NEW YORK--(BUSINESS WIRE)--Tuesday's interagency release of the final qualified residential mortgage (QRM) standards, a set of qualifying exemptions on the requirement to retain risk on mortgages securitized in the RMBS market, provide meaningful incentives for banks to maintain quality underwriting and avoid certain riskier mortgage products. The rule should curb many practices that led to severe bank pressures during and after the financial crisis, according to Fitch Ratings.
The final QRM, however, avoids minimum down payment standards originally proposed by regulators in 2011, thus providing mortgage originators considerable flexibility to lend to high loan-to-value (LTV) borrowers. Fitch believes this could modestly boost mortgage lending, with limited negative implications for banks' balance sheet exposure, as these loans could still be sold to RMBS trusts with zero percent risk retention. Any mortgage loans that are eligible for sale to Fannie Mae and Freddie Mac (or their successors) are automatically included under QRM, as long as the credit risk is ultimately borne by the US Treasury.
QRM is one component of the credit risk retention rule that applies to structured assets broadly and is mandated by the Dodd-Frank Act. The rule requires banks and other securitizers of assets to meet certain underwriting criteria or retain 5% of the securitization intended to be sold.
The QRM rule aligns with each of the seven main features of Qualified Mortgage (QM) rules, which focus on a borrower's ability to repay and create a safe harbor for originators when loans fail. Most notably, to qualify as both a QM and QRM, total debt-to-income for borrowers is capped at 43% and negative amortization, interest-only and balloon loans are restricted.
For banks originating commercial mortgage-backed securities (CMBS), the bar to be exempt from risk retention is relatively high compared to legacy regulatory underwriting guidelines. The risk retention rule limits commercial real estate loan LTVs at 65% and 70% for cumulative LTV. The current regulatory guidelines for commercial real estate loans are 85%. Auto loans likewise have higher bars to be exempt from risk retention, such as having to meet rules such as no 60-plus day delinquencies on any debt within the last 24 months and putting down or trading in at least 10% of the purchase price of the vehicle.
The risk retention rule is broadly consistent with the interagency regulatory guidelines on leveraged lending, which will require greater retention of loans sold through CLO structures Regulators continue to favor loans with lower leverage and amortization principal within a reasonable time frame. The leveraged lending guidance states that commercial loans should generally amortize 50% of principal within five to seven years. The risk retention rule is a bit more proscriptive in that 50% of principal should be amortized in five years or less. Fitch has commented separately on the final risk retention rule's impact to non-bank CLO managers. Please see "Fitch: Risk Retention Questions Grow for CLOs, Shrink for RMBS."
The final rule provides no flexibility for securitization sponsors to transfer retained risks. Additionally, the rule prohibits direct hedging of retained risk. However, indirect hedging is possible through macro hedges of similar asset classes or securities. Fitch believes indirect hedging is an important tool to reduce credit exposure in the case of systemic credit deterioration, but will not act as a perfect hedge against the risk. The ability to retain the 5% interest either in the form of a horizontal or a vertical tranche allows for some flexibility in structuring the economics and risk profile for various transactions.
The above article originally appeared as a post on the Fitch Wire credit market commentary page. The original article can be accessed at www.fitchratings.com. All opinions expressed are those of Fitch Ratings.