Will Regulators Start Over on Risk Retention?

WASHINGTON — With regulators facing the potential of significant revisions to their risk-retention rule, there is growing speculation among industry and consumer groups that the agencies will go back to the drawing board and issue a new proposal.

The plan, mandated under the Dodd-Frank Act and issued in March, drew hundreds of comment letters that detailed objections to the proposal. The sheer volume of comments and magnitude of changes sought have fueled talk that regulators will have to start over rather than trying to finalize the existing proposal.

"There is a fair probability that they would repropose given the depth and complexity of the issues," said Tom Deutsch, the executive director of the American Securitization Forum, which has pushed for such a move.

The proposal was meant to implement a Dodd-Frank provision that requires securitizers to hold 5% of the credit risk. But the industry complained about the scope of the plan, including how risk retention would be calculated, steps regulators took to prevent securitizers from skirting the impact of retention and proposed exemptions from the plan. Even several lawmakers who supported the original provision had issues with how regulators proposed to implement it.

"They want to make sure they get it right. It's possible they could conclude that rewriting it is better than just finalizing it," said Paul Leonard, vice president for the Financial Services Roundtable's Housing Policy Council.

At issue is how many changes regulators can make without issuing an entirely new proposal. Generally if there are too many alterations, regulators must seek comment again or at least issue an "interim" final rule that allows for additional feedback.

It is unclear how the agencies will proceed. Officials were said to be meeting recently about the rule, but it is not known whether they came to any decisions. The law requires a joint rule from the Department of Housing and Urban Development, Federal Deposit Insurance Corp., Federal Housing Finance Agency, Federal Reserve Board, Office of the Comptroller of the Currency and Securities and Exchange Commission. Representatives from the agencies declined to comment for this article.

Yet a second proposal has garnered more attention of late in the public discussion.

"We've heard that that could be an option. It would make sense for them to repropose it given that there were so many large issues that were commented on," said Pete Mills, a principal at Mortgage Banking Initiatives.

Laurence Platt, the financial services practice leader at K&L Gates, said that if a final rule is similar to the proposal, regulators could be seen as not having fully considered the comments, while a drastically different final rule could be viewed as depriving the public of commenting on new ideas. "The comments are so profound that it's hard to reconcile them in a [final] rule that could be deemed to have given proper notice to people," Platt said. "Unless they just disregard the hundreds of pages of comments, I suspect it's going to be materially different than what they originally proposed. From a pure administrative law perspective, it would be prudent for them to redo it simply to be able that they gave people fair notice and the opportunity to comment.

"This rule really goes to the core of housing availability and mortgage credit availability, and the comments were not reconcilable. I don't think they could split the baby without doing a new rulemaking."

The proposal would require the securitization sponsor to retain the risk, but companies could decide if their piece was 5% of the whole securitization or 5% of each tranche. It also outlined criteria for the "qualified residential mortgage," a special class coined by Dodd-Frank that is exempt from risk retention, limiting the exception to loans with a 20% down payment and low debt-to-income. It also would set rules for exempting loans other than mortgages, such as car loans.

In the months following the proposal, the conservative QRM criteria have caused the most controversy, with various stakeholders saying the strict criteria will constrain credit. Several groups have said the qualified residential mortgage does not need a down-payment requirement at all and that other loan characteristics are better predictors of performance. Others have just called for a lower down-payment requirement.

"The calls for redrafting the QRM have been strong, diverse and nearly universal," said Joe Ventrone, a vice president for the National Association of Realtors, which is part of a coalition of groups trying to effect changes to QRM standards. "The coalition would applaud the regulators if they proposed a new QRM regulation that did not include a down-payment requirement, per congressional intent. The housing recovery depends on them getting it right this time. Let's hope they do."

Meanwhile, public comments have identified other parts of the proposal besides the QRM as potentially damaging. Bankers say the proposal did not make clear whether the amount of risk retain is based on par or fair value.

Commenters have also warned about the proposed creation of "premium capture" reserve funds, meant to prevent securitizers from using bond sales to avoid negative effects of risk retention. A premium capture fund would hold proceeds from such bond sales, but also expose the securitizer to potential losses on the underlying assets. Yet critics have said requiring such funds, as proposed, could turn investors away from the market.

Deutsch said the eligibility requirements for exempting loans other than mortgages are another section with potential fallout. For example, the plan would generally apply an exemption to securitizations with car loans containing 20% down payments, similar to the standard for QRMs. "There's nobody who puts 20% down on a car loan," Deutsch said. "They basically copied and pasted the QRM exemption for the auto loan exemption but didn't account for the differences in the auto sector. There are these very significant complexities that if they miss it in the final rule, then you have to get six of them back together to fix it."

The regulators have faced pressure to finish other Dodd-Frank rules promptly to make deadlines required by the law, but the same does not apply to risk retention, Platt said. The private-label securitization market has been stalled since the crisis, and the proposal exempts loans backed by Fannie Mae, so regulators have more time before the rule has much impact, he said. "It doesn't really matter because it doesn't apply to Fannie or Freddie or Ginnie [Mae], and that's the only securitizations that are out there right now. It's not like there is a backlog of securitizations that are hampered by the absence of this rule."