization sponsor or traditional M&A representations, covenants servicer is whether the transaction will be and indemnities. On the other hand, if only

28 | Structured Finance Bulletin 2019 or predominantly loans or other financial low threshold, and to require a relatively assets are being sold, the parties may opt for high deductible, before certain of the execution of the transaction in a manner that seller’s indemnity obligations kick in. This is more typical of a capital markets trade and may contrast favorably for the seller with a follow a whole loan portfolio format. The more typical loan portfolio remedy, which decision to structure the sale using an M&A or is to repurchase individual loans on a a loan portfolio sale format may depend as loan-by-loan basis if the seller’s represen- much on the experience of the deal team tations are breached. However, if the seller executing the transaction as anything else. It is divesting an entire business line, it may may also depend on whether the buyer no longer be able to service repurchased intends to immediately finance the loans in loans or may find it cost prohibitive to the capital markets after the purchase, in do so. which case a whole loan portfolio execution • Ability to limit representations and warran- may be more desirable for the buyer. Finally, ties. M&A representations tend to be more the valuation method being used (whole general and qualified as to materiality or a business versus loan portfolio or assets under “material adverse effect” and knowledge management) may lead to a particular type of than representations in a securitization or execution. whole loan transaction. The spectrum of Advantages and disadvantages of M&A representations that can apply to financial execution include the following: assets ranges from the detailed and numerous representations found in capital • Ability to divest an entire business. A seller markets/securitization transactions to very that desires to divest an entire business limited “as is, where is” representations line may find the M&A-style execution contained in nonperforming loan sales more favorable for avoiding trailing liabil- to what may only be a single paragraph ities of the business and allowing a “clean of loan representations in an M&A break.” If the seller divests only the port- transaction qualified by materiality and folio of assets (and not the platform that knowledge. supported the operation of those assets), • Risk of receiving a lower purchase price it will be left with a platform (employees, for the portfolio. A disadvantage that office leases, etc.) that it no longer needs. may come hand in hand with the limited The buyer will need to consider what effect recourse and limited representations its acquisition of the operating platform points discussed above is that the buyer has on value. may pay a lower price for the portfolio. In • Ability to limit indemnification remedies. effect, the buyer may “price in” the cost of An M&A indemnity regime may allow its limited rights. the seller to cap certain of the buyer’s indemnification remedies to a relatively

MAYER BROWN | 29 Advantages and disadvantages of a whole • Importance of data tape. The data tape for loan portfolio style of execution include the the portfolio of loans takes on heightened following: importance in a loan portfolio execu- tion. The data tape typically is a large excel • Faster execution and lower cost. Because spreadsheet that contains hundreds of only financial assets are being purchased line items. It may be difficult to verify the in a whole loan portfolio sale, it is typically accuracy of each and every line item in the quicker and has lower legal and other data tape. As discussed below, an accurate transaction costs than an M&A-style data tape will be essential to the buyer’s transaction. financing plans as well as its compliance • Ability to quickly finance or securitize the with the securities laws in capital markets loans. Execution as a whole loan portfolio transactions going forward. sale will be preferred if the buyer plans to Whole Business v. Assets Under finance or securitize the loans immediately Management Valuations. The negotiation after or simultaneous with the closing of and drafting of the purchase price for the the purchase. The buyer’s goal will be acquisition of a securitization sponsor or to match to the greatest extent possible servicer can be quite complex and requires a the representations, warranties and deep understanding of the securitization covenants it receives from the seller to business being sold. Once the valuation and those demanded by its underwriters and purchase price mechanics are set, the rest of investors in the capital markets. the transaction terms should support the • Ability to accommodate a forward flow valuation and pricing methodology. The whole arrangement. The whole loan portfolio business valuation approach is likely to lead to style of execution is better suited to a an M&A platform sale execution while an forward flow arrangement, which is a loan assets under management approach lends sale program that will involve multiple itself to a whole loan portfolio execution. With loan sales over a period of time. The seller either valuation approach, closing and post- may seek a forward-flow sale arrangement closing adjustments may be used to reflect where it has a large portfolio of financial fluctuations in value of the entire business or assets for which it can obtain better value the portfolio alone, as applicable. by selling in blocks over time. • Retention of post-closing liabilities for Issue 2. How Will the individual loans. The seller may achieve Purchase be Financed? higher pricing in a whole loan portfolio sale but it will retain trailing liabilities for A key consideration for the buyer of a the portfolio, typically on a loan-by-loan securitization sponsor or servicer is whether basis. and how the business and financial assets will be financed. A related question is whether the

