Risk retention, QM legal standards create confusion
Forcing underwriters to retain a 5% stake in loans sent through the securitization process may seem like a good way to police mortgage securitizations, but too many conflicts of interest remain, making the measure a mere shot in the dark, according to Amherst Securities Group. Under the proposed risk-retention rule, underwriters are exempted from keeping a 5% stake in loans when the security is collateralized by qualified residential mortgages. However, Amherst Securities said conflicts of interest still remain during the securitization process even under new standards. For starters, Amherst Securities argues having to hold a 5% stake is not necessarily going to create an undue hardship when an originator makes a marginal loan. Amherst said if the originator in this situation "has the ability to choose to put it into a securitization with a 5% risk retention or hold it with 100% risk retention, it's a no-brainer — the loan goes into a securitization." "The difference between no risk retention under the current regime and 5% in this context is immaterial," Amherst analysts said. "Moreover, an originator can choose to originate to one standard for portfolio, but to a different one for securitization." Amherst added the concept of risk retention was created to ensure a system is in place where the underwriter polices the originator. However, this design is irrelevant when the originator also serves as the sponsor, according to Amherst's analysis. In that type of situation situation, holding 5% of a bad loan is better than holding 100%, the report said. "If the originator and the deal sponsor are different entities, the 5% risk retention will be more helpful, but is still not a solution," Amherst Securities said. "For the sake of the relationship with the originator, the deal sponsor may be reluctant to turn down certain loans." Amherst said when the main party is a bank, risk retention could be held as a group of loans that were never in a security and have no stake in detecting rep and warrant violations, which is a component needed to make the securitization process conflict free. "Bottom line — it is not clear what the purpose of skin-in-the-game (risk retention) really is," Amherst said. "We thought it was aimed at insuring the production of higher quality mortgages, as the sponsor would be forced to absorb some of the losses." The same Amherst report touches on some of the problems with the proposed qualified mortgage standard, which is not to be mistaken with the QRM. The qualified mortgage is a loan that meets enough criteria to be exempted from a proposed Regulation Z requirement under the Truth in Lending Act that stipulates a creditor has to predetermine whether a borrower can repay a mortgage. The rule also would offer a qualified mortgage exception, which could shield creditors from liability as long as the loan does not have negative amortization or unreasonable fees and the mortgage payment is underwritten using the maximum interest rate in the first five years. Amherst Securities, however, is troubled by some of the proposals surrounding the issue of liability when it comes to the QM. Analyst said there are two alternatives for interpreting legal compliance when it comes to whether the issuer created a qualified mortgage. Under one proposed alternative, meeting the QM standard would lead to full compliance with the rule and serve as a safe harbor, protecting creditors from liability. The other proposal would create a "rebuttable presumption" of compliance when it comes to the issue of whether the creditor satisfied the QM. It is this proposed legal standard that has the industry worried. "Our fear is that lenders, in order to be very sure of not being challenged on the “ability to pay” presumption, opt for very strict credit standards (close to QRM), choking off credit availability," Amherst said. "There is insufficient attention being paid to the interaction between these standards." Write to: Kerri Panchuk.