Lenders would have to offer mortgages with at least a 20 percent down payment if they want to repackage the loan to sell to other investors without keeping some of the risk on their books, according to a proposal bank regulators endorsed on Tuesday.
The Federal Deposit Insurance Corp. (FDIC) board and the Federal Reserve agreed to seek public comment on the proposal that is intended to restore lending discipline and define the safest form of mortgages that can be completely resold to other investors.
However, the rule is expected to have little near-term impact because not many investors are yet eager to buy repackaged mortgages and because it would not include loans sold to mortgage finance giants Fannie Mae and Freddie Mac.
Last year’s Dodd-Frank financial law requires firms that package loans into securities – a practice known as securitization – to keep at least 5 percent of the credit risk on their books.
The provision is meant to force securitizers to have "skin in the game," so they don’t churn out poorly underwritten loans and then pass along the risk to investors, as happened during the 2007-2009 financial crisis.
Mortgages that meet strict underwriting standards are exempt from the risk requirement.
Mortgages sold to Fannie and Freddie would also be able to escape the risk retention requirement, at least while the mortgage finance giants remain controlled by the government.
Some analysts argued that the proposal, as written, would not have much short-term impact on the housing and securitizations market.
"The zero risk retention requirement for loans sold to Fannie and Freddie really knock the teeth out of this proposal," said Jaret Seiberg, an analyst at MF Global Inc. "It means that 97 percent of the mortgage market will be outside the risk retention regime."
The federal government stands behind nearly 90 percent of home mortgages. Fannie and Freddie have already tightened their requirements for loans they will purchase, mandating higher credit scores for borrowers and bigger down payments.
The rule includes more than 170 questions that regulators are seeking feedback on from stakeholders, indicating the proposal could change significantly before it is finalized.
Small banks, consumer groups and some mortgage lenders have complained that a 20 percent down payment is too high and will make it difficult for many people to purchase a home, causing a further drag on the nation’s struggling housing market.
FDIC Chairman Sheila Bair said on Tuesday that the agency is particularly interested in responses focused on what impact the rule may have on low-income borrowers.
She said that overall she expects "qualified residential mortgages," those exempt from the risk retention requirement, will only be a "small slice of the market."
If true, banks would continue to offer a variety of loans with lower down payments, even if it meant keeping some of those riskier loans on their books.
The asset-backed securities market has struggled since the financial crisis and regulators have said they hope the rule will provide a level of certainty that will help it recover.
"If we are truly interested in restarting securitization, then we must restore investor confidence and the soundness of the securitization model," Bair said.
She said almost 90 percent of loans during 2005 and 2006 to borrowers with poor credit records, and loans with little documentation provided by the borrower, were privately securitized.
The Securities and Exchange Commission will consider the proposal on Wednesday and all of the agencies involved have said they will vote on it this week. The FDIC, whose members include Office of the Comptroller of the Currency, agreed to put the plan out for public comment for 60 days. (Reuters)