30 | Structured Finance Bulletin 2019 current financing on the financial assets to retain the seller’s financing facilities, a placed by the seller is attractive to the buyer complex review process must be undertaken: or whether the buyer would like to pay it • Review in a Stock Deal. In a stock deal, if down. A strategic buyer such as a large bank the seller has multiple securitizations, the or finance company may not need financing or buyer will need to understand the merger may find the seller’s financing less attractive and change in control provisions contained than what it could raise itself. A financial buyer in the securitization deal documents. In typically will seek financing in part to increase term securitizations, the merger provision its rate of return on the investment by adding is typically permissive and only applies to leverage. The buyer will need to do careful the entities in the deal. In private deals and diligence of the seller’s existing securitizations bank lending facilities, change in control and other financings as well as any covenants and events of default are much impediments to financing the financial assets. more common and will likely require direct Financing conditions are very unusual in the negotiations with lenders. current M&A environment but the buyer can reduce many of the risks of financing by • Review in an Asset Deal. In an asset deal, obtaining representations and covenants the analysis is even more complex. The designed to cover its risks. buyer needs to determine exactly which assets it wants to purchase. For example, DUE DILIGENCE OF FINANCING it may seek to purchase the stock of the ARRANGEMENTS depositors in each securitization and the Review When Using the Buyer’s Existing seller’s residual interests in the trans- Financing. If the buyer has its own sources of actions, each of which will likely require financing that it prefers to the seller’s existing their own analysis. Consents and multiple sources, the buyer’s counsel will need to legal opinions (as to compliance with the review the seller’s financing facilities for securitization agreements and tax and prepayment restrictions or penalties. Private UCC matters) may be required for each secured credit facilities are typically transaction. The buyer must also be sure prepayable at any time but many public or that it meets all eligibility requirements for Rule 144A securitizations (“term the sponsor, depositor or servicer roles securitizations”) cannot be prepaid. As a and consider amending the transaction result, the buyer will need to consider the cost documents if needed. Where consents will and operational hassle of leaving the seller’s be protracted and the parties seek to close term securitizations outstanding while they quickly, it may be possible to structure an wind down to the deal’s clean-up call. interim servicing arrangement whereby the seller runs the transaction on behalf of Review When Retaining the Seller’s the buyer until all consents are received. Financing Facilities. Where the buyer seeks Here again, the securitization agreements

MAYER BROWN | 31 must be reviewed to see if there is any securitization sponsor or servicer include state prohibition on subservicing or outsourcing licenses to hold consumer loans, mortgage arrangements. servicing licenses, debt collection licenses and change of control filings and approvals. Review When the Buyer Seeks New Obtaining all of the necessary licenses, even if Securitization Financing. In some cases, a the transaction is structured as a stock strategic financial buyer will seek to place its purchase or a merger, can take a significant own securitization facilities in order to finance amount of time. In order to present a more the purchase of the financial assets. Like any attractive bid, the financial buyer may team up other leveraged acquisition, the buyer may with an existing servicer to make its bid or enter into a short-term bridge facility in the may enter into an interim or long-term form of a loan warehouse facility pending servicing agreement with the seller or a access to a syndicated secured loan facility or third-party. The seller may be willing to a structured finance capital markets provide interim servicing as an transaction. Complexity increases if the buyer accommodation with “as is, where is” seeks to finance the financial assets servicing standards as opposed to the quite simultaneously with the closing of the robust service level agreements currently seen acquisition. for consumer loan servicing. Issue 3. How Will Licenses Issue 4. Due Diligence of the Affect Structure and Timing? Contracts Relating to the State licensing issues may have a significant Financial Assets impact on structure and speed of execution of an M&A transaction involving a securitization DUE DILIGENCE AND REVERSE DUE sponsor or servicer. Financial buyers such as DILIGENCE private equity and hedge funds (unlike The buyer’s due diligence in an acquisition of strategic buyers) typically do not have all the a securitization sponsor or servicer requires state licenses needed to hold and service extensive familiarity with the underlying consumer loans. The financial buyer must securitization transactions, including the anticipate a lengthy process, potentially as structures, risks and regulatory issues that long as six months to a year, to obtain all relate to these transactions. Increasingly, a these licenses. Moreover, applications for seller must also engage in due diligence of these licenses often require disclosure of the buyer, especially if the seller is a bank or personal information about principals, criminal finance company subject to regulation by the record checks, fingerprinting and the like. banking regulators or the Consumer Financial Licenses and notifications or approvals that Protection Bureau (the “CFPB”). may be required in acquisitions involving a

