Federal Agencies Propose New Risk Retention Rule

April 2011Newsletters In the Zone

Six federal agencies are seeking comment on a proposed rule that would require sponsors of asset-backed securities (ABS) to retain at least five percent of the credit risk of the assets underlying the securities and would not permit sponsors to transfer or hedge that credit risk. In crafting the proposed rule, the agencies sought to ensure the amount of credit risk retained is meaningful so that lenders held a stake in the asset.

The risk retention rule is proposed by the Federal Reserve Board, Office of the Comptroller of the Currency, Federal Deposit Insurance Corporation, U.S. Securities and Exchange Commission, Federal Housing Finance Agency and Department of Housing and Urban Development. It would provide sponsors with various options for meeting the risk-retention requirements of the Dodd-Frank Wall Street Reform and Consumer Protection Act.

As required by the act, the proposal includes descriptions of loans that would not be subject to these requirements, including asset-backed securities that are collateralized exclusively by residential mortgages that qualify as “qualified residential mortgages” (QRMs). The proposal establishes a definition for QRMs incorporating such criteria as borrower credit history, payment terms and loan-to-value ratio. The objective was to design QRMs that ensure the mortgages are of very high credit quality.

The rule would mandate potential borrowers place a 20 percent down payment for QRMs.

Borrowers who cannot afford to put 20 percent down on a home and are unable to obtain FHA financing will be expected to pay a premium of two percentage points for a loan in the private market to offset the increased risk to lenders. This would disqualify about five million potential home buyers, resulting in 250,000 fewer home sales and 50,000 fewer new homes being built per year, according to NAHB economists.

The Dodd-Frank law currently exempts FHA and VA loans from the risk retention requirement, and the proposed risk retention rules will not apply to Fannie Mae and Freddie Mac while they remain in conservatorship.

The agencies request comments on the proposed rule by June 10, 2011.

For more information, please contact Lauren W. Taylor at 215.918.3625 or [email protected].