The Federal Deposit Insurance Corp. (FDIC) held a press conference this morning ahead of its meeting to discuss the proposal on risk retention and the all important missing piece of the puzzle — Qualifying Residential Mortgages (QRM).
The FDIC will also discuss the minimum servicing requirement for QRMs. According to a FDIC spokesperson, this rule will require that the servicers have the proper incentive and align their interest to provide risk servicing and to work with borrowers facing financial difficulties to look at various risk mitigating options, including loan obligations.
Risk retention under Dodd-Frank requires securitizers to hold not less than 5% risk retention in any ABS that they sell out into the market. The rule also asks that regulators prohibit sponsors from hedging this risk and from transferring this risk to anyone else.
The FDIC noted that, despite much of the attention surrounding risk retention, it is not a new concept.
"It's been there all along just in a different form," the FDIC spokesperson said. "The form that has been used has been overcollateralization pool that provides for risk retention. It didn't work in the fashion that the market was using so we have taken this whole process and applied it in a way that we believe will keep the market from being able to game the system and result in true risk retention. The overall discount being applied here should not be significantly higher than what was applied to the more stabilized market prior to the bubble."
There are certain exceptions to risk retention requirements, the primary one that most people in the industry have been interested in pertains to QRM.
The QRM standard, the FDIC spokesperson said, features ultimately the idea that, for certain assets underwritten with certain standards, these mortgages can be written by the sponsors with zero risk retention.
"By being conservative and by being prescriptive they are easily understood and will help make the whole process more transparent," the spokesperson said.
The primary characteristics for a QRM rely on the borrower's debt-to-income ratio calculated both on the (1)front end, which is that the housing debt and all costs associated with the home should comprise 28% of income and (2) the back end, which makes up all other debt that should be calculated at no more than 36% of income.
A borrower would have to make a 20% down payment and could not have a 60-day delinquency on any debt obligation within the past two years. A maximum LTV ratio of 80% under a purchase transaction would be required for a home purchase.
The FDIC said the LTV ratio would be calculated without including mortgage insurance and emphasized that it wants the borrower to have an equity position in the home.
Qualified assets such as auto loans, commercial loans, commercial real estate, and residential mortgages will also not be required to retain any part of the credit risk if they meet the underwriting standards included in the proposal.
As such, the risk retention exemption will only apply to the most conservative underwriting standards and will leave out a long list of products such as negative amortization, interest-only payments, or significant interest rate increases that add risk to mortgage loans.
The FDIC said the sponsor of the securitization, which takes the loan from the originator before it is packaged for the secondary market, is required to hold the required risk retention.
The summary lays out seven options for how a sponsor could structure risk retention. They include a"vertical slice," in which a sponsor holds 5% of each tranche in the securitization.
Alternatively, sponsors could hold a "horizontal" piece, in which their first-loss position would be on the whole securitization. A third option would involve sponsors taking an "L-shaped interest", in which the 5% interest would be split 50-50 between a vertical slice and horizontal loss position.
The FDIC spokesperson said that regulators have created a varied menu of option that sponsors may select from so that they can apply whichever approach they believe is most appropriate for the type of asset security backing the securitization.
While the GSEs are under conservatorship, their risk retention is covered by the guaranty, which, the spokesperson said, was about the best risk retention that could be had. However, the GSEs and any successor entity, as long as they have the backing of the U.S. government, will continue to be covered by that ongoing guaranty.