32 | Structured Finance Bulletin 2019 DUE DILIGENCE OF LOANS, LOAN Servicer Advances. Similarly, the buyer FILES AND SERVICING AGREEMENTS should consider requesting from the seller a schedule delivered prior to closing (or a series Review of Loans, Leases and Other of updated schedules if there is a period of Receivables. The buyer typically will want to time between signing and closing) that sets review the forms of loans, leases or other forth any advances made by the seller as receivables that comprise the bulk of the servicer as of the date of the schedule. Note assets being sold. Other items of interest to that servicer advances are most relevant in the buyer would typically include consumer mortgage securitization or other mortgage complaint information, compliance audits, financing transactions and are much less licenses, and policies and procedures. In common for other asset classes, such as auto addition, most buyers will insist on at least loans, credit cards and student loans. sampling a statistically significant number of loan files for missing documents and other Servicing Agreements and Underlying potential defects. In an asset deal or loan Servicing Rights. Because the relevant portfolio sale, counsel should confirm that the servicing agreements and the underlying loans, leases or other receivables are freely servicing rights are critical to many assignable by the seller as lender without securitization-related acquisitions, a seller will notice to or consent from the borrower. The often provide representations specifically buyer may seek to exclude certain types of related to the quality of these documents, loans if it determines that the risk of enforcing including that it has the sole right to act as these loans is too high or servicing the loans is servicer under the servicing agreements and not cost effective. The seller may be willing to that the transfer of the servicing rights will entertain a lower price from the buyer if the grant to the buyer all of the seller’s servicing buyer is willing to take on all types of loans on rights under these agreements free and clear essentially an “as is, where is” basis. at closing.

Review of Servicing Agreements. Servicing Quality of Servicing. Securitization buyers agreements are often key assets being sold in also typically request certain representations a securitization-related M&A transaction and regarding the quality of servicing related to must be carefully vetted for consents and the underlying financial assets in a transaction. issues relating to assignability. The buyer’s Normally a seller who also acted as servicer financing arrangements for the M&A for the loans or leases in the transaction will transaction may require amendments to the be required to represent and warrant that servicing agreement to ensure that the buyer servicing has been performed in compliance is an “eligible servicer” or that the servicing with the applicable loan documents, servicing rights can be pledged to the buyer’s lender. agreements and law.

MAYER BROWN | 33 DATA TAPE ISSUES AND INFORMATION litigation or regulatory issues may cause the TECHNOLOGY buyer to seek to restructure a stock sale as an asset sale to attempt to isolate the buyer from Another area for the buyer to explore is the any lingering liabilities. accuracy and reliability of the data tape for any portfolio of loans, leases or other Issue 5. What Consents are receivables. Data tape issues are one of the most common areas of stress for a seller, Required? especially for a seller with an older portfolio As discussed above, M&A transactions where the seller’s information technology involving financial assets that are subject to systems may represent an amalgamation of securitization may require the consent of many older systems that may have grown by numerous third parties. The consents required past acquisitions. Information technology in to transfer these financial assets, regardless of general will be a detailed area for due whether a buyer is proposing to acquire an diligence as well if the seller intends to sell its entire loan origination and/or servicing technology systems. Large financial business or just certain financial assets, is institutions may not be able to easily separate often driven by the transaction structure. the systems for the securitization business Generally, if the transaction is structured as an from the systems for the businesses it is asset sale, which would trigger the various retaining and thus may not include information assignment provisions in the operative technology assets in the sale or may need to agreements, the consent process is more time provide detailed IT transition services to the consuming and complicated. If the transaction buyer. is structured as a merger or a sale of stock (or, LITIGATION AND REGULATORY ISSUES in some instances, as a sale of substantially all of the seller’s servicing platform assets), Buyers and sellers will want to carefully however, the transfer process is generally less diligence any litigation or regulatory issues complicated and time consuming because the that have arisen with the other party. Even in third-party consent provisions may not be an asset sale where all pre-closing liabilities triggered (although there are other will be retained by the seller, the buyer needs requirements that the parties must satisfy to understand what the problems have been before closing). and whether they will require changes to the operations of the business after the Consent-Based Price Adjustments. Another closing. Pending regulatory investigations purchase price variation seen in securitization- must be explored with careful consideration related M&A transactions arises from as the parties must refrain from revealing consent-based price adjustments. Where the confidential supervisory information or primary assets of the business are waiving attorney-client privilege. Significant securitization or customer agreements and

34 | Structured Finance Bulletin 2019 multiple consents are needed to transfer Approval of State and/or Federal Mortgage ownership, the buyer may only be willing to Regulators. Finally, because of the close on assets for which consents have been heightened scrutiny that governmental received. In this case, each contract is authorities have placed on the consumer assigned a price and the buyer closes and finance industry, a mortgage M&A transaction pays for that contract only when consent is may require the approval of state and/or obtained. federal mortgage regulators. These regulators may want to confirm that the buyer will Consent Issues in an Asset Sale. If a buyer adequately manage the financial assets that it and a seller structure a securitization M&A is proposing to acquire. These regulatory transaction as an asset sale, nearly all of the concerns may lead to detailed pre- and operative servicing agreements involved will post-closing covenants for the buyer and the contain an assignment provision that sets seller. forth extensive requirements that must be satisfied prior to the transfer/assignment. Amendments to Servicing Agreements. In Because servicing is such a critical component addition to the often lengthy and complicated of any financial asset financing, third-party consent process, the proposed transfer of a stakeholders in the financing (e.g., rating securitization sponsor’s platform or certain of agencies, master servicers, trustees and in its assets (in particular, servicing rights) also some cases security holders) will want to generally requires that each of the operative confirm that a proposed M&A transaction servicing agreements be amended in order to involving the transfer of servicing to a new effect the proposed transaction. This process servicer will not weaken the performance of is typically document intensive involving the financing. numerous parties, which can essentially require a mini closing for each of the Consent Issues in a Merger or Stock Sale. If amendments. a buyer and a seller structure a securitization M&A transaction as a merger or a stock sale Issue 6. Should the Seller (or, in some instances, as a sale of substantially all of the servicer’s assets), the transfer Engage in Reverse Due process can be less difficult because the Diligence? transfer provisions in servicing agreements are generally more relaxed in the case of a merger An emerging area in the consumer financial or stock sale. Typically, under these assets M&A market is whether the seller transaction structures, third-party consents needs to complete “reverse due diligence” on are not needed, but the buyer’s proposed prospective buyers. A new issue arising for servicer must satisfy several regulatory and bank and non-bank sellers that are regulated financial requirements. by the Office of the Comptroller of the

