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From Banking and Finance Law Daily, August 28, 2013

Agencies repropose “skin in the game” rules

By John M. Pachkowski, J.D.

The bank regulatory agencies—Office of the Comptroller of the Currency, Federal Reserve Board, and Federal Deposit Insurance Corporation—along with the Securities and Exchange Commission, Federal Housing Finance Agency, and Department of Housing and Urban Development have issued a notice revising a proposed rule requiring sponsors of securitization transactions to retain risk in those transactions. The new proposal revises a proposed rule the agencies issued in 2011 to implement the risk retention requirement in the Dodd-Frank Act.

Comments on the proposed rule are due by Oct. 30, 2013.

The proposed rule would implement section 15G of the Securities Exchange Act which is intended to help address problems in the securitization markets that led to the financial crisis, namely the deficiencies in the prevailing “originate-to-distribute” business model, which rewarded volume over asset quality, as lenders retained little or no continuing exposure in loans they originated for securitization. As noted in the statute’s legislative history, “When securitizers retain a material amount of risk, they have ‘skin in the game,’ aligning their economic interest with those of investors in asset-backed securities.”

Section 15G exempted qualified residential mortgages (QRMs) from the risk retention requirements, and directed the agencies to develop a definition for QRM that takes into consideration underwriting and product features that historical loan performance data indicate result in a lower risk of default.

The agencies are reproposing their risk retention regulations in light of the over 10,500 comment letters they received in response to their April 2011 proposal. A large majority of commenters criticized the agencies’ definition of QRM which included a requirement for a loan-to-value (LTV) ratio no higher than 80 percent (and lower, if the mortgage was a refinancing), credit history metrics, conservative debt-to-income (DTI) requirements (no greater than 36 percent), and certain other requirements. The original proposal also included underwriting standards for commercial, CRE, and automobile loans underlying ABS to qualify for exemption from risk retention.

Fair value. Under the new proposal, asset-backed securities (ABS) sponsors would have several options to satisfy the risk retention requirements. The April 2011 proposal generally measured compliance with the risk retention requirements based on the par value of securities issued in a securitization transaction and included a so-called premium capture provision. The agencies are now proposing that risk retention generally be based on fair value measurements without a premium capture provision.

A memorandum by the FDIC’s staff noted that that the “menu of options approach to risk retention, together with exemptions and risk retention options for specific types of securitizations, will help ensure that securitizers and (where applicable) others retain a meaningful amount of credit risk in a way that minimizes potential adverse impacts.” The memorandum continued that the proposed rule is consistent with the stated objectives of section 15G and will foster sound underwriting and prudent risk management practices with respect to loan origination.

QRM-equals-QM. The agencies’ new proposal would define QRMs to have the same meaning as the term qualified mortgages as defined by the Consumer Financial Protection Bureau’s Ability-to-Repay (ATR) rule. Under the CFPB’s ATR, a mortgage is considered to be a qualified mortgage if it does not have any excess up-front points and fees; contains no risky loan features, such as negative amortization, interest only, or balloon features; and is generally provided to people with DTI ratios of less than or equal to 43 percent.

The new proposal also requests comment on an alternative definition of QRM that would include certain underwriting standards in addition to the qualified mortgage criteria. This alternative, called the “QM-plus approach,” uses the core QM criteria to define QRM but requires three more aspects of the loan’s underwriting to be considered. First, QRM status would be available only for first-lien loans secured by one-to-four family real properties that constitute the principal dwelling of the borrower, and would not be available if any other recorded or perfected liens on the property exist at closing. Second, QRM would only be available if the LTV at closing did not exceed 70 percent. Third, the borrower’s credit history would need to indicate an ability to manage debt.

Exempt securitizations. Similar to the April 2011 proposal, the new proposal would exempt securitizations of commercial loans, commercial mortgages, and automobile loans of low credit risk from the risk retention requirements.

GSE guarantees. Finally, the proposed rule would recognize the full guarantee on payments of principal and interest provided by Fannie Mae and Freddie Mac for their residential mortgage-backed securities as meeting the risk retention requirements while Fannie Mae and Freddie Mac are in conservatorship or receivership and have capital support from the U.S. government. This provision also is unchanged from the original proposal.

Reaction. Following release of the proposal, Comptroller of the Currency Thomas J. Curry said, “Today’s reproposal of the risk retention rule makes important strides in ensuring our mortgage markets can operate in a safe and sound manner while meeting the needs of creditworthy borrowers.” He added, “I support the QRM-equals-QM approach provided in today’s proposed rule and believe that soliciting comments on the alternative approach helps promote a robust conversation and richer understanding of the consequences of the rule we are proposing. Given the magnitude of these and other changes the agencies have made to address commenters’ concerns, I think it makes sense to repropose the rule and encourage all stakeholders to take the opportunity to provide comment on this important proposed rule.”

Speaking on behalf of the American Bankers Association, Frank Keating, the ABA’s President and Chief Executive Officer stated, “We applaud the proposed Qualified Residential Mortgage rule released by federal regulators today. Gratefully, the proposed rule aligns the QRM definition with the existing Qualified Mortgage rule. This will encourage lenders to continue offering carefully underwritten QM loans, including those with lower down payments. As a result, it will help the economy and ensure the largest number of creditworthy borrowers are able to access safe, quality loan products at competitive prices.”

Richard Hunt, President/CEO of the Consumer Bankers Association, added, “Today’s proposal aligning Qualified Residential Mortgages with the CFPB’s QM rule will help reduce the cost of credit and make it more readily available to home buyers. It is critical not to disrupt the marketplace for the funding and securitization of mortgages, and this proposal would go a long way toward that goal. It is a win for consumers and the still recovering housing industry.”

Camden R. Fine, President and CEO of the Independent Community Bankers of America, added, “ICBA is pleased that the proposed rule would include ‘qualified mortgage’ (QM) loans as defined under the ability to repay rules issued by the CFPB and loans backed by Fannie Mae and Freddie Mac in the ‘qualified residential mortgage’ (QRM) definition. … The proposed approach would establish a clear set of rules with fewer impediments to credit availability than the original proposal, which included a 20 percent down payment requirement.”

The Center for Responsible Lending called the proposal “a big step forward in strengthening the U.S. housing market and economy.”

Finally, House Financial Services Committee Chairman Jeb Hensarling (R-Texas) said, “The decision by Washington regulators to revamp these proposed regulations is another sign of the incomprehensible complexity of Dodd-Frank and also an acknowledgment that their original proposal would harm our economy and make it harder for Americans to buy homes. The better solution is not to paper over the flaws in these regulations and pretend that they will work but to get rid of them altogether, and that’s what the PATH Act does. No unaccountable bureaucrat in Washington should be able to dictate who gets a mortgage and who does not.”

Companies: American Bankers Association; Center for Responsible Lending; Consumer Bankers Association; Fannie Mae; Freddie Mac; Independent Community Bankers of America

MainStory: TopStory BankingOperations CFPB DoddFrankAct FederalReserveSystem FinancialStability GovernmentSponsoredEnterprises Loans Mortgages SecuritiesDerivatives

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