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1 1 (October 30, 2014)

handle is hein.crs/govccuz0001 and id is 1 raw text is: 0 ;0 October 30, 2014 QRM: Risk Retention and the Mortgage Market In October 2014, federal regulators issued a final rule implementing the credit risk retention (CRR) requirement of Section 941 of the Dodd-Frank Act (DFA). The CRR rule applies to many different types of asset-backed securities (ABS), including ABS backed by student loans, auto loans, credit card receivables, and other asset classes. This In Focus, however, focuses on the elements of the rule related to the residential mortgage market. RNuk Re~tnton,, What Is Securitization? Securitization is the process in which an institution acquires and pools assets that have a stream of payments and issues securities to investors. The streams of payments of the assets are forwarded to the investors who purchase the securities. The assets that are the source of the underlying payments are said to collateralize the security, thus making it an asset-backed security. In the case of a mortgage-backed security (MBS), the assets that are pooled together are mortgages. The institution that organizes and initiates the securitization transaction is the sponsor of the securitization. The sponsor could be a bank or a nonbank, and the CRR rule applies to both. What Is Credit Risk? Credit risk is the risk that a borrower will not repay its debt as required. In the case of a MBS, if homeowners do not make their monthly mortgage payments, less money would be paid to investors who purchased the MBS that is collateralized by those mortgages. What Is the Credit Risk Retention Rule? Under the CRR rule, the sponsor of a securitization is required to retain at least 5% of the credit risk of the assets that comprise the ABS. The sponsor, with a few exceptions, is not allowed to hedge or transfer the credit risk that it is required to retain. The requirement to retain risk expires after several years, depending on the type of assets collateralizing the ABS. In some cases, if the assets that collateralize the ABS meet certain requirements indicating a low credit risk, the sponsor may be allowed to retain less than 5% of the credit risk. In the case of mortgages, if all the mortgages collateralizing a MBS are qualified residential mortgages (QRMs), then the sponsor does not have to retain any of the credit risk. Securitizing QRVs is a way for a sponsor to be exempt from the risk retention requirements. Why Was This Rule Adopted? In its deliberations on the DFA, Congress noted that the financial crisis shed light on several weaknesses in securitization transactions and attempted to address those weaknesses in various portions of the act. One of the weaknesses addressed by the CRR rule concerned the originate-to-distribute (OTD) model of funding mortgages. The OTD model describes a process in which mortgages were originated with the intention of securitizing them and selling the MBS to investors. Because those involved in the securitization process sold the credit risk to other investors, the argument goes, the securitizer did not have sufficient incentive to ensure that the underlying mortgages in the MBS were made to borrowers who would repay. Some argue that this led to a loosening of underwriting standards for mortgages. By requiring a securitizer to retain some of the credit risk (have some skin in the game), the securitizer may have more incentive to monitor the quality of the underlying assets. Others, however, question the extent to which the OTD model contributed to the financial crisis, arguing that securitizers often retained risk in their deals for their own business purposes. Congress intended the risk retention requirements... to help address problems in the securitization markets by requiring that securitizers, as a general matter, retain an economic interest in the credit risk of the assets they securitize. - Preamble to the CRR Rule What Is a QRM? Section 941 of the DFA provided the regulators with some discretion in coming up with a definition for QRM. It directed the regulators to take into consideration underwriting and product features that historical loan performance data indicate result in a lower risk of default. Section 941 also directed the regulators to make the QRM definition no broader than the definition for a qualified mortgage (QM). In the CRR Rule, the regulators decided to align the definition for QRM with the definition of QM, meaning that a mortgage is a QRM if it meets the definition for QM. The definition of QRM is significant because, as mentioned before, if all the assets in a MBS are QRM, the sponsor of the securitization is exempt from retaining the credit risk. What Is a QM? Title XIV of the DFA established the ability-to-repay (ATR) requirement and instructed the Consumer Financial Protection Bureau (CFPB) to establish the definition for QM as part of its implementation. The ATR rule requires a lender to determine based on documented and verified information that at the time a mortgage loan is made, the borrower has the ability to repay the loan. Lenders that fail to comply with the ATR rule could be subject to legal liability. A lender is presumed to have complied with the ATR rule when it offers a QM. A QM is a mortgage that satisfies certain underwriting and product feature requirements, such as being below specified debt-to-income ratios, having a term of 30 years or fewer, and having fees associated with .O 'T p\w -- , gnom goo mppm qq\ a , q 'S I 11LIANJILiN,

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