MAYER BROWN | 35 Currency (“OCC”) or the CFPB is what level of after M&A transactions include disclosures due diligence sellers must engage in with required by Regulation AB relating to respect to their buyers prior to and after a sale sponsors, depositors, servicers, static pool, of consumer assets. Even if the seller is not legal proceedings and attestation criteria as directly regulated by the OCC or the CFPB, it well as the requirement to disclose a change should consider whether the seller or the in servicer on Form 8-K. In addition, a buyer buyer may be swept within OCC or CFPB should complete an analysis of whether a supervision, or similar federal or state failure to timely file required securities filings supervision, in the future and whether the by the seller will have an impact on the ability seller should diligence the buyer as if their of the buyer’s eligibility to register the sale of rules and guidance applied. The bank seller securities on Form SF-3 or could expose the may also need to address OCC and Federal buyer to liability or penalties in connection Reserve Board guidance regarding with missed filing deadlines by the seller. outsourcing and third-party vendors. While the outsourcing guidance may not typically Issue 8. Who Will Service the apply in a sale context, where a transaction Assets After Closing? contemplates future loan sales on a flow basis or a subservicing agreement for certain assets Transfer of Servicing. In addition to the not transferred, this guidance should be customary covenants present in most M&A considered. deals, in financial asset M&A transactions, because the transfer of an origination and/or Issue 7. What SEC Disclosure servicing platform and any related Issues Arise? securitization or other financing agreements can be such a complicated and technical Both the buyer and the seller must be aware process, the buyer and the seller often agree of what SEC disclosure requirements will be to cooperate with each other to work to triggered in connection with an M&A effectuate the transfer of servicing. This transaction involving securitization sponsor or covenant will generally set forth the transfer servicer. Potential SEC disclosures could be procedures and require the parties to develop triggered by (i) events or circumstances that a more comprehensive set of transfer occurred prior to the M&A transaction and (ii) instructions in order to ensure that all rights any ongoing or future deals after the M&A and obligations are properly transferred under transaction closes. These potential SEC the operative securitization or other financing disclosure requirements are very fact-specific documents. and will heavily depend on the structure of the Deficiencies in Loan Files. Depending on the M&A transaction. A non-exhaustive list of relative bargaining power of the buyer in a some common disclosure requirements and financial asset M&A transaction, it can also considerations for sponsors and servicers in require the seller to covenant that it will public securitization transactions during and address the deficiencies in its loan files

36 | Structured Finance Bulletin 2019 between signing and closing. Because loan services, with regulated industries in particular origination and servicing activities are so facing digital transformation. Financial paper intensive and the loan portfolios are so institutions are making huge investments in voluminous, platform operators often fail to technology and cybersecurity as well as fully comply with the regulatory requirements developing more sophisticated technology regarding the contents of each of its loan files. driven products for millennials and Generation Who bears the cost of clean-up activities Z who interact predominantly online. M&A relating to deficient loan files is a negotiated deals—particularly those involving financial point between the buyer and the seller. assets—are increasingly impacted by technology. Key issues in a technology— Interim Subservicing or Servicing driven acquisition include risks relating to Agreements. If the parties are unable to open source software and cybersecurity and obtain all necessary consents and/or satisfy all data privacy compliance. The parties may necessary requirements to transfer the enter into technology agreements, including servicing business under the servicing short-term transition services agreements agreement prior to closing, the parties may be where the seller provides interim technology able to enter into an interim subservicing services to the buyer pending conversion to arrangement where the seller will continue to the buyer’s system or long-term arrangements service the receivables acquired by the buyer to receive services back from the buyer, which until the buyer is fully qualified to do so, more closely resemble outsourcing agreements. including as required under any securitization or other financing agreements. In these circumstances, the parties will negotiate an Issue 10. How Will the interim subservicing agreement prior to Purchase Agreement Differ closing, which will remain in effect for a relatively short period of time post-closing. from a “Regular” M&A Deal? Similarly, if the seller retains some of the REPRESENTATIONS AND WARRANTIES financial assets after its platform and financial assets are sold, it may require a short-term or Buyers in M&A transactions for securitization long-term servicing agreement from the businesses will typically customize traditional buyer’s servicer. M&A representations as appropriate so that they specifically address the issues that are Issue 9. How Will the unique to M&A involving securitization Technology be Transitioned? sponsors and servicers. Buyers will typically request that the seller make detailed A key factor in the current financial services representations as to the loans, leases or M&A environment is the ongoing other financial assets being purchased and the convergence of technology and financial servicing and securitization or other financing

