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From Securities Regulation Daily, August 28, 2013

Two commissioners object to federal agencies' reproposed credit risk retention rules

By Jacquelyn Lumb

The SEC and five other federal agencies have reproposed their joint proposal from April 2011 revising the risk retention requirements as required by the Dodd-Frank Act. The risk retention rules require securitizers to retain no less than 5 percent of the credit risk of any asset they transfer, sell, or convey to a third party. The reproposal redefines qualified residential mortgages (QRM), whose securitizations are exempt from the risk retention rules, to have the same meaning as the term qualified mortgage (QM) as defined by the Consumer Financial Protection Bureau. Both Commissioners Daniel Gallagher and Michael Piwowar issued dissents in response to the issuance of the reproposal.

Congress intended that by requiring securitizers to retain a portion of the credit risk of the assets being securitized, they would have an incentive to monitor and ensure the quality of the assets underlying the transaction, better aligning their interests with those of investors. Exchange Act Section 15G requires that the definition of a QRM be no broader than the definition of a qualified mortgage under the Truth in Lending Act, as amended by the Dodd-Frank Act.

A majority of commenters criticized the originally proposed QRM standard and said the 20-percent down payment requirement would significantly increase the costs of credit for most home buyers and restrict access to capital. The new proposal requests comments on an alternative definition of QRM that would include certain underwriting standards in addition to the qualified mortgage criteria.

Gallagher’s dissent. Gallagher said he was pleased that the agencies were reproposing the initial rules rather than adopting what he considered flawed rules. The feedback from commenters reflected a need to reexamine the original proposal, he said. However, in his view the reproposal, if adopted, would ensure that the vast majority of mortgages in the U.S. are insured or owned by the government. The rules would introduce another flawed government imprimatur of creditworthiness into the markets, he said, and would disincentivize proper risk management and due diligence in the mortgage markets.

Gallagher characterized the CFPB’s definition of a qualified mortgage as deeply flawed. He said it eviscerates the ability-to-repay criterion and replaces underwriter judgment with a new government standard for mortgage lending. In Gallagher’s view, the QRM label will carry the exact type of government imprimatur that, in the context of credit ratings, created the moral hazards that were a major contributor to the financial crisis. He questioned the point of adopting a risk retention standard and then exempting everything from it.

In response to numerous commenters’ criticisms of the initial QRM standard, Gallagher said that rulemakings are not referenda. Regulators must apply their experience and expertise regardless of the volume of negative comments, he said. Gallagher added that the majority of negative comments came from unbiased parties, such as low-income-housing advocates and the real estate industrial complex.

Independence concerns. Gallagher also sees the reproposal as another incursion on the SEC’s independence. The risk retention provision is in a new section of the Exchange Act, but the Dodd-Frank Act vests responsibility for the joint rulemaking with the chair of the Financial Stability Oversight Council. The commissioners were not given the opportunity to make any changes, which Gallagher said runs counter to the deliberative, interactive rulemaking process the SEC is legally obligated to undertake.

Gallagher also maintained that defining the term QRM to mean QM as defined through the CFPB’s implementing regulations subjects the definition to alteration by the CFPB. Any future amendments made by the CFPB would not be subject to the SEC’s rulemaking process, he said, and he questioned as a matter of administrative law the validity of any amendments.

Piwowar’s dissent. Piwowar’s objections were based on the reproposal’s lack of the necessary economic analysis and consideration of alternatives. While the SEC conducted a robust analysis, he said, the joint nature of the proposal, which falls under Exchange Act Section 15G, suggests that the other agencies also have an obligation to conduct an economic analysis or to adopt the SEC’s analysis.

Piwowar also noted that the reproposal does not address the effect of the SEC’s rules that were adopted in 2011 to improve the securitization markets. Those rules were effective on February 14, 2012, so a year of data was available for the agencies’ consideration. He said it does not appear that the agencies made use of this information in connection with the reproposal.

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