Developments in Securities Regulation, Corporate Governance, Capital Markets, M&A and Other Topics of Interest. MORE

The Office of the Comptroller of the Currency, Treasury (OCC), Board of Governors of the Federal Reserve System (Board), Federal Deposit Insurance Corporation (FDIC), U.S. Securities and Exchange Commission (SEC), Federal Housing Finance Agency (FHFA); and Department of Housing and Urban Development (HUD) (the “Agencies”) are in the process of proposing credit risk retention rules that are required as set forth in Section 15G of the Exchange Act as amended by Section 941 of the Dodd-Frank Act.  Section 15G generally requires the securitizer of asset-backed securities to retain not less than five percent of the credit risk of the assets collateralizing the asset-backed securities. Section 15G includes a variety of exemptions from these requirements, including an exemption for asset-backed securities that are collateralized exclusively by residential mortgages that qualify as “qualified residential mortgages,” or QRMs, as such term is defined by the Agencies by rule. 

Options For Risk Retention


Section 15G of the Exchange Act expressly provides the Agencies the authority to determine the permissible forms through which the required amount of risk retention must be held.  Consistent with this flexibility, Subpart B of the proposed rules would provide sponsors with multiple options to satisfy the risk retention requirements of Section 15G. The options in the proposed rules are designed to take into account the heterogeneity of securitization markets and practices, and to reduce the potential for the proposed rules to negatively affect the availability and costs of credit to consumers and businesses. However, importantly, each of the permitted forms of risk retention included in the proposed rules is subject to terms and conditions that are intended to help ensure that the sponsor (or other eligible entity) retains an economic exposure equivalent to at least five percent of the credit risk of the securitized assets. Thus, the forms of risk retention would help to ensure that the purposes of Section 15G are fulfilled.

 The proposed rules would prohibit a sponsor from transferring, selling or hedging the risk that the sponsor is required to retain, thereby preventing sponsors from circumventing the requirements of the rules by selling or transferring the risk after the securitization transaction has been completed. The proposed rules also include disclosure requirements that are an integral part of and specifically tailored to each of the permissible forms of risk retention.  The disclosure requirements are integral to the proposed rules because they would provide investors with material information concerning the sponsor’s retained interests in a securitization transaction, such as the amount and form of interest retained by sponsors, and the assumptions used in determining the aggregate value of asset backed securities, or ABS, to be issued (which generally affects the amount of risk required to be retained).  Further, the disclosures are also integral to the rule because they would provide investors and the Agencies with an efficient mechanism to monitor compliance with the risk retention requirements of the proposed rules.

Qualified Residential Mortgages

 Section 15G of the Exchange Act provides that the risk retention requirements shall not apply to an issuance of ABS if all of the assets that collateralize the ABS are QRMs.  Section 15G also directs all of the Agencies to define jointly what constitutes a QRM, taking into consideration underwriting and product features that historical loan performance data indicate result in a lower risk of default.   Moreover, Section 15G requires that the definition of a QRM be “no broader than” the definition of a “qualified mortgage” (QM), as the term is defined under section 129C(b)(2) of the Truth in Lending Act, or TILA, as amended by the Dodd-Frank Act, and regulations adopted thereunder.

The underwriting and product features established by the Agencies for QRMs include standards related to the borrower’s ability and willingness to repay the mortgage (as measured by the borrower’s debt-to-income (DTI) ratio); the borrower’s credit history; the borrower’s down payment amount and sources; the loan-to-value (LTV) ratio for the loan; the form of valuation used in underwriting the loan; the type of mortgage involved; and the owner-occupancy status of the property securing the mortgage.

Check frequently for updates on the Dodd-Frank Act and other important securities law matters.

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