MAYER BROWN | 37 transactions related to the business. However, COVENANTS these M&A-style representations will typically The majority of the key covenants in the not be nearly as detailed as those found in a acquisition agreement cover the period securitization or whole loan purchase of the between signing and closing, but certain same financial assets, which may cause covenants remain in effect after the closing. difficulties in negotiations. As with representations and warranties, Loans or Leases. Regardless of whether a covenants will also vary depending on buyer is proposing to acquire an entire whether the securitization buyer is acquiring origination and/or servicing platform or just the entire business or just a portfolio, and may specific financial assets, it should consider cover topics such as (i) conduct of the negotiating with the seller for representations business between signing and closing, (ii) that cover the loan or lease portfolio, consents, (iii) governmental inquiries, (iv) including any related servicing agreements post-closing covenants addressing delivery of and securitization transactions and the loan files, notifications to credit reporting underlying loans or leases being acquired. agencies, terminations and transfers of vendor Compliance with Law. Given the current agreements and transfers of ordinary course regulatory environment, the seller may also be collections litigation, and (v) post-closing concerned with what it needs to disclose transition of servicing. under the typical “compliance with law” INDEMNITIES representation. The seller’s counsel may encourage the seller to disclose anything that The indemnification provisions in an could possibly have gone or go wrong from a acquisition agreement involving financial legal compliance point of view on the seller’s assets are not particularly different from disclosure schedules despite the fact that non-finance company deals. However, these none of those issues are likely to be material. M&A-style indemnities are quite different Disclosure issues can be aggravated where from those found in a securitization or whole there are emerging views on “best practices” loan sale, where the buyer’s remedy is for compliance by finance companies, as is the typically to have the seller repurchase the case with CFPB and state consumer law financial asset with respect to which a regulation. representation has been breached. Some transactions may contain a hybrid set of Buyer Representations. Another product of remedies that combine aspects of both an the current regulatory environment is that the M&A indemnity regime and a securitization- seller is much more likely to seek style warranty repurchase. representations and covenants from the buyer covering topics such as (i) privacy and data security, (ii) licenses, registration and insurance, (iii) loss mitigation, and (iv) loan file due diligence.

38 | Structured Finance Bulletin 2019 Endnotes

1 Ms. Raymond is a financial institution M&A partner at Mayer Brown LLP. She appreciates the assistance of Julie Gillespie, Angela Ulum, Chadwick Hoyt and Jeffrey Taft, partners at Mayer Brown, and Pablo Puente, an associate at Mayer Brown. This article is a condensed version of a more in-depth analysis of issues in mergers and acquisition transactions for securitization sponsors and servicers. A more detailed review and discussion of the key considerations can be found in the complete article, Top 10 Issues in M&A For Securitization Sponsors and Servicers, at www. mayerbrown.com/ Top-10-Issues-in-MA-for-Securitization-sponsors- and-Servicers-02-08-2019/

MAYER BROWN | 39 Asset Valuations in the Mortgage Loan and Real Estate Warehouse Contexts

DARIUS HORTON SUSANNAH SCHMID DAVID STEWART

A primary financial driver in any asset-based observations in how these market valuation warehouse deal is how the borrowing base is provisions are negotiated with respect to determined. Typically, the borrowing base is different real estate and mortgage loan based on a percentage of the value of the warehouse facility contexts. underlying assets. How valuations are determined in the mortgage loan and real Residential Real Estate estate warehouse and repurchase facility Mortgage Loans contexts is subject to much negotiation. If these valuations are based on objective The advance rate for most plain vanilla metrics that do not vary over the time the residential real estate loan warehouse underlying asset is pledged, the borrower facilities is based on the lesser of the unpaid has certainty over its lending base. However, principal balance of the loan, the takeout if the valuations can be increased or price with respect to a loan (if applicable) decreased, the borrower may be able to and the “market value.” While the unpaid extract more financing from the underlying balance and takeout price are two objective appreciating asset, or the borrower may have tests, the determination of the “market to contribute cash or other assets related to value” introduces a level of subjectivity that a depreciating asset. While there is a benefit may differ from lender to lender. The to both parties to have a true valuation of “market value” is typically the value of a loan the underlying asset, lenders typically want determined by the lender, which may take control over the valuation process. How this into account the price at which the loan can control is exerted through contractual be sold while a borrower is in default and language may introduce a level of other macro-economic forces. Because this subjectivity, which borrowers will typically try standard permits the lender to predict the to combat through contractual future with respect to the housing market, it negotiations. The following are our can become very difficult for a borrower to predict on any given day what financing it

