Credit Risk Retention Rules and QRM

The long awaited credit risk retention rules for securitization are out. The big question--whether the qualified residential mortgage or QRM exemption would be narrower than the CFPB's qualified mortgage or QM safe harbor to the Ability to Repay requirement for mortgages is no. QRM=QM. The short version is that the rule doesn't require meaningful credit risk retention where it counts, and imposes significant market-shaping safe-harbor requirements where skin in the game isn't so important.

The basic rule is that 5% credit risk must be retained, unhedged, by the securitization sponsor, either as a pro rata vertical slice of the deal or as a horizontal slice equal to 5% of the fair market value of the deal as of the closing date. But there are lots of exceptions: CMBS B-pieces suffice, Ginnie Maes, Fannie/Freddie (as long as they have "capital support form the United States" (they can still qualify with the QRM exception and other exceptions for multi-family even without US capital support), etc. Commercial loans, commercial mortgages, and auto loans all have their own QRM-type safe harbors.

In fact, as far as I can tell from a quick perusal of the rule, there is only a meaningful credit risk retention requirement without exemptions for (1) credit card securitization, (2) non-pass-through CDOs, and (3) auto and equipment leases and less common sorts of securitizations. Everything else has either a blanket safe harbor or a safe harbor provided that the underlying assets meet certain requirements.

This makes the risk retention rule largely (but not entirely) show. Whatever the wisdom of credit risk retention requirements for securitization, regulators have largely gutted it with this rule-making. Skin in the game is a meaningless requirement for credit card securitization--the deals already require it. No one is doing CDOs these days, but it's good to see the stake in the dragon's heart nonetheless. The other categories that don't benefit from a safe harbor are small markets, relatively speaking.

What is notable, however, is just how detailed some of the exemptions are when based on the specifics of underlying assets, particularly commercial loans, commercial mortgages, and auto loans. We're talking on the level of mandatory covenants. I would expect this rule to really start to shape lending practices so that everything can be securitized without skin in the game. That might not be a bad outcome, if the requirements are the right ones, but are they?

I worry about this in the case of auto loans. To qualify for the exemption, auto loans, must have a borrower debt-to-income ratio of no more than 36%. Compare that to QM/QRM's 43% for a mortgage. The auto lender must verify the borrower's income, there must be 24 months of credit history (sorry 19 year olds), no bills more than 30 days over due in the past year or 60 plus overdue in the past two years, no bankruptcies, foreclosures, repos in the last 3 years. In other words, no securitization of subprime auto loans is going to be happening. But a lot of other people are going to get swept up in what is not a systemically important asset class.

Oh, I forgot the real kicker. There's a downpayment requirement. Not for mortgages, but for cars. 10% plus dealer fees! title, registration, warranties, and tax. That's probably getting closer to 20% than 10%. So we have serious requirements if you want to securitize an auto loan--stricter than for a mortgage. That's nuts. The result will be less credit/higher costs for those with poor credit or without the cash to do large downpayment or limited credit histories. The subprime auto market is often abusive, but this isn't going to fix it. If anything it might exacerbate problems.

Not only are the requirements for getting around credit risk retention for car loans more strict than for home mortgages, so too are those for commercial mortgages where, lo and behold, there is a downpayment requirement: 30%! The original QRM proposal had a 20% downpayment requirement. Now there's none. There's also a restriction on junior liens on commercial mortgages over the 70% CLTV limit in order to get a credit risk retention exemption. In contrast, lenders are forbidden from prohibiting junior mortgages on residential property by federal law.

I read the commercial loan exemption as also prohibiting junior liens. If so, it's going to be hard for CLOs to buy syndications where the borrower wants to have the flexibility to have a junior lien loan. (Btw, the claim that CLOs finance "Main Street" is misleading--CLOs finance parts of enormous syndicated loans to very large businesses.) No sure how this applies to single loans with an A/B facility structure with separate liens. So what did we get with this rule-making? A solution to the wrong problem, and an attempt to gut Congress's solution to the mortgage securitization problem. That said, it's not as if the private label mortgage securitization market is about to come back in force.