Banks and other lenders will be able to include many more delinquent loans in new offerings of asset-backed securities, thanks to new guidelines from the Securities and Exchange Commission.
Surprising many, the SEC has advised that companies bringing asset- backed securities to market under shelf registrations may include "total delinquencies" of up to 20%.
Previously, the agency had insisted that companies could not use shelf registrations to sell such securities if more than 5% of the supporting assets were 30 to 59 days delinquent, or if any loans were more than 60 days overdue.
The changed policy is a big victory for banks, subprime auto lenders, home equity lenders, and other issuers who had urged the SEC to relax its stance.
But a number of market observers were startled by how much the commission changed its tune. They expressed concern that the move could trigger deterioration in the credit quality of securities feeding the nation's fastest-growing debt market.
"This ruling will give a hell of a lot of leeway to issuers whose delinquencies have been creeping up," said Jeffrey P. Salmon, asset-backed analyst at UBS Securities.
"It certainly takes the onus off issuers to 'cull the herd,'" said Sean Sheerin, an analyst at Duff & Phelps Credit Rating Co. "Clearly the collateral entering the market will change."
The shift came in a written SEC response to a plea from the Bond Market Association, a trade group for underwriters and sellers of asset-backed securities formerly known as the Public Securities Association.
James X. Callahan, executive director at the Pentalpha Group, a Greenwich, Conn., consultancy, said the ruling will force ratings agencies to grade asset-backed securities more conservatively, which would in turn make it more expensive for companies to issue them.
But for now, it appears that banks and other issuers have gotten what they wanted: the right to continue to issue asset-backed securities using shelf registrations at a time of rising delinquencies.
The new ruling also opens the possibility of shelf registration to new companies, including subprime auto lenders, said Renwick D. Martin, a partner in the New York law firm of Brown & Wood who has been closely involved in asset-backed securities since the market began.
Shelf registration, a practice begun in the 1980s, allows issuers to comply with SEC registration requirements as much as two years before a public offering. The method is meant to ease administrative requirements and allow issuers to take advantage of market opportunities.
The significant advantage of the shelf registration is avoiding the time and expense of preparing a separate prospectus each time an issuer wants to sell asset-backed securities.
At the same time, by selling asset-backed securities "off the shelf," issuers don't have to disclose to the SEC the most recent chargeoff or delinquency rates of their loans-although the ratings agencies typically track those numbers.
While the 5% delinquency rule has long been on the books, industry observers say it was not strictly enforced until this summer, when First Commerce Corp. of New Orleans applied for a shelf registration to sell credit card securities.
Many banks and others rely on the asset-backed market as a cheap source of funds to finance their lucrative credit card operations.
The commission, with new policymakers in its corporate finance division, saw First Commerce's delinquency rates and invoked the 5% rule, delaying the bank's application. SEC staff argued that delinquency rates in credit card securities should be low because delinquencies cannot be converted into cash, and so are not assets.
But the Bond Market Association argued that few companies would be able to sell asset-backed securities using shelf registrations if the 5% delinquency rule was regularly enforced.
George P. Miller, the association's deputy general counsel, said the 20% delinquency rule was reached because the SEC will typically request audited financial statements when 20% of a pool of securities contain assets from a single company. "In general, 20% is invoked in somewhat related contexts," Mr. Miller said.
Analysts said Monday that they doubted reputable companies would use the new guidelines to foist their bad loans on investors. "Companies that have good ratings will do all they can to keep those ratings," Duff & Phelps' Mr. Sheerin said.
But Mr. Callahan, a former bond trader, warned that investors in asset- backed securities will be seeing not only more securities with low-quality credits to begin with but also more securities likely to slide in quality very quickly.
"We're in a period of economic strength now, and you're going to be dealing with securities where 20% of the people have gone to the well to begin with-well, buyer beware," he said.
