Landrieu-Isakson Amendment Carves Out Exemption from 5 Percent "Skin in the Game" Requirement
An amendment carving out qualified residential mortgages from the requirement in the Senate financial reform bill that originators retain a 5 percent interest in mortgages underlying mortgage-backed securities has been approved. Sponsored by Senators Mary Landrieu (D-LA) and Johnny Isakson (R-GA), the amendment ensures that originators of mortgages that have 20 percent down and a high FICO rating will not have to retain the 5 percent skin in the game required of other securitized assets. According to Senator Isakson, the only risk retention that will be required is when someone is making a bad loan. The amendment embodies the principle that underwriting, not risk retention, is the cure all to good lending. Cong. Rec. May 12, 2010, S3576. While skin in the game is important, echoed Senator Mark Warner, more important is the underlying quality of the mortgage. Senator Warner added that the amendment remains true to the intent of the legislation to ensure that the mortgage securitization process requires the originators of the mortgages to have some skin in the game. Cong. Rec. May 12, 2010, S3576.
The amendment to Section 941 of S3217, which effectively amends new Section 15G of the Exchange Act, requires the SEC and the federal banking and housing authorities to jointly issues regulations exempting qualified residential mortgages from the risk retention requirements of S3217. In defining the term qualified residential mortgage, the amendment directs the SEC and the other authorities to consider underwriting and product features that historically have indicated a low risk of default, such as, in addition to 20 percent down, the mortgagor’s residual income and ratio of the mortgage payment to total monthly income. The SEC must also consider whether the mortgage prohibits or restricts the use of ballon payments, prepayment penalties, interest only payments, and other features that have historically demonstrated a higher risk of borrower default.
The regulations must provide that an asset-backed security that is collateralized by tranches of other asset-backed securities must not be exempted from the risk retention requirements.
An important part of the amendment directs the SEC to require an issuer to certify, for issuances of asset-backed securities exclusively collateralized by qualified residential mortgages, that the issuer has evaluated the effectiveness of its internal controls with regard to the process for ensuring that all the assets collateralizing the asset-backed security are qualified residential mortgages.
There is broad agreement that a key element of the reform of the securitization process is that originators of mortgage-backed securities must retain a portion of the risk, discouraging them from selling junk because they would have to keep some of it for themselves. The House financial reform legislation, HR 4173, would require companies that sell products like mortgage-backed securities to keep some “skin in the game” by retaining at least five percent of the credit risk. Section 1502. However, the House legislation does not have an analog to the Landrieu-Isakson Amendment carving out securitized qualified residential mortgages form the risk retention requirement.