U.S. regulators proposed exempting banks and bond issuers who meet high underwriting standards from rules requiring them to keep a stake in loans they securitize, according to a draft proposal.
The Federal Deposit Insurance Corp. and the Federal Reserve Board today agreed to seek comment on the measure. Other agencies including the Securities and Exchange Commission are set to consider it this week.
“Fundamentally this rule is about reforming the ‘originate-to-distribute’ model for securitization and realigning the interests in structured finance,” FDIC Chairman Sheila Bair said before the vote.
The risk-retention proposal offers a package of options tailored for business, auto, commercial real estate and home loans, which would be eligible for exemptions under certain conditions.
The rule would create a class of qualified residential mortgages, or QRMs, that are exempt from having to retain risk. Borrowers on those loans must be creditworthy and make down payments of at least 20 percent. The goal is to avoid the incentives that led to a flood of subprime mortgages and helped trigger the 2008 financial collapse.
“This does not mean that under the rule all home buyers would have to meet these high standards to qualify for a mortgage,” Bair said. “On the contrary, I anticipate that QRMs will be a small slice of the market.”
Jerry Selitto, chief executive officer of Mount Laurel, New Jersey-based mortgage lender PHH Corp. (PHH), disagreed.
“It’s going to be more difficult for people to get mortgages,” he said. “It will be more difficult for people to buy homes.”
Qualified mortgages would be limited to fixed-rate loans for borrowers with the best credit who make at least a 20 percent down payment and spend no more than 36 percent of their income on debt payments.
The rules, mandated by the Dodd-Frank law that overhauled the financial industry last year, were designed to prevent shoddy underwriting practices.
The 367-page draft rule, which took six agencies eight months to write, presents a range of possibilities rather than a one-size-fits-all plan for regulating the $2.5 trillion private asset-backed securities market.
In addition to the FDIC, Fed and SEC, the Department of Housing and Urban Development, Federal Housing Finance Agency, and Office of the Comptroller of the Currency also need to approve the rule before it’s formally proposed.
Firms including New York-based JPMorgan Chase & Co. (JPM) and Ford Motor Co. (F), based in Dearborn, Michigan, had told regulators that imposing a single method for retaining risk on different types of bonds would force expensive changes on sectors that already retain risk, such as auto lending. That would make loans scarce and raise borrower costs, they said.
Regulators responded with a mosaic of alternatives, tailoring the rules for different types of debt and offering options within each category that can raise or lower a bond’s risk-retention requirement.
Under the proposal, firms that securitize loans could avoid holding a stake in the debt if their loans meet underwriting standards set by regulators. The measure applies to originators and issuers of debt tied to credit cards, student loans, auto leases, and residential and commercial mortgages.
It presents four approaches, allowing lenders to keep 5 percent of every part of a security, known as a vertical slice; a 5 percent stake in the riskiest tranche, called a horizontal slice; a combination of the two; or a “representative sample” of loans from the pool.
In the home-loan market, which makes up about a third of asset-backed securities, falling housing prices led to defaults in mortgage bonds. As mandated by Dodd-Frank, the plan is designed to prevent defaults even if house prices decline by encouraging higher down-payments. Regulators will ask whether other steps, such as requiring private-mortgage insurance, would also decrease a loan’s risk of default.
Housing advocates, small banks and mortgage insurers such as Radian Group Inc. (RDN) and Genworth Financial Inc. (GNW) are seeking a lower down-payment option backed by insurance to protect lenders in case of default.
Loans guaranteed by Fannie Mae and Freddie Mac, the mortgage companies seized by the federal government in 2008, would be exempt from retaining risk as long as they remain in government conservatorship.
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