House panel concerned premium capture rule could raise mortgage costs
A House subcommittee heard renewed concerns Tuesday over a rule forcing mortgage bond securitizers to set aside even more in a cash reserve account than the 5% required under the proposed risk-retention rule.
The premium capture cash reserve account, which was not required under the Dodd-Frank Act, could raise mortgage interest rates lenders charge to borrowers by 1 to 4 percentage points, according to Moody's Chief Economist Mark Zandi and industry panelists.
"Everything we've seen and canvassing of our own members has shown that it would increase mortgage rates substantially," said Tom Deutsche, executive director of the American Securitization Forum, at the hearing. (Click here for his written testimony.)
Banking regulators continue to finalize the risk-retention rule, which is not expected until next year. In the latest proposal, the agencies require a firm bundling loans into a security to fund a premium capture cash reserve account equal to two possible amounts.
It could be the proceeds from the sale of the bond. Or, the account must equal the par value of all interests in the security.
Kenneth Bentsen, executive vice president of the Securities Industry and Financial Markets Association, gave an example in his testimony. If a security has a pool of loans at par value of $100 and the proceeds from the sale of the bond is $104, the $4 above par value would be put into the premium capture cash reserve account. This, he said, would be in addition to the $5 held back to cover the 5% risk-retention rule. The level of risk retained is then 8.7% rather than the 5% required under Dodd-Frank.
The agencies built in this extra cash reserve account to keep securitizers from dodging the risk-retention rule in the first place. According to a study by Zandi, regulators were concerned securitizers would raise fees rather than improve underwriting guideline in their programs.
Securitizers already charge borrowers a higher rate than is paid to the investor, known as the "excess spread," in order to cover the costs of originating and servicing the loan and to reserve against future defaults, but they can issue interest-only bonds backed by the spread in order to collect this amount upfront rather than as the loans payoff.
"The premium capture rule will effectively end this practice by making it prohibitively expensive," Zandi said in his report released in September. "Securitizers would have to wait until the loans backing the bond had been exhausted and all proceeds paid to bondholders before collecting their fees from whatever cash remained."
Bentsen called it a "misconception" that securitizers not putting the entire excess spread toward the residual interest in the security devalues that interest, but regulators are using this thinking in order to justify the additional provision.
"The economic result of this approach would be so severe that, if it were implemented through the risk retention rules, many sponsors would avoid securitization," Bentsen said.
The subcommittee chair Rep. Scott Garrett, R-N.J., said the hearing was not intended to strip out the Dodd-Frank Act reforms entirely but to identify rulemaking that was not intended under the law.
Anne Simpson, senior portfolio manager for the California Public Employees' Retirement System, pleaded with committee members to keep the central reforms in place, such as requiring lenders to keep "skin in the game" for loans they write (click here for her written testimony).
"We simply cannot afford another crisis," Simpson said. "At the worst, dark days of the recent crisis, CalPERS was $70 billion down. Now we've grown our way back from where we were, but it's simply not achievable to earn enough to fill that gap. So these reforms are system critical for long-term stability."
Both Brentsen and Deutsche advocated eliminating the premium capture cash reserve account provision.
"We've asked the regulators if there is anything that refutes the Zandi report (the provision's effect on mortgage rates), and we haven't gotten an answer from them," Garrett said.