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From Securities Regulation Daily, October 21, 2014

OCC and FDIC adopt risk retention rules; SEC vote set for tomorrow

By Jim Hamilton, J.D., LL.M.

The OCC and FDIC have adopted credit risk retention rules as directed by the Dodd-Frank Act. These are interagency rules that were also proposed by the SEC and the FED, which are expected to adopt the rules at scheduled meetings tomorrow.

The rules require lenders to retain some of the risk for the loans that go into securitized pools except for home mortgages that meet the standards necessary under the qualified residential mortgage, or QRM, exception. Under the final rules, QRM is equivalent to QM, that is, the Qualified Mortgage rule approved by the Consumer Financial Protection Bureau. The final risk retention rules will provide more certainty in the securitization markets, which play a vital role in financing the needs of consumers, from autos to housing.

Residential mortgage rule. Senator Robert Corker (R-Tenn.), a key member of the Banking Committee, had strongly encouraged the financial regulators to consider drafting a qualified residential mortgage rule as part of the risk-retention regulations that syncs up with the qualified mortgage regulations adopted by the Consumer Financial Protection Bureau. Senator Corker reasoned that matching the CFPB’s version of a safe loan for any borrower with the definition of what constitutes a loan that the SEC and banking agencies ultimately decide is safe for securitization make sense for the financial system and is wholly consistent with the intent of the Dodd-Frank Act.

The rules take effect one year after Federal Register publication with respect to asset-backed securities collateralized by residential mortgages and two years with respect to all other classes of asset-backed securities.

Section 941 of the Dodd-Frank Act added Section 15G of the Exchange Act to require the securitizer of asset-backed securities to retain not less than 5 percent of the credit risk of the assets collateralizing the asset-backed securities. Section 15G contains an exemption for asset-backed securities that are collateralized exclusively by residential mortgages that qualify as qualified residential mortgages, a term of art, as QRMs are defined by the regulators.

The agencies believe that a QRM definition aligned with the definition of a QM meets the statutory goals and directive of Section 15G of the Exchange Act to protect investors and enhance financial stability, in part by limiting credit risk, while also preserving access to affordable credit and facilitating compliance.

Comptroller of the Currency, Thomas Curry, noted that regulators have committed to reviewing the QRM standards in four years. By then, he surmised, there should be enough experience with the standards to know whether they strike the right balance between long-term financial stability and consumer home-financing needs, and can be adjusted if necessary.

These timeframes are also designed to coordinate the agencies’ review of the QRM definition with the timing of the CFPB’s statutorily mandated assessment of QM. But is should be noted that the final rule provides that the SEC or any of the other adopting agencies may request a review of the definition of QRM at any time as circumstances warrant.

The final rules apply a minimum 5 percent base risk retention requirement to all securitization transactions that are within the scope of Section 15G of the Exchange Act and prohibit the sponsor from hedging or otherwise transferring its retained interest prior to the applicable sunset date. The final rules also allow a sponsor to satisfy its risk retention obligation by retaining an eligible vertical interest, an eligible horizontal residual interest, or any combination thereof as long as the amount of the eligible vertical interest and the amount of the eligible horizontal residual interest combined is no less than 5 percent.

The amount of the eligible vertical interest is equal to the percentage of each class of asset-backed securities interests issued in the securitization transaction held by the sponsor as eligible vertical risk retention. The amount of eligible horizontal residual interest is equal to the fair value of the eligible horizontal residual interest divided by the fair value of all asset-backed securities interests issued in the securitization transaction.

After considering numerous comments, the agencies concluded that the proposed cash flow restriction on the eligible horizontal residual interest (as well as the alternative described in the re-proposal) could lead to unintended consequences or have a disparate impact on some asset classes. The agencies therefore decided not to include such restrictions in the final rules.

MainStory: TopStory DoddFrankAct

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