A revised “risk retention rule” offered up by federal regulators this week would ease up on proposed requirements for mortgage lenders to maintain a financial stake in many of the the loans they securitize. The retreat ends, for now, a requirement that would have forced homebuyers to offer up at least a 20 percent down payment when obtaining a mortgage.

On Wednesday, six federal agencies announced revisions to a proposed rule requiring sponsors of securitization transactions to retain risk in those transactions. The new proposal revises a proposal issued in April of 2011 to implement risk retention requirements of the Dodd-Frank Act.

The re-proposal was jointly issued jointly by the Board of Governors of the Federal Reserve, the Department of Housing and Urban Development, the Federal Deposit Insurance Corporation, the Federal Housing Finance Agency, the Office of the Comptroller of the Currency, and the Securities and Exchange Commission. The deadline for public comments is Oct. 30.

Asset-backed securities are derivative investments, where a financial firm bundles together debts, such as home mortgages, or car and student loans, and lets investors buy into the revenue stream. The proposed rule would provide asset-backed securities sponsors with options to satisfy risk retention requirements demanded by the Dodd-Frank Act.

Dodd-Frank contemplated that most mortgage securitizations would be subject to risk retention, except those underwritten to exceptionally high standards and categorized as Qualified Residential Mortgages (QRM). This requirement was initially met by requiring banks and lenders to hold 5 percent of the credit risk for residential mortgages that they securitize and sell to investors, unless those mortgages met QRM exemptions.

In the agencies' first efforts to define QRM, those exemptions included down payments of 20 percent and a debt-to-income (DTI) ratio of 36 percent. Many commenters raised concerns that this high standard would make it too expensive for many to get loans.

The re-proposal modifies the definition of QRM, synching it to the definition of a Qualified Mortgage (QM) finalized by the Consumer Financial Protection Bureau. The QM rule does not include underwriting based on credit history, loan-to-value (LTV), or down payment. It does, however, include an analysis of the borrower's ability to repay, with a maximum DTI of 43 percent. Loan terms could not exceed 30 years. The QM definition also prohibits interest-only loans, balloon payments, and negatively amortizing loans. 

Provided a monthly mortgage payment does not exceed 43 percent of the borrower's income, a lender would be exempt from the 5 percent holding requirement. Also exempt, are loans backed by Fannie Mae and Freddie Mac, so long as they continue to have “capital support from the U.S. government.” QM allows exceptions for rural lenders and small lenders. Securitizations of commercial loans, commercial mortgages, or automobile loans of low credit risk would not be subject to risk retention requirements. 

The re-proposal also offers up for debate a second, alternative definition of QRM that expands upon credit underwriting standards. This alternative, QM-plus, would be available only for first-lien loans secured by one-to-four family real properties that constitute the principal dwelling of the borrower, and if the LTV at closing did not exceed 70 percent, likely meaning a 30 percent down payment would be required.

The primary proposal was met with objections from the two Republican commissioners on the SEC.

By deferring to the CFPB's definition of qualified mortgage, the agencies, seeking to maintain affordable loans, “are demonstrating that they are not considering default rates or risk levels,” SEC Commissioner Daniel Gallagher said in a statement.

 “While increasing the rate of home ownership is a laudable goal, a return to the failed housing policies that served as the primary driver of the financial crisis is too high a cost to pursue that goal,” he said.

Gallager was aware that “an overwhelming majority” of comments criticized the earlier proposed QRM standard. “But rulemakings are not referenda,” he said. “While independent regulatory agencies like the SEC must always be mindful of the points raised by commenters, ultimately, they must apply their experience and expertise regardless of the volume of negative comments.”

SEC Commissioner Michael Piwowar also objected to the proposal. An analysis by SEC economists of the costs and benefits “largely fulfills” its obligation to do so, he said. However, the re-proposal does not include such analysis from any of the other agencies, an omission he calls “particularly glaring given the large number of discretionary choices.”

National Association of Realtors President Gary Thomas lauded the re-proposal. It “will give creditworthy buyers access to safe and affordable loan products without overly burdensome downpayment requirements,” he said.

Thomas was critical, however, of the opening debate on an alternative that could require buyers to put 30 percent down to qualify for a QRM loan, calling it “a restrictive measure that dramatically favors the wealthy.” He noted research that shows that it would take the average American more than 25 years to save enough money to meet that threshold.

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