Federal regulators say that a risk-retention rule outlined today will help bring investors back to the mortgage-backed securities market. But investors and mortgage bankers see it differently — calling the rule too rigid. Another point of contention is servicing standards promulgated in the rule.
The risk-retention rule was proposed on Tuesday by the Federal Reserve Board. Risk retention is required under the Dodd-Frank Wall Street Reform and Consumer Protection Act.
Joining the Fed in proposing the rule were the Federal Housing Finance Agency, the Department of Housing and Urban Development, the Office of the Comptroller of the Currency, the Federal Deposit Insurance Corp. and the Securities and Exchange Commission.
According to the Fed, sponsors of asset-backed securities — including residential mortgage-backed securities — would be required to retain 5 percent of the underlying assets’ credit risk. Sponsors would be given various options.
FDIC Chairman Sheila C. Bair said misaligned incentives that arose from the widespread use of private mortgage securitizations were a key driver of the housing crisis. She noted that nearly 90 percent of subprime and Alt-A mortgages originated between 2005 and 2006 were privately securitized.
“During that period, the separation of originating and securitizing loans from the risk of loss in the event of default fed a massive amount of lax, unaffordable lending which fueled the housing bubble,” Bair stated. “Since neither lenders nor securitizers appeared to hold any real risk in the transaction, the ‘originate-to-distribute’ model of mortgage finance misaligned incentives to reward the volume of loans originated, not their quality.”
Bair said that private securitizations fell from more than $1 trillion in the peak years of 2005 and 2006 to just 5 percent of that level in 2009 and 2010. She noted that the “market needs strong rules that assure investors that the process is not rigged against them.”
Fannie Mae and Freddie Mac will be considered to have met new risk-retention requirements through their 100 percent guarantees while they are operating in conservatorship or receivership and receiving capital support from the government.
Exempted from the rule are U.S. government-guaranteed ABS.
Also exempted would be non-agency RMBS with loans that meet the requirements of “qualified residential mortgages.” Such an exemption would apply to “very high credit quality” mortgages based on credit histories and maximum loan-to-value ratios of 80 percent — regardless of whether mortgage insurance is obtained.
But HUD Secretary Shaun Donovan explained that two LTV options have been laid out.
“While there is no question that larger down payments correlate with better loan performance, down payments only tell part of the story,” Donovan stated. “That’s why we have laid out two alternatives, one requiring a 10 percent down payment and another requiring 20 percent.”
Borrowers on qualified loans cannot be 30 days past due on any debt and must not have been 60 days late during the past 24 months. No bankruptcies, repossessions or foreclosures are allowed within the preceding 36 months. A three-year requirement also exists for short sales and deeds-in-lieu of foreclosure as well as federal or state judgments for collection of unpaid debt.
Originators would have to verify the credit history with two major credit repositories no more than 90 days before the loan closing.
No balloon, interest-only or negative-amortization loans can be considered qualified. Also prohibited are loans with prepayment penalties and adjustable-rate mortgages where the rate can increase more than 200 basis points a year or more than 600 BPS over the life of the loan.
“In drafting the proposed rule, staff at the Federal Reserve Board and at the other agencies sought to ensure that the amount of credit risk retained is meaningful, while taking into account market practices and reducing the potential for the rule to negatively affect the availability and cost of credit to consumers and businesses,” the Fed’s statement said.
Initially, the rule should have little impact given that Fed data indicate non-agency residential securitizations tumbled to just $48 billion in 2009 from $642 billion in 2007. During the first nine months of last year, the Fed said issuance was less than $40 billion.
But the long-term impact could be to push investors out of the U.S. securitization market for residential loans and extend the decline in home prices, according to Tom Deutsch, executive director of the American Securitization Forum.
“The extremely rigid proposals for a qualified residential mortgage, combined with explicit exemptions for the mortgages guaranteed by the U.S. taxpayer through the government sponsored enterprises, will further prolong the U.S. government’s 95 percent market share of the credit risk of newly originated mortgages,” Deutsch said in a statement. “The QRM proposals will keep a significant amount of private capital on the sidelines, while pressuring the Federal Housing Administration to continue to fill this role with American taxpayers as the backstop for mortgage credit risk.”
Deutsch also warned that proposals by the joint regulators go way beyond what was mandated in Dodd-Frank by promulgating servicing standards as part of the risk-retention requirements.
Acting Comptroller of the Currency John Walsh explained in a statement that the servicing standards are needed given the dislocations and breakdowns that occurred in mortgage servicing.
“Regulators must promulgate comprehensive mortgage servicing standards, applicable to all mortgages and to both bank and non-bank servicers,” Walsh proclaimed in a statement. “That effort would extend well beyond securitized QRMs and well beyond securitization to the entire servicing process.”
The FDIC’s Bair concurred with Walsh.
“Continued turmoil in the housing market caused by inadequate and poor quality servicing underscores the need to make sure that future securitization agreements provide appropriate resources and incentives to mitigate losses when loans become distressed,” Bair said. “Servicing standards must also provide for a proper alignment of servicing incentives with the interests of investors and address conflicts of interest.”
She added that it was the financial crisis — not this rulemaking — that killed the securitization market.
The rules should alleviate some market uncertainty, Mortgage Bankers Association Chairman Michael D. Berman testified Tuesday.
“Several factors contribute to the current uncertainty and lack of private capital in the housing market,” Berman reportedly said before the Senate Banking Committee. “Ongoing uncertainty on risk retention rules, GSE reform, and the future of the conforming loan limits raises questions about the consistency of national housing policy.”
In a subsequent MBA statement, outgoing MBA President and CEO John A, Courson expressed “profound concerns” about the implications the rule will have on residential lending.
Courson warned about “the rigid and highly prescriptive nature of the proposed rule” and called for flexibility on some of the QRM requirements when strong compensating factors exist.
The Fed is accepting comments on the rule until June 10.
