US federal agencies on Tuesday published 233 pages of proposed rules around credit risk retention for sponsors of asset-backed securities, a requirement laid down in the Dodd-Frank legislation.
Sexy lede, right? Wait, come back…
The report is actually a great battleplan for the last war. It covers most forms of ABS but focuses on RMBS.
Dodd-Frank, remember, exempts banks from risk retention rules on their RMBS if the mortgages are deemed “qualified.” For all, um, “unqualified” RMBS securitisations, originators and issuers have to hold on to a 5 per cent slice of the asset. (For previous FT Alphaville posts on this topic click here or here.)
We won’t dwell here on the forms of risk retention allowed. In brief, banks can hold this slice pretty much however they want: “vertically”, “horizontally”, heck, even “L-shaped”. (We anticipated this in a post back in October.)
Instead, we’ll look at the draft definition of a “qualified residential mortgage” (QRM). Mortgage insurers and some banks have, according to the NYT, lobbied hard for a broad QRM definition, i.e. one that included as many mortgages as possible.
But the proposal looks pretty narrow:
Maximum front-end and back-end borrower debt-to-income ratios of 28% and 36%, respectively;
A maximum loan-to-value (LTV) ratio of 80% in the case of a purchase transaction (with a 75% combined LTV for refinance transactions, reduced to 70% for cash-out refis);
A 20% down payment requirement in the case of a purchase transaction; and
Borrower credit history restrictions, including no 60-day delinquencies on any debt obligation within the previous 24 months.
Appendix A (starting on page 116) reaffirms that first impression.
It has an interesting couple of counterfactual history tables for the housing wonks and RMBS traders out there. The first shows, for the period 1997 – 2009, how many GSE mortgages would have been defined as QRM.
Between 1997 – 2009, around 20 per cent of GSE-supported mortgages would have been classified as QRM. Note the big drop from 2003 through 2008 as the sub-prime borrowing accelerated.
The second table shows, for the same period, how many of the same batch of “QRM” mortgages would have been classed as seriously delinquent, i.e. loans more than 90 days delinquent or in foreclosure.
Between 1997 and 2009, only around 0.69 per cent of would-have-been QRM mortgages would have been in serious delinquency at some point. Interestingly, even during the sub-prime crisis this figure never breaks 3 per cent, showing how conservative a rule this is — at least at face value.
It also suggests that there is the potential for a lot of poor-performing loans to remain within the risk retained mortgage pool. Skin in the game helps a little, but by itself it’s not enough to guard against shoddy analysis of underlying borrower quality.
But to be fair to the federal agencies, they’re trying to juggle a lot of conflicting objectives. Preventing the next sub-prime crisis, restarting the RMBS market, keeping home ownership as an option for lower and middle income (LMI) Americans, and so on.
At first glance it looks like caution has ruled, at the possible expense of LMI home-ownership, since rates on non-QRM mortgages must surely rise. We won’t know the winners and losers for sure, however, until the full report has been finalised.
One group worried about ending up on the losing side was the mortgage insurers.
According to analysis by FBR capital markets in February, MIs were worried that the use of mortgage insurance would not count towards the QRM definition. (This makes intuitive sense: insurance decreases the costs of default but not its likelihood.)
Bad news, perhaps, from the report:
The LTV ratio must be calculated without considering mortgage insurance. Although mortgage insurance protects investors from losses when borrowers default, and thus lessens the severity of the loss, the statute directs the agencies, in developing the QRM criteria, to consider whether mortgage insurance reduces the risk that default will occur in the first place.
Or is it? In a note out Monday evening, FBR argue that this setback is balanced out by the exemption for GSEs from risk retention requirements.
The report implies that while
nationalised under receivership, Fannie and Freddie will, unlike others, still be able securitise high-LTV loans with mortgage insurance without retention requirements.
The end of the home ownership “dream” – FT Alphaville
One size does not fit all in ABS risk, Fed says – FT Alphaville
Strange meddling – FT Alphaville
The plain vanilla mortgage LIVES! – FT Alphaville