Risky mortgage lending may have triggered the financial crisis, but final risk retention rules go much easier on mortgages than securitizations of other kinds of assets.
Mortgages do not have to include a down payment to be exempt from risk retention, though federal regulators will review the impact of the rule every four years. That is in stark contrast to their original 2011 plan to limit the exemption to borrowers who put down 20%.
Despite the lighter approach, the rule is unlikely to do much to jumpstart private label mortgage securitization. That’s because Fannie Mae and Freddie Mac still buy the bulk of mortgages, and the new regulation effectively frees the government-sponsored enterprises from doing any risk retention. The GSEs' popularity is only heightened by recent steps by the Federal Housing Finance Agency to allow the GSEs to back loans with down payments as low as 3%.
The QRM rule "further cements the role of Fannie, Freddie and the" Federal Housing Administration, part of a "confluence of events that push a lot of mortgage production to the GSEs," said Edward Mills, a policy analyst at FBR Capital Markets.
To protect investors, the Dodd-Frank Act required 5% credit risk retention for securitized loans, but instructed regulators to define a class of "qualified residential" mortgages excused from the requirement.
The rule approved Tuesday by the Federal Deposit Insurance Corp. and other regulators preserves the plan from last year's re-proposal equating QRM with the "Qualified Mortgage" standard, used by the Consumer Financial Protection Bureau to define well-underwritten loans. QM carries no down payment requirement. The Federal Reserve Board and Securities and Exchange Commission voted on Wednesday.
In addition to residential mortgages, there are also exemptions for securitizations of auto loans and commercial mortgages that meet specific underwriting criteria. But these exemptions are much more restrictive.
For commercial mortgages, there are minimum loan to value ratios, debt service coverage ratios, and term lengths as well as amortization requirements. The CMBS industry had lobbied for special treatment of securitizations of single-asset, single-borrower loans, but regulators were not swayed.
Standards for auto loans are also fairly stringent: they must be secured by a light vehicle for personal use. That means no individual leases or fleet leases, and loans secured by motorcycles or RVs are not eligible. The borrower can’t be more than 30 days delinquent on any debt.
And, in sharp contrast with mortgages, qualified auto loans must include a down payment of at least 10%.
In one area auto loans and commercial mortgages did get a break: securitizations that co-mingle qualified and non-qualified loans, the minimum amount of risk retained may be lower, as low as 2.5% if at least 50% of the collateral qualifies. Securitizers of residential mortgages get no relief for co-mingling QRM and non-QRM loans. A deal with a single non-QRM loan is subject to the full 5% risk retention.
However, analysts think that CMBS sponsors are unlikely to take advantage because there are so few loans that meet the criteria for a qualified commercial mortgage.
Collateralized loan obligations got even less relief. There is no carve-out for corporate loans of any stripes. That means a CLO manager must retain a 5% stake in each deal. The only alternative is for the lead arranger of each loan in the CLO to retain a 5% stake in the loan for as long as the CLO holds it, an option that appeared in last years’ re-proposal that has been widely dismissed as unworkable.
On the plus side, regulators abandoned onerous restrictions on cash flow to CLO equity being retained by a sponsor to comply with the rule. This was a feature in the 2013 re-proposal.
For securitizations of federally guaranteed student loans, the risk retention amount is lower, typically 3%. Federal Family Education Loan Program loans carry government guarantees that range from 97% to 100% of defaulted principal and accrued interest. For ABS backed by FFELP loans, the risk retention amount would be the non-guaranteed amount in the pool, which for most deals is 3%.
Risk retention rules come into effect after one year for RMBS and two years for other kinds of securitizations, meaning that deals issued up to that point will be grandfathered. So the rule creates an incentive for managers to issue over the next two years.