The Risks of Risk Retention: There Is a Lot Not to like about the Proposed Qualified Residential Mortgage (QRM) Definition. and Regulators Are Hearing All about It
Stowe, Robert, Mortgage Banking
It was regulatory whipsaw. * The mortgage industry was looking for clarity and regulatory restraint in new rules to govern how and when sponsors would need to keep 5 percent of the credit risk in new securitizations of mortgages in order to better align incentives to originate good credit-quality mortgages. * It was hoped that when the rules were proposed, they would be reasonable and have demarcation lines that would be bright and definitive, while also being flexible enough to allow markets to function. This hoped-for approach was seen as a necessary next step to pave the way for a revival of the private-label residential mortgage-backed securities (RMBS) market and a strengthening of the struggling commercial mortgage-backed securities (CMBS) market. * Expectations that new risk-retention regulations would clear away the uncertainty in the markets and spark a private-sector securitization revival were raised with the release of a Treasury white paper in February. The paper made it clear the ultimate end game for policy proposals was to phase out and wind down Fannie Mae and Freddie Mac, and take steps to revive private-sector mortgage securitization as the key driver of funding for mortgages in a new mortgage finance system. * Such hopes were put on hold, however, when the proposed risk-retention rules were unveiled March 31. Mortgage bankers and other financial institutions were astonished at a plethora of onerous provisions that they said would essentially prevent a significant rebound of the private-label market for RMBS and entrench the government and government-sponsored enterprises (GSEs) as the dominant providers of mortgage credit--with the taxpayer on the hook indefinitely. * Furthermore, the regulators, without specific congressional authority, expanded the scope of the rules from what was required under Section 941 of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. Rules were not proposed just for mortgage securitizations but for virtually every type of securitization that exists, including securitized auto loans and collateralized loan obligations--businesses that did not contribute to the financial crisis--as well as asset-backed commercial paper.
In the world of mortgage banking, the regulators, without specific authorization from the statute, also proposed a narrow set of underwriting guidelines in their definition of a Qualified Residential Mortgage (QRM). Under Dodd-Frank, securitizations of these mortgages would be exempt from the risk-retention requirement. The regulators proposed that to meet the QRM carve-out, a mortgage should come with a 20 percent down payment for home purchases. For refinancings, the home-owner's QRM-eligible mortgage must not exceed 75 percent of the value of the home. If there is a cash-out, it cannot exceed 70 percent.
Under the proposed rule, the QRM also threw out borrowers who were late on any bill by more than 60 days in the past two years and set strict debt-to-income (DTI) ratios of 28 percent for the mortgage and 36 percent for all household debt.
The regulators exempted loans sold to the government-sponsored enterprises Fannie Mae and Freddie Mac from having to comply with the risk-retention rules while the two remained in conservatorship.
The 376-page proposed rule, as published by the Office of the Comptroller of the Currency (OCC) within the Treasury Department, was also proposed by five other regulators, each with its own varying constituency of regulated entities: the Federal Reserve System, the Federal Deposit Insurance Corporation (FDIC), the Securities and Exchange Commission (SEC), the Department of Housing and Urban Development (HUD) and the Federal Housing Finance Agency (FHFA).
A chorus of critics
Not surprisingly, a gusher of criticism has erupted in response to the proposed rules. Indeed, the outcry was such that the regulators extended the deadline for submitting comments to them on the proposed rule from June 10 to Aug. …