U.S. regulators finalized a securities risk retention rule on Tuesday designed to set the stage for the future of the secondary mortgage market.
The Federal Deposit Insurance Corp. approved a final rule at its morning meeting that will require lenders to retain at least a 5% stake in loans they securitize unless they meet the definition of "qualified residential mortgages." The final rule defines QRM to match with the Consumer Financial Protection Bureau's separate "qualified mortgage" rule, which governs underwriting standards.
Still, regulators left a window to review the definition of QRM in 2019, four years after it becomes effective next year. The timing of the review parallels the CFPB's own pending review of its QM regulation.
The final securitization rule is due to be approved today by the Federal Housing Finance Agency and the Office of the Comptroller of the Currency, with the Federal Reserve Board and Securities and Exchange Commission scheduled to vote on it Wednesday.
"Aligning the qualified residential mortgage standard with the existing qualified mortgage definition also means more clarity for lenders and encourages safe and sound lending to credit worthy borrowers," FHFA Director Mel Watt said in a statement.
Comptroller Thomas Curry added: "I believe this final rule will provide more certainty in the securitization markets, which will have a positive effect on our economy."
Regulators did make two exceptions to the QRM rule, one for community lenders and one for 3-4 unit owner occupied mortgage loans and adjusted some the risk structures allowed.
No such carve out exists for other asset classes, despite lobbying by managers of collateralized loan obligations. The Loan Syndications and Trading Association released a statement saying that the 5% risk retention requirement would "result in a signficant reduction of CLO issuance," raising borrowing costs for below-investment grade companies.
"CLOs currently provide nearly $350 billion in loans to job-creating corporations across the nation," LSTA Executive Director Bram Smith said. "Unfortunately, very few CLO managers, who function as asset managers on a fee for service model, have the capital necessary to hold securities equal to 5% of the fair value of the CLO as required under the final rule."
The riks retention rules could also discourage issuance of bonds backed by a single, large commercial mortgage, according to JP Morgan.
The CMBS industry had lobbied for special treatment of securitizations of single-asset, single-borrowers loans, but regulators were not swayed. These deals are not exempt from the requirement that sponsors retain a 5% stake.
Ultimately, the regulators felt that SASB deals are not of sufficiently low risk to warrant a special exemption from risk retention given their lack of diversity, analysts stated in research published late Tuesday.
JP Morgan expects that the rules, which take effect two years after adoption, will make it less attractive to securitize single large loans, since such deals do not utilize the “B-piece” mechanism of the conduit market. The underlying risk is a senior loan, and even junior tranches have relatively low spreads. “The inability to lever this risk and a five-year hold period could limit the number of natural buyers of a junior horizontal slice,” the report states.
It said these complications could hamper issuance, absent a structural solution.