40 | Structured Finance Bulletin 2019 will have in place and what will need to be commercial real estate. However, some repaid. In addition, because of the opaque lenders are reluctant to offer even this nature of these determinations, borrowers are concession. Since commercial real estate can typically concerned that this subjectivity could be so heterogeneous, some lenders are enable a lender to mark down certain assets uncomfortable representing that they have of a particular borrower unfairly, tying the consistent marking practices across assets. value of the loan to the credit quality of the borrower. To help control some of this Fix and Flip Mortgage Loans subjectivity, borrowers may request that the In recent years, “fix and flip” mortgage loans determination be made in good faith or on have been increasingly popular assets for terms consistent with how the lender would warehouse lenders. Also known as residential value other similar residential mortgage loans bridge loans or residential construction loans, for different lenders or for similar loans held these are business purpose loans secured by for their own account. The purpose of this single-family homes. Typically, the mortgagor request by borrowers is to try to ensure that, intends to rehabilitate the mortgaged at the very least, the borrower won’t be property and sell it within a short period of adversely selected by the lender for reasons time. Historically, these loans were originated outside of such borrower’s control. Because by small “hard money” lenders operating in the typical number of loans in a pool tends to local markets. Recently, larger finance be quite large and because of the relative companies have moved into this space, homogeneity based on certain product types, attracted by the high yield and short some lenders will agree to this. maturities that fix and flip loans usually Commercial Real Estate feature. This in turn has led to an increasing number of commercial banks offering Mortgage Loans warehouse financing. Fix and flip loan facilities present unique challenges for warehouse Commercial real estate loan warehouses are lenders looking to mark the assets. Similar to usually secured by “lumpier” pools than are transition commercial loans, the mortgaged residential mortgage loan financings. They properties are often in a state of disrepair and generally include a small number of loans with their value is highly dependent on the skill of much higher principal balances than the mortgagors in rehabilitating the residential loan balances. As a result, lenders properties. On the other hand, there are more are very sensitive to risk regarding the value of assets spread over a wider geographic area the assets and insist on the right to mark all than in a commercial mortgage pool, so assets on a daily basis in their sole lenders are exposed to less risk with respect discretion. If a borrower has any leverage to to any particular asset or real estate negotiate these provisions, they will usually market. As a result, many fix and flip facilities ask that a lender mark their assets consistently do not have mark to market provisions at with their practice of marking similarly situated

MAYER BROWN | 41 all. Instead, the lender relies on third-party Single Family Rental appraisals to determine the value of the assets. Typically, the lender also has the right Properties to request new appraisals or broker price Single family rentals present another type of opinions if an asset becomes delinquent or is asset class where “market valuations” are otherwise in default. In addition, a warehouse important. Single family rental facilities are lender will sometimes have the right to unique in that their values can be based on challenge an appraised value and ask for a the rental income stream and the underlying new appraisal if they determine that the valuation of a property if such property is original appraisal used unfounded owned by the borrower. Frequently, the assumptions or was otherwise invalid. Of advance rate may be based on a valuation of course, some lenders insist on full mark to the property determined by an appraisal, a market provisions for fix and flip loans, in broker-priced opinion (BPO) or an automated which case the provisions are negotiated on valuation mode (AVM). While these valuations the same basis as a commercial mortgage introduce a third-party mark on the asset, loan facility. lenders will frequently try to introduce an REO Properties obligation that the valuations will be refreshed after a period of time or when certain trigger A first cousin to “fix and flip” mortgage loan events occur. Obtaining these new valuations financing is the financing of real estate-owned can be costly and inefficient. To minimize (REO) properties. Like “fix and flip,” REO these costs, borrowers may negotiate what properties are often in a state of disrepair; will be reviewed in a valuation and how however, the valuations do not take into frequently they can occur. Valuations that take account any rehabilitation of the into account solely an exterior inspection are property. While sometimes appraisals are much less costly than those that have both the required for these properties, because interior and exterior examined. appraisals add to the cost of what is already a distressed asset, lenders will often reduce the Dispute Mechanics advance rate for real estate-owned properties and base the valuations on market valuations Regardless of asset class, if a lender has the similar to residential mortgage loans. right to mark asset values, borrowers may ask for the right to challenge the lender’s mark. In the context of plain vanilla residential

42 | Structured Finance Bulletin 2019 mortgage loans, lenders are typically reluctant to give challenge rights on valuations. However, in commercial real estate, single family rental and fix and flip facilities, these challenges usually come in two varieties. First, the borrower (at its own cost) can order new appraisals for any assets that the lender marks down. If the new appraised value is materially higher than the lender’s mark, the new appraised value will control. Even if a lender is willing to subject its mark to such a challenge, it will usually retain the right down again in the future in its sole discretion. Alternatively, the borrower sometimes has the right to solicit bids from bona fide third parties to purchase the pool. If the borrower can find some minimum number of good faith bids (often three) that are for a higher value than the lender has marked the assets, the higher value will control. However, it is not clear if in practice a borrower would ever be able to find the required number of bidders. In any case, while a mark is subject to challenge, the borrower is generally required to post cash collateral with the lender to cure any borrowing base deficiency if they lose the challenge.

Regardless of the specific asset type, the ability for lenders to value the underlying asset is a critical component to any warehouse facility. Negotiating these provisions should be undertaken with the utmost care from a drafting perspective in order to preserve as much objectivity in this process as is permitted.

MAYER BROWN | 43 Divisive Mergers: Hazards and Opportunities

BARBARA GOODSTEIN GER O’DONNELL JENNIFER KRATOCHVIL LANCE WORKMAN STUART LITWIN

Effective August 1, 2018, the Delaware The LLC Act also sets forth certain key Limited Liability Company Act (“LLC Act”) terminology: was amended to enable a limited liability • “Dividing company” – the LLC that is company (“LLC”) to be divided into two or being divided into two or more entities. more LLCs (a “divisive merger”).1 Allowing Section 18-217(a)(1). divisive mergers provides additional flexibility for Delaware LLCs to manage and • “Resulting company” – the LLC that dispose of assets and liabilities and facilitates results from the division as a separate spinoffs. These changes may create and distinct entity from the dividing structuring opportunities in asset-backed company. Section 18-217(a)(6). deals, but may also create potential hazards • “Division company” – refers to both for lenders/investors to keep in mind. the dividing company and the resulting company. Section 18-217(a)(3). Overview of New Law The plan of division must include, among There are three key amendments set forth in other things, the names of each division Section 18-217 of the LLC Act. First, the LLC company post-division and the allocation of Act provides LLCs with the ability to divide: assets, property, rights, series, debts, liabilities and duties of the dividing company “Pursuant to a plan of division, any domestic among the division companies. Section limited liability company may, in the manner 18-217(g). Although the plan of division is not provided in this section, be divided into two publicly filed, both a certificate of division, or more domestic limited liability which includes, among other things, a companies.” Section 18-217(b). statement that the plan of division is on file with each division company, and the

44 | Structured Finance Bulletin 2019 certificate of formation of each resulting This provision makes clear that assets and company must be filed with the Delaware liabilities allocated to a division company are Secretary of State. Section 18-217(h). not transferred or assigned, which may give rise to structuring opportunities where Second, the LLC Act sets out the effect of transfers are undesirable or may be used to the division, which includes, among other avoid restrictions on transfers things, that:

“Each division company shall, from and after Opportunities in Structuring effectiveness of the certificate of division, be The ability to do divisive mergers will enable liable as a separate and distinct domestic creative parties to structure transactions in limited liability company for such debts, unique ways to solve problems. This liabilities and duties of the dividing opportunity is especially true given that company as are allocated to such division Section 18-217(l)(8) provides that “rights, company pursuant to the plan of division in privileges, powers and interests in property of the manner and on the basis provided in the dividing company that have been subsection (g)(1)(ii) of this section.” Section allocated to a division company … shall not be 18-217(l)(3) (emphasis added). deemed, as a result of the division, to have This provision makes clear that a division been assigned or transferred to such division company is only liable for obligations company for any purpose of the laws of the allocated to it under the plan of division,2 State of Delaware.” For example, this provision which may allow assets to be split from may create opportunities in structuring liabilities to the potential detriment of transactions to provide for transferring of lenders/investors. assets or liabilities that might otherwise be difficult to effectuate, such as licenses, Third, the LLC Act provides that a division is recorded or titled property, structured not a transfer or assignment: settlements or risk retention pieces. “The rights, privileges, powers and interests in property of the dividing company that have Hazards to Consider been allocated to a division company, as well Although the LLC Act does provide a bit of as the debts, liabilities and duties of the protection for deals entered into before dividing company that have been allocated to August 1, 2018 with LLCs created before such such division company pursuant to a plan of date,3 most transaction documents do not yet division, shall remain vested in each such restrict divisive mergers. Additionally, since division company and shall not be deemed, as assets reallocated are not “transferred,” a result of the division, to have been assigned traditional restrictions on transfer may provide or transferred to such division company for little protection to lenders/investors. any purpose of the laws of the State of Moreover, although the LLC Act provides that Delaware.” Section 18-217(l)(8).

MAYER BROWN | 45 “all liens upon any property of the dividing Conclusion company shall be preserved unimpaired” (Section 18-217(l)(4)), a dividing company Delaware’s divisive merger law will provide could allocate assets to one division company opportunities to structure transactions in new and liabilities to another, thereby creating ways that may overcome previous obstacles. opportunities to avoid restrictions in However, lenders/investors not only need to transaction documents. Furthermore, be mindful of this new flexibility but also need although such an existing lien would apply to to adopt appropriate limitations or restrictions the assets in existence at the time of division, to protect their interests. subsequently originated assets would not be subject to the lien, unless the applicable division company were subject to the security arrangement and UCC financing statements were properly filed. Given the foregoing, lenders/investors will need to make sure that Endnotes their facilities include appropriate limitations 1 Note that the term “divisive merger” is often or restrictions on divisive mergers as well as referred to by commentators but not explicitly used certain further assurance provisions, if in the LLC Act. 2 applicable, to ensure that appropriate security There are two exceptions to this rule where joint and several liability would apply: 1) to fraudulent arrangements are put in place and necessary transfers (Section 18-217(l)(5)); and 2) to debts and UCC financing statements are properly filed, liabilities not allocated under the plan of division (Section 18-217(l)(6)) in connection with a divisive merger. 3 “All limited liability companies formed on or after August 1, 2018, shall be governed by this section. Application beyond All limited liability companies formed prior to August 1, 2018, shall be governed by this section; Delaware LLCs provided, that if the dividing company is a party to any written contract, indenture or other agreement Although the LLC Act currently only applies to entered into prior to August 1, 2018, that, by its Delaware LLCs, it is expected that the divisive terms, restricts, conditions or prohibits the consum- mation of a merger or consolidation by the dividing merger concept will be expanded to other company with or into another party, or the transfer Delaware entities. Additionally, several states, of assets by the dividing company to another party, then such restriction, condition or prohibition shall such as Arizona,4 Pennsylvania5 and Texas,6 be deemed to apply to a division as if it were a already have divisive merger statutes in place merger, consolidation or transfer of assets, as and others, such as Illinois, are contemplating applicable.” Section 18-217(o). such statutes. As a result, it is important that 4 29 Ariz. Rev Stat §2601 et seq. any restrictions on divisive mergers be broadly 5 15 Pa. Consol. Stat. §361 et seq. drafted to contemplate an expansion of 6 Texas Business Organizations Code §10.001 et seq. applicability.

46 | Structured Finance Bulletin 2019 Securitization & Structured Finance

INDUSTRY LEADERS Mayer Brown’s Structured Finance practice is one of the largest and most balanced in the industry, with genuine strengths across the entire range of asset classes—from mortgage-backed securities, asset-backed commercial paper, credit cards, and auto/equipment loans and leases to IP assets, marketplace loans, renewable energy, whole businesses and insurance-linked securities. We are regularly called upon by both arrangers and issuers, and we are regularly at the top of the league tables in both categories. We are leaders not only in ABS/MBS transactions but also in transactions privately funded by banks, hedge funds and asset-backed commercial conduits. Many of the structured finance transactions that are commonplace today were first initiated by lawyers at Mayer Brown—for example, the first CLO transaction in 1988, the first partially enhanced multi-seller commercial paper conduit in 1989 and the first ABS shelf registration in 1992. A key factor in our ability to structure cutting-edge transactions is our depth of knowledge resulting from decades of industry leadership on the entire range of regulatory, securities, bank capital, accounting and other issues that affect securitizations.

MAYER BROWN | 47 100+ Structured Finance lawyers in 10 offices

Partners with 20+ years of Structured Finance 19 experience

13 Chambers-ranked Structured Finance lawyers

3 of the last 5 years named IFLR Americas 3 “Structured Finance and Securitization Team of the Year”

Consecutive years as the most active ABS/ 3 MBS securitization firm (source:Asset-Backed Alert)

Represented issuer or underwriter on 283 $186B public and 144A rated US ABS/MBS deals totaling > $186 billion in 2017-2018 (source: Asset-Backed Alert)

48 | Structured Finance Bulletin 2019 Accolades

Ranked First for ABS/MBS Ranked Tier 1 for Structured Issuer Counsel Finance: Securitization Asset-Backed Alert 2018 Legal 500 USA 2018

ABS Law Firm of the Year Ranked Tier 1 for Capital Best Overall Securitization Law Markets: Structured Finance and Firm (second consecutive year) Securitisation – United States GlobalCapital’s 2017 US IFLR1000 2019 Securitization Awards

Ranked First for US Straight Ranked Fourth for ABS/MBS Debt Including ABS & MBS, Underwriter Counsel Issuer Counsel Asset-Backed Alert 2018 Thomson Reuters 2018

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MAYER BROWN | 49 50 | Structured Finance Bulletin 2019 MAYER BROWN | 51 Mayer Brown is a distinctively global law firm, uniquely positioned to advise the world’s leading companies and financial institutions on their most complex deals and disputes. With extensive reach across four continents, we are the only integrated law firm in the world with approximately 200 lawyers in each of the world’s three largest financial centers—New York, London and Hong Kong—the backbone of the global economy. We have deep experience in high-stakes litigation and complex transactions across industry sectors, including our signature strength, the global financial services industry. Our diverse teams of lawyers are recognized by our clients as strategic partners with deep commercial instincts and a commitment to creatively anticipating their needs and delivering excellence in everything we do. Our “one-firm” culture—seamless and integrated across all practices and regions—ensures that our clients receive the best of our knowledge and experience.

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